Nuance Communications
Annual Report 2009

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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, 2009ORoo 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 of (I.R.S. EmployerIncorporation or Organization) Identification No.) 1 Wayside RoadBurlington, Massachusetts(Address of Principal Executive Offices) 01803(Zip Code)Registrant’s telephone number, including area code:(781) 565-5000SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:Title of Each Class Name of Each Exchange on Which RegisteredCommon stock, $0.001 par value NASDAQ Stock Market LLCSECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:NoneIndicate 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 Exchange Actof 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  No oIndicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive DataFile required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or forsuch shorter period that the registrant was required to submit and post such files). Yes o 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 this Form 10-Kor 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 $2.3 billion based upon the last reported sales price on the NasdaqNational Market for such date. For purposes of this disclosure, shares of Common Stock held by officers and directors of the Registrant and bypersons who hold more than 5% of the outstanding Common Stock have been excluded because such persons may be deemed to be affiliates. Thisdetermination of affiliate status is not necessarily conclusive.The number of shares of the Registrant’s Common Stock, outstanding as of October 31, 2009, was 278,666,124.DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant’s definitive Proxy Statement to be delivered to stockholders in connection with the Registrant’s 2010 Annual Meeting ofStockholders 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 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 47 Item 8. Financial Statements and Supplementary Data 48 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 113 Item 9A. Controls and Procedures 113 Item 9B. Other Information 114 PART III Item 10. Directors, Executive Officers and Corporate Governance 114 Item 11. Executive Compensation 114 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related StockholderMatters 114 Item 13. Certain Relationships and Related Transactions, and Director Independence 114 Item 14. Principal Accountant Fees and Services 115 PART IV Item 15. Exhibits and Financial Statement Schedules 115 EX-21.1 Subsidiaries of the Registrant EX-23.1 Consent of BDO Seidman, LLP EX-31.1 Section 302 Certification of Chief Executive Officer EX-31.2 Section 302 Certification of Chief Financial Officer EX-32.1 Section 906 Certification of Chief Executive Officer and Chief Financial Officer Table 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 2010 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 devices and systems, and how they create, share and use documents. Our solutions are used every day bymillions of people and thousands of businesses for tasks and services such as requesting information from a phone-based self-servicesolution, dictating medical records, searching the mobile Web by voice, entering a destination into a navigation system, or working withPDF documents. Our solutions help make these interactions, tasks and experiences more productive, compelling and efficient.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 intellectual property, technologies, applications and solutions through both internaldevelopment and acquisitions. We expect to continue to pursue opportunities to expand our assets, geographic presence, distributionnetwork and customer base through acquisitions of other businesses and technologies.Solutions offered in our three core markets; Mobile-Enterprise, Healthcare-Dictation, and Imaging, include:Healthcare Solutions — The healthcare industry is under significant pressure to streamline operations, reduce costs and improvepatient care. In recent years, healthcare organizations such as hospitals, clinics, medical groups, physicians’ offices and insuranceproviders have increasingly turned to speech solutions to automate manual processes such as the dictation and transcription of patientrecords.We provide comprehensive dictation and transcription solutions and services that automate the input and management of medicalinformation. Our hosted and on-premise solutions provide platforms to generate and distribute clinical documentation through the use ofadvanced dictation and transcription features, and allow us to deliver scalable, highly productive medical transcription solutions, as wellas accelerate future innovation to transform the way healthcare providers document patient care. We also offer speech recognition solutionsfor1 Table of Contentsradiology, cardiology, pathology and related specialties, that help healthcare providers dictate, edit and sign reports without manualtranscription.Hospitals, clinics and group practices, as well as physicians, use our healthcare solutions to manage the dictation and transcriptionof patient records. We utilize a focused, enterprise sales team and professional services organization to address the market andimplementation requirements of the healthcare industry. Our fiscal 2008 acquisition of Philips Speech Recognition Systems significantlyenhanced our ability to deliver innovative, speech-driven clinical documentation and communication solutions to healthcare organizationsthroughout Europe. In some cases, our healthcare solutions are priced under a traditional software perpetual licensing model. However,certain of our healthcare solutions, in particular our transcription solution, are also offered on an on-demand model, charged as asubscription and priced by volume of usage (such as number of lines transcribed). During fiscal 2009, we experienced a significant shiftin customer preference toward our subscription pricing model.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, allowing us to deliver end-to-end speech solutions andsystem integration for speech-enabled customer care. In addition, we offer solutions that can meet customer care needs through directinteraction with thin-client applications on cell phones, enabling customers to very quickly retrieve relevant information. Use of ourspeech-enabled and thin-client customer care solutions can dramatically decrease customer care costs, in comparison to calls handled byoperators. Our acquisition of SNAPin, Inc., a developer of self-service software for mobile devices, during fiscal 2009 expanded ourpresence and capabilities in these areas.Our solutions are used by 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. In addition to our own sales and professional services teams,we often work closely with industry partners, including Avaya, Cisco and Genesys, that integrate our solutions into their hardware andsoftware platforms. Our enterprise solutions offerings include both a traditional software perpetual licensing model and an on-demandmodel, charged as a subscription and priced by volume of usage (such as number of minutes callers use the system or number of callscompleted in the system).Mobile Solutions — Today, an increasing number of people worldwide rely on mobile devices to stay connected, informed andproductive. We help consumers use the powerful capabilities of their phones, cars and personal navigation devices by enabling the use ofvoice commands and keypad solutions to control these devices more easily and naturally, and to access the array of content and servicesavailable on the Internet.Our portfolio of mobile solutions and services includes an integrated suite of voice and text-to-speech solutions, predictive texttechnologies, mobile messaging services and emerging services such as Web search and voicemail-to-text. Our solutions are used bymobile phone, automotive, personal navigation device and other consumer electronic manufacturers and their suppliers, includingAmazon, Apple, BMW, Ford, Garmin, LG Electronics, Mercedes Benz, Nokia, Samsung and TomTom. In addition,telecommunications carriers, web search companies and content providers are increasingly using our mobile search and communicationsolutions to offer value-added services to their subscribers and customers. Our mobile solutions are sold to device manufacturers, on aroyalty model, generally priced per device sold. In addition, our mobile solutions are sold through telecommunications carriers or directlyto consumers, and priced on a volume of usage model (such as per subscriber or per use). During fiscal 2009, we expanded our mobilepresence and product offerings through our acquisitions of2 Table of ContentsZi Corporation; nCore Ltd.; Jott Networks, Inc.; and certain assets from Harman Becker Automotive Systems GmbH.Desktop Dictation — Our suite of general purpose desktop dictation applications increases productivity by using speech to createdocuments, streamline repetitive and complex tasks, input data, complete forms and automate manual transcription processes. OurDragon 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 desktop dictation products. Ourdesktop dictation solutions are generally sold under a traditional perpetual software license model.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 quickly enable distribution of documents to users’ desktops or to enterprise applications, as well as software development toolkits forindependent software vendors. Our imaging solutions are generally sold under a traditional perpetual software license model. We utilize acombination of our global reseller network and direct sales to distribute our imaging products. We license our software to originalequipment manufacturers such as Brother, Canon, Dell, HP and Xerox, which bundle our solutions with multifunction devices, digitalcopiers, printers and scanners, on a royalty model, priced per unit sold. During fiscal 2009, we expanded our imaging product offeringsthrough our June 2009 acquisition of X-Solutions Group B.V. and September 2009 acquisition of eCopy, Inc.Research 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 our markets. Our technologies are based on complex algorithms whichrequire extensive amounts of linguistic and image data, acoustic models and recognition techniques. A significant investment in capitaland 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 approximately 1,800 issued patents and 1,600 patent applications. Our intellectual property, whether purchased or developedinternally, is critical to our success and competitive position and, ultimately, to our market value. We rely on a portfolio of patents,copyrights, trademarks, services marks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect ourintellectual property and proprietary rights. We incurred research and development expenses of $119.4 million, $115.0 million, and$80.0 million in fiscal 2009, 2008 and 2007, respectively.International OperationsWe have principal offices in a number of international locations including: Australia, Belgium, Canada, Germany, Hungary, India,Japan, 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.3 Table of ContentsGeographic revenue classification is based on the geographic areas in which our customers are located. For fiscal 2009, 2008 and2007, 74%, 77% and 78% of revenue was generated in the United States and 26%, 23% and 22% 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 mostinnovative and proficient products in their respective categories. Our speech technology has industry-leading recognition accuracyand provides a natural, speech-enabled interaction with systems, devices and applications. Our imaging technology is viewed asthe most accurate in the industry. Technology publications, analyst research and independent benchmarks have consistentlyindicated that our products rank at or above performance levels of alternative solutions. • Broad Distribution Channels. Our ability to address the needs of specific markets, such as financial, legal, healthcare andgovernment, and introduce new products and solutions quickly and effectively through our extensive global network of resellers,comprising system integrators, independent software vendors, value-added resellers, hardware vendors, telecommunicationscarriers and distributors; our dedicated direct sales force; and our e-commerce website (www.nuance.com). • 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 and domain knowledge of ourprofessional services organization, allows our customers and partners to place a high degree of confidence and trust in our abilityto deliver results.In our core markets, we compete with companies such as Adobe, Medquist, Microsoft, Google and Spheris. In addition, a numberof smaller companies in both speech and imaging produce technologies or products that are competitive with our solutions in somemarkets. In certain markets, some of our partners such as Avaya, Cisco, Genesys and Nortel develop and market products and servicesthat might be considered substitutes for our solutions. Current and potential competitors have established, or may establish, cooperativerelationships among themselves or with third parties to increase the ability of their technologies to address the needs of our prospectivecustomers.Some of our competitors or potential competitors, such as Adobe, Microsoft and Google, have significantly greater financial,technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emergingtechnologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of theirproducts than we do.EmployeesAs of September 30, 2009, we had approximately 5,800 full-time employees in total, including approximately 700 in sales andmarketing, approximately 1,150 in professional services, approximately 950 in research and development, approximately 450 in generaland administrative and approximately 2,550 that provide transcription and editing services. Approximately 51 percent of our employeesare based outside of the United States, the majority of whom provide transcription and editing services and are based in India. Ouremployees are not represented by any labor union and are not organized under a collective bargaining agreement, and we have neverexperienced a work stoppage. We believe that our relationships with our employees are generally good.4 Table of ContentsCompany InformationWe were incorporated in 1992 as Visioneer, Inc. under the laws of the state of Delaware. In 1999, we changed our name toScanSoft, Inc. and also changed our ticker symbol to SSFT. In October 2005, we changed our name to Nuance Communications, Inc.and in November 2005 we changed our ticker symbol to NUAN.Our 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. Our SEC filings are also available on the SEC’swebsite at http://www.sec.gov. Alternatively, you may access any document we have filed by visiting the SEC’s Public Reference Room at100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling theSEC at 1-800-SEC-0330. Except as otherwise stated in these documents, the information contained on our website or available byhyperlink from our website is not incorporated by reference into this report or any other 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 operations may not meet the expectations of securities analysts or investorsin the future. If this occurs, the price of our stock would likely decline. Factors that contribute to fluctuations in operating results includethe 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 intellectual property portfolio; • concentration of operations with one manufacturing partner and our inability to control expenses related to the manufacturing,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;5 Table of Contents • timing of significant marketing and sales promotions; • impairment charges against goodwill and intangible assets; • 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. We may continue to issue equity securities forfuture acquisitions, which would dilute existing stockholders, perhaps significantly depending on the terms of such acquisitions. Wemay also incur additional debt in connection with future acquisitions, which, if available at all, may place additional restrictions on ourability to operate our business.Our 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 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.6 Table of ContentsAs 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, for transactions which closed prior to October 1, 2009, theamount of direct transaction costs as the cost of acquiring the company or business. We have allocated that cost to the individual assetsacquired and liabilities assumed, including various identifiable intangible assets such as acquired technology, acquired tradenames andacquired customer relationships based on their respective fair values. 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, 2009, we had identified intangible assets of approximately $706.8 million, net of accumulated amortization, and goodwillof approximately $1.9 billion. In addition, purchase accounting limits our ability to recognize certain revenue that otherwise would havebeen recognized by the acquired company as an independent business. The combined company may delay revenue recognition orrecognize less revenue than we and the acquired company would have recognized as independent companies.Changes in the accounting method for business combinations may have an adverse impact on our reported or futurefinancial results.For the years ended September 30, 2009 and prior, in accordance with Statement of Financial Accounting Standard (“SFAS”) 141“Business Combinations,” (“SFAS 141”), all acquisition-related costs, such as attorney’s fees and accountant’s fees, as well ascontingent consideration to the seller, which is recorded when it is beyond a reasonable doubt that the amount is payable, are capitalizedas part of the purchase price.In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (revised 2007), “BusinessCombinations,” (“SFAS 141R”), now referred to as FASB Accounting Standards Codification 805 (“ASC 805”), which requires anacquirer to do the following: expense acquisition-related costs as incurred; reflect such payments as a reduction of cash flow fromoperations; record contingent consideration at fair value at the acquisition date with subsequent changes in fair value to be recognized inthe income statement and cash flow from operations. ASC 805 applies to business combinations for which the acquisition date is on orafter October 1, 2009. ASC 805 may have a material impact on our results of operations and our financial position due to our acquisitionstrategy.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, 2009, we had a total of $900.7 million of gross debt outstanding,including $650.3 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 line available to us through March 2012. As of September 30,2009, there were $16.2 million of letters of credit issued under the revolving credit line but there were no other outstanding borrowingsunder the 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;7 Table of Contents • 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 interest rate swap agreementslimiting our exposure for a portion of our debt, the agreements do 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.We 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 $12.2 million, $30.1 million and $14.0 million for the fiscal years 2009, 2008 and 2007, respectively. Ifwe are unable to achieve and maintain profitability, the market price for our stock may decline, perhaps substantially. We cannot assureyou that our revenue will grow or that we will achieve or maintain profitability in the future. If we do not achieve and maintainprofitability, we may be required to raise additional capital to maintain or grow our operations. The terms of any transaction to raiseadditional capital, if available at all, may be highly dilutive to existing investors or contain other unfavorable terms, such as a highinterest rate and restrictive covenants.8 Table of ContentsSpeech 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 the acceptance of speech technologies in general and our products in particular. The continued development of the market forour current 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 slowerthan we expect, and, consequently, our business could be harmed and we may not recover the costs associated with our investment in ourspeech 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, Microsoft,Google, and other smaller providers. Within healthcare dictation and transcription, we compete with Spheris, Medquist and other smallerproviders. Within imaging, we compete directly with ABBYY, Adobe, I.R.I.S. and NewSoft. In speech, some of our partners such asAvaya, Cisco, Edify, Genesys and Nortel develop and market products that can be considered substitutes for our solutions. In addition,a number of smaller companies in both speech and imaging produce technologies or products that are in some markets competitive withour solutions. Current and potential competitors have established, or may establish, cooperative relationships among themselves or withthird 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, Microsoft and Google, have significantly greaterfinancial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new oremerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion andsale 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. If weare unable to develop new products and enhance functionalities or technologies to adapt to these changes, or if we are unable to realizesynergies 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 contains an assessment bymanagement of the effectiveness of our internal control over financial reporting. In addition, our independent registered public accountingfirm must attest to and report on the9 Table of Contentseffectiveness of our internal control over financial reporting. Any failure in the effectiveness of our system of internal control overfinancial reporting could have a material adverse impact on our ability to report our financial statements in an accurate and timelymanner, could subject us to regulatory actions, civil or criminal penalties, shareholder litigation, or loss of customer confidence, whichcould result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financialstatements, which ultimately could negatively impact our stock price.A significant portion of our revenue is derived, and a significant portion of our research and development activities arebased, outside the United States. Our results could be harmed by economic, political, regulatory and other risks associatedwith these international regions.Because we operate worldwide, our business is subject to risks associated with doing business internationally. We anticipate thatrevenue from international operations could increase in the future. Most of our international revenue is generated by sales in Europe andAsia. In addition, some of our products are developed and manufactured outside the United States and we have a large number ofemployees in India that provide transcription services. A significant portion of the development and manufacturing of our speech productsare conducted in Belgium and Canada, and a significant portion of our imaging research and development is conducted in Hungary. Wealso have significant research and development resources in Aachen, Germany, and Vienna, Austria. Accordingly, our future resultscould 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 the hedged transaction. We do not engage in foreign currency speculation. Forward exchange contracts hedging firmcommitments qualify for hedge accounting when they are designated as a hedge of the foreign currency exposure and they are effective inminimizing such exposure. With our increased international presence in a number of geographic locations and with international revenueand costs projected to increase, we are exposed to changes in foreign currencies including the Euro, British Pound, Canadian Dollar,Japanese Yen, Indian Rupee and the Hungarian Forint. Changes in the value of the Euro or other foreign currencies relative to the value ofthe U.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.10 Table of ContentsCustomer relationships are amortized on an accelerated basis based upon the pattern in which the economic benefits of customerrelationships are being utilized. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives.We assess the potential impairment of identifiable intangible assets on an annual basis, as well as whenever events or changes incircumstances indicate that the carrying value may not be recoverable. Factors that could trigger an impairment of such assets, include thefollowing: • 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.Our sales to government clients subject us to risks, including early termination, audits, investigations, sanctions andpenalties.We derive a portion of our revenues from contracts with the United States government, as well as various state and localgovernments, and their respective agencies. Government contracts are generally subject to audits and investigations which could identifyviolations of these agreements. Government contract violations could result in a range of consequences including, but not limited to,contract price adjustments, civil and criminal penalties, contract termination, forfeiture of profit and/or suspension of payment, andsuspension or debarment from future government contracts. We could also suffer serious harm to our reputation if we were found to haveviolated 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 twocontracts. The final resolution of this matter may adversely impact our financial 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:11 Table of Contents • 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. Although we have systems and policies in place for safeguardingprotected health information from unauthorized disclosure, these systems and policies may not preclude claims against us for allegedviolations of applicable requirements. There can be no assurance that we will not be subject to liability claims that could have a materialadverse 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 economies 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 any of the major countries in which we do business wouldalso likely harm our business, results of operations and financial condition.Current uncertainty in the global financial markets and the global economy may negatively affect our financial results.Current uncertainty in the global financial markets and economy may negatively affect our financial results. These macroeconomicdevelopments could negatively affect our business, operating results or financial condition in a number of ways which, in turn, couldadversely affect our stock price. A prolonged period of economic decline could have a material adverse effect on our results of operationsand financial condition and exacerbate some of the other risk factors described herein. Our customers may defer purchases of ourproducts, licenses, and services in response to tighter credit and negative financial news or reduce their demand for them. Our customersmay also not be able to obtain adequate access to credit, which could affect their ability to make timely payments to us or ultimately causethe customer to file for protection from creditors under applicable insolvency or bankruptcy laws. If our customers are not able to maketimely payments to us, our accounts receivable could increase.Our investment portfolio, which includes short-term debt securities, is generally subject to credit, liquidity, counterparty, marketand interest rate risks that may be exacerbated by the recent global financial crisis. If the banking system or the fixed income, credit orequity markets deteriorate or remain volatile, our investment portfolio may be impacted and the values and liquidity of our investmentscould be adversely affected.In addition, our operating results and financial condition could be negatively affected if, as a result of economic conditions, either: • the demand for, and prices of, our products, licenses, or services are reduced as a result of actions by our competitors orotherwise; or12 Table of Contents • our financial counterparties or other contractual counterparties are unable to, or do not, meet their contractual commitments to us.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 and security of third-party information is critical to ourbusiness. Any failures in our security and privacy measures could have a material adverse effect on our financial position and results ofoperations. If we are unable to protect, or our clients perceive that we are unable to protect, the security and privacy of our electronicinformation, our growth 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 conditions 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. Third parties claiming intellectual propertyinfringement may be able to obtain injunctive or other equitable relief that could effectively block our ability to develop and sell ourproducts.13 Table of ContentsWe 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 largest stockholder may enable them to influence matters requiring stockholder approval.As of September 30, 2009, Warburg Pincus beneficially owned approximately 25% of our outstanding common stock, includingwarrants exercisable for up to 10,062,422 shares of our common stock, and 3,562,238 shares of our outstanding Series B PreferredStock, each of which is convertible into one share of our common stock. Because of their large holdings of our capital stock relative toother stockholders, this stockholder has a strong 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 number of shares of our common stock by our largest stockholders, or theperception that such sales could occur, could also contribute to the volatility or our stock price. While we cannot predict the individualeffect that these factors may have on the market price of our common stock, these factors, either individually or in the aggregate, couldresult in significant volatility in our stock price during any given period of time. Moreover, companies that have experienced volatility inthe market price of their stock often are subject to securities class action litigation. If we were the subject of such litigation, it could resultin substantial costs and divert management’s attention and resources.14 Table of ContentsCompliance 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, approximately4.0 million shares of our common stock in connection with our September 2009 acquisition of eCopy. No prediction can be made as to theeffect, if any, that future sales of shares of common stock, or the availability of shares of common stock for future sale, will have on thetrading 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.15 Table 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, 2009: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 Administrative, sales, marketing, research anddevelopment, professional services, customersupport functions.Sunnyvale, California 71,000 September 2013 Administrative, research and development,sales, marketing and customer supportfunctions.Mahwah, New Jersey 38,000 June 2015 Professional services and sales functions.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 and sales functions(1)The lease for this property was assumed as part of our acquisition in September 2005 of Nuance Communications, Inc, which werefer 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, 2009, 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 stock of Former Nuance,16 Table of Contentswhich we acquired in September 2005, between April 12, 2000 and December 6, 2000. Those complaints have been consolidated into oneaction. The complaint generally alleges that various investment bank underwriters engaged in improper and undisclosed activities relatedto the allocation of shares in Former Nuance’s initial public offering of securities. The complaint makes claims for violation of severalprovisions of the federal securities laws against those underwriters, and also against Former Nuance and some of Former Nuance’sdirectors and officers. Similar lawsuits, concerning more than 250 other companies’ initial public offerings, were filed in 2001. InFebruary 2003, the Court denied a motion to dismiss with respect to the claims against Former Nuance. In the third quarter of 2003, aproposed settlement in principle was reached among the plaintiffs, the issuer defendants (including Former Nuance) and the issuers’insurance carriers. The settlement called for the dismissal 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 certainclaims. The settlement was not expected to have any material impact, as payments, if any, were expected to be made by insurancecarriers, rather than by us. On December 5, 2006, the Court of Appeals for the Second Circuit reversed the Court’s order certifying aclass in several “test cases” that had been selected by the underwriter defendants and plaintiffs in the coordinated proceeding. Theplaintiffs petitioned the Second Circuit for rehearing of the Second Circuit’s decision, however, on April 6, 2007, the Second Circuitdenied the petition for rehearing. At a status conference on April 23, 2007, the district court suggested that the issuers’ settlement could notbe approved in its present form, given the Second Circuit’s ruling. On June 25, 2007 the district court issued an order terminating thesettlement agreement. The plaintiffs in the case have since filed amended master allegations and amended complaints. On March 26,2008, the Court largely denied the defendant’s motion to dismiss the amended complaints. On April 2, 2009, the plaintiffs filed a motionfor preliminary approval of a new proposed settlement between plaintiffs, the underwriter defendants, the issuer defendants and theinsurers for the issuer defendants. Under the settlement, which remains subject to Court approval, the insurers would pay the fullamount of the settlement attributable to Former Nuance, and Former Nuance would not bear any financial liability. The Court issued anorder granting preliminary approval of the settlement, dated June 9, 2009, and a hearing on final approval of the settlement was held onSeptember 10, 2009. On October 5, 2009, the court issued an opinion granting plaintiffs’ motion for final approval of the settlement,approval of the plan of distribution of the settlement fund and certification of the settlement classes. On October 20, 2009, a petition forpermission to appeal the court’s October 5, 2009 certification of the settlement classes was filed in the United States Court of Appeals forthe Second Circuit. Due to the inherent uncertainties of litigation, we are unable to determine the ultimate outcome or potential range ofloss, if any, associated with this matter.We believe that the final outcome of the matter described above will not have a significant adverse effect on our financial position orresults of operations. However, even if our defense is successful, the litigation could require significant management time and will becostly. Should we not prevail in this litigation matter, our operating results, financial position and cash flows could be adverselyimpacted.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.17 Table 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 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 Fiscal 2009: First quarter $6.18 $14.28 Second quarter 7.58 11.29 Third quarter 10.50 14.61 Fourth quarter 10.90 15.04 HoldersAs of October 31, 2009, there were 1,168 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.Furthermore, the terms of 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.18 Table of ContentsItem 6. Selected Consolidated Financial DataThe 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. Fiscal Year Ended September 30, 2009 2008 2007 2006 2005 Operations: Total revenue $950.4 $868.5 $602.0 $388.5 $232.4 Gross margin 590.8 552.8 404.1 267.5 163.2 Income from operations 57.6 32.6 39.0 8.4 2.0 Provision for income taxes 40.4 14.6 22.5 15.1 6.8 Net loss $(12.2) $(30.1) $(14.0) $(22.9) $(5.4)Basic and Diluted Earnings Per Share Data: Net loss $(0.05) $(0.14) $(0.08) $(0.14) $(0.05)Weighted average common shares outstanding: Basic and diluted 253.6 209.8 176.4 163.9 109.5 Financial Position: Cash, cash equivalents and short and long-term marketablesecurities $527.0 $261.6 $187.0 $112.3 $95.8 Total assets 3,499.6 2,846.2 2,172.8 1,235.1 757.2 Long-term debt, net of current portion 888.6 894.2 899.9 350.0 — Total stockholders’ equity 2,003.4 1,424.9 878.3 576.6 514.7 Selected Data and Ratios: Working capital $376.6 $133.5 $164.9 $51.3 $12.1 Depreciation of property and equipment 18.7 16.4 12.1 8.4 5.0 Amortization of intangible assets 115.4 82.6 37.7 30.1 13.1 Gross margin percentage 62.2% 63.7% 67.1% 68.8% 70.2%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.Forward-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 our core markets; • the potential of future product releases; • our product development plans and investments in research and development;19 Table of Contents • 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 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 devices and systems, and how they create, share and use documents. Our solutions are used every day bymillions of people and thousands of businesses for tasks and services such as requesting information from a phone-based self-servicesolution, dictating medical records, searching the mobile Web by voice, entering a destination into a navigation system, or working withPDF documents. Our solutions help make these interactions, tasks and experiences more productive, compelling and efficient.Our technologies address our three core markets: • Mobile-Enterprise. We deliver a portfolio of solutions that improve the experience of customer communications, mobileinteractions and personal productivity. Combining our expertise in enterprise and mobile solutions allows us to help consumers,businesses and manufacturers more effectively utilize mobile devices for accessing an array of content, services and capabilities.Our enterprise solutions help automate a wide range of customer services and business processes in a variety of information andprocess-intensive vertical markets such as telecommunications, financial services, utilities, travel and entertainment, andgovernment. Our mobile solutions add voice control and texting capabilities to mobile devices and services, allowing people tomore easily dial a mobile phone, enter destination information into an automotive navigation system, dictate a text message orhave emails and screen information read aloud. • Healthcare-Dictation. Our healthcare solutions comprise a portfolio of speech-driven clinical documentation andcommunication solutions that help healthcare provider organizations to reduce operating costs, increase reimbursement, andenhance patient care and safety. Our solutions automate the input and management of medical information and are used by manyof the largest hospitals in the United States. We offer a variety of different solutions and deployment options to address thespecific requirements of different healthcare provider organizations. Our Dragon NaturallySpeaking family of products helppeople and businesses increase productivity by using speech to create documents, streamline repetitive and complex tasks, inputdata, complete forms and automate manual transcription processes. Our Dragon Medical solution is a desktop application thatprovides front-end speech recognition for smaller groups of physicians and clinicians to create and navigate medical records. • Imaging. Our PDF and document imaging solutions reduce the time and cost associated with creating, using and sharingdocuments. Our solutions benefit from the widespread adoption of the PDF format and the increasing demand for networkedsolutions for managing electronic documents. Our solutions are used by millions of professionals and within large enterprises.We leverage our global professional services organization and our network of partners to design and deploy innovative solutions forbusinesses and organizations around the globe. We market and distribute our products20 Table of Contentsthrough a global network of resellers, including system integrators, independent software vendors, value-added resellers, hardwarevendors, telecommunications carriers and distributors, and also sell directly through a dedicated sales force and through our e-commercewebsite.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.We have built a world-class portfolio of intellectual property, technologies, applications and solutions through both internaldevelopment and acquisitions. We expect to continue to pursue opportunities to broaden these assets and expand our customer basethrough acquisitions. In evaluating the financial condition and operating performance of our business, management focuses on revenue,earnings, gross margins, operating margins and cash flow from operations. A summary of these key financial metrics for the fiscal yearended September 30, 2009, as compared to the fiscal year ended September 30, 2008, is as follows: • Total revenue increased by $81.9 million to $950.4 million; • Net loss decreased by $17.9 million to $12.2 million; • Gross margins declined by 1.5 percentage points to 62.2%; • Operating margins improved by 2.3 percentage points to 6.1%; and • Cash provided by operating activities for the year ended September 30, 2009 was $258.7 million, an increase of $62.5 millionfrom the same period in the prior fiscal year.StrategyIn fiscal 2010, 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 Asia and Latin America. We continue to add regionalexecutives and sales employees in different geographic regions to better address demand for speech based solutions and services.21 Table of Contents • 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.RESULTS OF OPERATIONSThe following table presents, as a percentage of total revenue, certain selected financial data for fiscal 2009, 2008 and 2007. 2009 2008 2007 Revenue: Product and licensing 39.3% 47.7% 51.8%Professional services and hosting 43.3 35.2 27.5 Maintenance and support 17.4 17.1 20.7 Total revenue 100.0 100.0 100.0 Cost of revenue: Cost of product and licensing 3.9 5.3 7.2 Cost of professional services and hosting 26.8 24.6 19.0 Cost of maintenance and support 3.1 3.6 4.5 Cost of revenue from amortization of intangible assets 4.0 2.8 2.2 Gross margin 62.2 63.7 67.1 Operating expenses: Research and development 12.6 13.3 13.3 Sales and marketing 23.1 26.6 30.7 General and administrative 11.8 12.2 12.5 Amortization of intangible assets 8.1 6.7 4.1 In-process research and development — 0.3 — Restructuring and other charges (credits), net 0.5 0.8 — Total operating expenses 56.1 59.9 60.6 Income from operations 6.1 3.8 6.5 Other income (expense), net (3.1) (5.6) (5.1)Income (loss) before income taxes 3.0 (1.8) 1.4 Provision for income taxes 4.3 1.7 3.7 Net loss (1.3)% (3.5)% (2.3)%22 Table of ContentsTotal RevenueThe following tables show total revenue from our three core market groups and revenue by geographic location, based on the locationof our customers, in dollars and percentage change (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Mobile-Enterprise $462.3 $438.8 $246.8 5.4% 77.8%Healthcare-Dictation 418.4 349.8 281.3 19.6% 24.4%Imaging 69.7 79.9 73.9 (12.8)% 8.1%Total Revenue $950.4 $868.5 $602.0 9.4% 44.3% % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 United States $706.9 $669.3 $471.6 5.6% 41.9%International 243.5 199.2 130.4 22.2% 52.8%Total revenue $950.4 $868.5 $602.0 9.4% 44.3%Fiscal 2009 Compared to Fiscal 2008The increase in total revenue for fiscal 2009, as compared to fiscal 2008, was driven by a combination of organic growth andcontributions from acquisitions. Mobile-Enterprise revenue increased $23.5 million, primarily driven by contributions from ouracquisition of SNAPin, as well as growth in our hosted, on-demand solutions. Healthcare-Dictation revenue increased $68.6 million,primarily driven by contributions from our acquisitions of eScription and PSRS, and organic growth of our iChart transcriptionsolution. Imaging revenue decreased $10.2 million primarily due to a decline in Windows-based software sales and a general decline incorporate spending due to current economic conditions.Based on the location of our customers, the geographic split for fiscal 2009 was 74% of total revenue in the United States and 26%internationally, as compared to 77% of total revenue in the United States and 23% internationally for the same period last year. Theincrease in the proportion of revenue generated internationally was primarily due to contributions from our acquisition of PSRS near theend of fiscal 2008.Fiscal 2008 Compared to Fiscal 2007The increase in total revenue for fiscal 2008, as compared to fiscal 2007, was driven by a combination of organic growth andcontributions from acquisitions. Mobile-Enterprise revenue increased $192.0 million, primarily driven by contributions from ouracquisitions of BeVocal, Viecore, Tegic and VoiceSignal. Healthcare-Dictation revenue increased $68.5 million, primarily due tocontributions from our acquisitions of Focus, Commissure, Vocada and eScription. Imaging revenue increased $6.0 million.Based on the location of our customers, the geographic split for fiscal 2008 was 77% of total revenue in the United States and 23%internationally, as compared to 78% of total revenue in the United States and 22% internationally for the prior year. 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.23 Table of ContentsProduct and Licensing RevenueProduct and licensing revenue primarily consists of sales and licenses of our technology. The following table shows product andlicensing revenue, in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Product and licensing revenue $373.4 $414.4 $311.8 (9.9)% 32.9%As a percentage of total revenue 39.3% 47.7% 51.8% Fiscal 2009 Compared to Fiscal 2008The decrease in product and licensing revenue for fiscal 2009, as compared to fiscal 2008, consisted of a $27.8 million decrease inMobile-Enterprise revenue primarily due to customers migrating to our on-demand services solutions and an $11.3 million decrease inImaging revenue primarily due to a decline in Windows-based software sales and a general decline in corporate spending due to currenteconomic conditions. Healthcare-Dictation product and licensing revenue decreased slightly primarily due to decreased consumer spendingin our non-medical sales of Dragon NaturallySpeaking, as well as, customers continued migration to our on-demand service solutions,this decrease was partially offset by the positive revenue impact of our acquisition of PSRS in September 2008. As a percentage of totalrevenue, product and licensing revenue decreased 8.4 percentage points primarily due to changes in revenue mix attributable to theaccelerated growth in professional services and hosting revenue relative to product and licensing revenue.Fiscal 2008 Compared to Fiscal 2007The increase in product and licensing revenue for fiscal 2008, as compared to fiscal 2007, consisted of a $90.7 million increase inMobile-Enterprise revenue primarily due to contributions from our acquisitions of VoiceSignal and Tegic, and a $5.5 million increase inImaging revenue. Healthcare-Dictation revenue increased by $6.4 million, including contributions from the acquisition of Commissure,and the release of Dragon NaturallySpeaking Version 10 in the fourth fiscal quarter of 2008, but partially offset by a decline in healthcareproduct and licensing revenue as customers migrated to our iChart hosted services solution. As a percentage of total revenue, product andlicensing revenue decreased 4.1 percentage points primarily due to changes in revenue mix attributable to the accelerated growth inprofessional services and hosting revenue relative to product and licensing revenue.Professional Services and Hosting RevenueProfessional services revenue primarily consists of consulting, implementation and training services for speech customers. Hostingrevenue primarily relates to delivering hosted transcription and dictation services over a specified term, as well as self-service, on-demandofferings to carriers and enterprises. The following table shows professional services and hosting revenue, in dollars and as a percentageof total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Professional services and hosting revenue $411.4 $305.5 $165.5 34.7% 84.6%As a percentage of total revenue 43.3% 35.2% 27.5% Fiscal 2009 Compared to Fiscal 2008The increase in professional services and hosting revenue for fiscal 2009, as compared to fiscal 2008, consisted of a $61.8 millionincrease in Healthcare-Dictation revenue, including contributions from our acquisition of24 Table of ContentseScription and organic growth of our iChart transcription solution. Additionally, there was a $44.1 million increase in Mobile-Enterpriserevenue, primarily due to contributions from our acquisition of SNAPin, and growth in our hosted, on-demand solutions. The growth inthese organic and acquired revenue streams outpaced the relative growth of our other revenue types, resulting in an 8.1 percentage pointincrease in professional services and hosting revenue as a percentage of total revenue.Fiscal 2008 Compared to Fiscal 2007The increase in professional services and hosting revenue for fiscal 2008, as compared fiscal 2007, consisted of an $88.3 millionincrease in Mobile-Enterprise revenue, including contributions from our acquisitions of BeVocal and Viecore. Additionally, there was a$51.8 million increase in Healthcare-Dictation revenue, primarily due to 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 and hosting revenue as apercentage of total revenue.Maintenance and Support RevenueMaintenance and support revenue primarily consists of technical support and maintenance services. The following table showsmaintenance and support revenue, in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Maintenance and support revenue $165.6 $148.6 $124.6 11.4% 19.3%As a percentage of total revenue 17.4% 17.1% 20.7% Fiscal 2009 Compared to Fiscal 2008The increase in maintenance and support revenue for fiscal 2009, as compared to fiscal 2008, consisted primarily of an$8.7 million increase related to the expansion of our current installed base of Healthcare-Dictation solutions, and a $7.2 million increasein Mobile-Enterprise maintenance and support revenue, driven by organic growth.Fiscal 2008 Compared to Fiscal 2007The increase in maintenance and support revenue for fiscal 2008, as compared to fiscal 2007, consisted primarily of a$13.2 million increase in Mobile-Enterprise maintenance and support revenue, driven by a combination of organic growth and growthfrom our acquisition of Viecore, and a $10.4 million increase related to the expansion of our current installed base of Healthcare-Dictationsolutions. As a percentage of total revenue, maintenance and support revenue decreased by 3.6 percentage points, primarily due to changesin revenue mix attributable to the accelerated growth in professional services and hosting revenue relative to maintenance and supportrevenue.25 Table of ContentsCOSTS 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 dollars and as a percentage of productand licensing revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Cost of product and licensing revenue $37.3 $45.7 $43.2 (18.4)% 5.8%As a percentage of product and licensing revenue 10.0% 11.0% 13.8% Fiscal 2009 Compared to Fiscal 2008The decrease in cost of product and licensing revenue for fiscal 2009, as compared to fiscal 2008, was primarily due to a$4.7 million decrease in Healthcare-Dictation costs, a $2.7 million decrease in Imaging costs and a $1.0 million decrease in Mobile-Enterprise costs as a result of customer migration to hosted, on-demand solutions and declining Windows-based license revenues. Thecost of product and licensing revenue decreased as a percentage of revenue due to a change in the revenue mix towards products withhigher margins.Fiscal 2008 Compared to Fiscal 2007Cost of product and licensing revenue increased $2.5 million for fiscal 2008, as compared to fiscal 2007, primarily due to increasedroyalty expense associated with our Imaging product and partially offset by reduced Healthcare-Dictation costs. Cost of product andlicensing revenue decreased as a percentage of product and licensing revenue primarily due to increased product and licensing revenuerelated to recent acquisitions that do not carry significant related costs, and, to a lesser extent, to a change in the revenue mix towardsproducts with higher margins.Cost of Professional Services and Hosting RevenueCost of professional services and hosting revenue primarily consists of compensation for consulting personnel, outside consultantsand overhead, as well as the hardware and communications fees that support our subscription and hosted, on-demand solutions. Thefollowing table shows cost of professional services and hosting revenue, in dollars and as a percentage of professional services andhosting revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Cost of professional services and hosting revenue $254.8 $214.0 $114.2 19.1% 87.4%As a percentage of professional services and hosting revenue 61.9% 70.0% 69.0% Fiscal 2009 Compared to Fiscal 2008The increase in cost of professional services and hosting revenue for fiscal 2009, as compared to fiscal 2008, was primarily due to a$36.2 million increase in Mobile-Enterprise costs driven by our acquisition of SNAPin and a $4.5 million increase in Healthcare-Dictation professional services and hosting costs driven by a full year impact of our acquisitions of eScription and PSRS in late fiscal2008. As a percentage of revenue, cost of professional services and hosting revenue decreased due to faster growth in our higher marginhosted, on-demand solutions.26 Table of ContentsFiscal 2008 Compared to Fiscal 2007The increase in the cost of professional services and hosting revenue for fiscal 2008, as compared to fiscal 2007, was primarilydriven by the Mobile-Enterprise acquisition of Viecore, the full year impact of the fiscal 2007 Healthcare-Dictation acquisition of Focus,as well as organic growth in the core business. The cost of professional services and hosting revenue increased modestly in fiscal 2008,as a percentage of the related revenue, as we increased spending to support our current and future growth, particularly in our hosted, on-demand solutions. These solutions require infrastructure spending in advance of the 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 2009 vs 2008 vs 2009 2008 2007 2008 2007 Cost of maintenance and support revenue $29.1 $31.5 $27.5 (7.6)% 14.5%As a percentage of maintenance and support revenue 17.6% 21.2% 22.0% Fiscal 2009 Compared to Fiscal 2008The decrease in cost of maintenance and support revenue for fiscal 2009, as compared to fiscal 2008, was primarily due to a$1.7 million decrease in Healthcare-Dictation costs as a result of effective cost containment actions, offset by an increase in costsassociated with our acquisitions of eScription and PSRS. As a percentage of revenue, cost of maintenance and support revenue decreaseddue to effective cost controls in our core business and changes in the overall revenue mix.Fiscal 2008 Compared to Fiscal 2007The increase in cost of maintenance and support revenue for fiscal 2008, as compared to fiscal 2007, was primarily due to a$2.2 million increase in Mobile-Enterprise related to the acquisition of Viecore and $1.1 million increase in Healthcare-Dictation related tothe acquisitions of Vocada and Commissure. The cost of maintenance and support revenue as a percentage of the related revenue decreasedby 0.8 percentage points.Research and Development ExpenseResearch and development expense primarily consists of salaries, benefits and overhead relating to engineering staff. The followingtable shows research and development expense, in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Research and development expense $119.4 $115.0 $80.0 3.8% 43.8%As a percentage of total revenue 12.6% 13.2% 13.3% Fiscal 2009 Compared to Fiscal 2008The increase in research and development expense for fiscal 2009, as compared to fiscal 2008, primarily consisted of a $5.7 millionincrease in infrastructure investment to support ongoing research and development projects, as well as a $2.5 million increase incompensation expense attributable to the additional headcount from our acquisitions during the period. This increase is partially offset bya reduction of $3.0 million related to temporary employees and professional services. To date, we have not capitalized any internalsoftware development27 Table of Contentscosts as costs incurred after technological feasibility, but before release of our licensed software products, and development work relatedto our on-demand solutions have not been significant.Fiscal 2008 Compared to Fiscal 2007The increase in research and development expense for fiscal 2008, as compared to fiscal 2007, primarily consisted of a$28.9 million in compensation expense attributable to the additional headcount from our acquisitions during the period, and a$3.6 million increase in temporary employees and professional services to support ongoing research and development projects. Theremaining increase is related to infrastructure investment.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 2009 vs 2008 vs 2009 2008 2007 2008 2007 Sales and marketing expense $219.2 $231.2 $184.9 (5.2)% 25.0%As a percentage of total revenue 23.1% 26.6% 30.7% Fiscal 2009 Compared to Fiscal 2008The decrease in sales and marketing expenses for fiscal 2009, as compared to fiscal 2008, was primarily attributable to a$4.9 million decrease in compensation and other variable costs, such as commissions and travel expenses, a $4.6 million decrease inmarketing program spending and a $1.3 million decrease in temporary employees and professional services. Sales and marketing expenseas a percentage of total revenue decreased by 3.5 percentage points, as a result of increased cost efficiencies of our sales and marketingexpenditures.Fiscal 2008 Compared to Fiscal 2007The increase in sales and marketing expenses for fiscal 2008, as compared to fiscal 2007, was primarily attributable to a$39.9 million increase in compensation and other variable costs, such as commissions, stock-based compensation and travel expensesrelated to increased headcount from our acquisitions during the period, and a $5.0 million increase in marketing program spending. Salesand marketing expense as a percentage of total revenue decreased by 4.1 percentage points, as a result of increased cost efficiencies of oursales and marketing expenditures and a reduction of the share-based compensation relative to the increase in revenue.General and Administrative ExpenseGeneral and administrative expense primarily consists of personnel costs for administration, finance, human resources, informationsystems, facilities and general management, fees for external professional advisors including accountants and attorneys, insurance, andprovisions for doubtful accounts. The following table shows general and administrative expense, in dollars and as a percentage of totalrevenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2008 2008 2007 2008 2007 General and administrative expense $112.1 $105.9 $75.6 5.9% 40.1%As a percentage of total revenue 11.8% 12.2% 12.6% 28 Table of ContentsFiscal 2009 Compared to Fiscal 2008The increase in general and administrative expense for fiscal 2009, as compared to fiscal 2008, was primarily attributable toincreased legal costs of $11.4 million associated with acquisition and integration activities. This increase is partially offset by a reductionof $2.4 million in bad debt expense resulting from improved collection and a $2.6 million decrease in expenses related to temporaryemployees and professional services as a result of cost containment efforts and acquisition related synergies.Fiscal 2008 Compared to Fiscal 2007The increase in general and administrative expense for fiscal 2008 compared to fiscal 2007 was primarily attributable to increasedcompensation and stock-based compensation of $20.9 million associated with our 2008 acquisitions. An additional $5.1 million increasein general and administrative expenses related to temporary employees and professional services in order to support the incrementalrequirements resulting from our growth from acquisitions, and $3.6 million related to increased third-party legal fees.Amortization of Intangible AssetsAmortization of acquired patents and core and completed technology are included in cost of revenue and the amortization of acquiredcustomer and contractual relationships, non-compete agreements, acquired tradenames and trademarks, and other intangibles areincluded in operating expenses. Customer relationships are amortized on an accelerated basis based upon the pattern in which theeconomic benefit of customer relationships are being realized. Other identifiable intangible assets are amortized on a straight-line basis overtheir estimated useful lives. Amortization expense was recorded as follows (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Cost of revenue $38.4 $24.4 $13.1 57.4% 86.3%Operating expense 77.0 58.2 24.6 32.3% 136.6%Total amortization expense $115.4 $82.6 $37.7 39.7% 119.1%As a percentage of total revenue 12.1% 9.5% 6.3% Fiscal 2009 Compared to Fiscal 2008The increase in amortization of intangible assets for fiscal 2009, compared to fiscal 2008, was primarily attributable to theamortization of acquired customer relationship and core technology intangible assets from our acquisitions of eScription in May 2008,PSRS in September 2008, SNAPin in October 2008, and our acquisitions during the third quarter of fiscal 2009. Fiscal 2009amortization expense also increased over fiscal 2008 due to our acquisition and licensing of certain technology from other third-partiesduring 2009.Fiscal 2008 Compared to Fiscal 2007The increase in amortization of intangible assets for fiscal 2008, compared to fiscal 2007, was primarily attributable to theamortization of acquired customer relationships and core technology from our acquisitions in fiscal 2008 and 2007, as well as newtechnology licensed in fiscal 2008. The amortization expense in fiscal 2008 included $3.6 million representing impairment chargesrecorded from our review of our ability to realize future cash flows relating to certain of our intangible assets. We did not record anyimpairment charges in fiscal 2007.Based on our balance of amortizable intangible assets as of September 30, 2009, and assuming no impairment or reduction inexpected lives, we expect amortization of intangible assets for fiscal 2010 to be $126.2 million29 Table of ContentsIn-Process Research and DevelopmentIn fiscal 2008, we recorded in-process research and development charges of $2.6 million in connection with our acquisition ofPSRS. We did not have any in-process research and development charges for any other acquisitions completed in fiscal 2009, 2008 or2007. 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. The rates utilized to discount the netcash flows to their present value were based on a number of factors, including our estimated costs of capital. Due to the nature of theforecasts and the risks associated with the projected growth and profitability of these projects, discount rates of 25% to 35% wereconsidered appropriate.Restructuring and Other Charges (Credits), NetFor fiscal 2009, we recorded restructuring and other charges of $5.4 million, composed primarily of $5.3 million related to theelimination of approximately 220 personnel across multiple functions within our company.For fiscal 2008, we recorded restructuring and other charges of $7.0 million, of which $4.2 million related to the elimination ofapproximately 155 personnel across multiple functions, $1.4 million related to a non-recurring, adverse ruling arising from a vendor’sclaims of underpayment of historical royalties for technology discontinued in 2005 and $1.4 million related to the consolidation orelimination of excess facilities.The following table sets forth the activity relating to the restructuring accruals in fiscal 2009, 2008 and 2007 (in millions): Personnel Facilities Related Costs Other Total Balance at October 1, 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 Restructuring and other charges (credits), net 5.3 0.1 — 5.4 Cash payments (5.0) (0.6) (1.4) (7.0)Balance at September 30, 2009 $0.6 $0.3 $— $0.9 30 Table of ContentsOther 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 2009 vs 2008 vs 2009 2008 2007 2008 2007 Interest income $3.6 $8.0 $6.0 (55.0)% 33.3%Interest expense (40.1) (55.2) (36.5) (27.4)% 51.2 Other income (expense), net 7.2 (1.0) — 820% — Total other income (expense), net $(29.3) $(48.2) $(30.5) As a percentage of total revenue (3.1)% (5.6)% (5.1)% Fiscal 2009 Compared to Fiscal 2008The change in other income (expense), net for fiscal 2009, as compared to fiscal 2008, was primarily driven by gains on foreigncurrency forward contracts. During the three months ended December 31, 2008, we entered into foreign currency forward contracts tomanage exposure on our Euro-denominated deferred acquisition payment obligation of €44.3 million related to our acquisition of PSRS.The deferred acquisition payment was paid on October 22, 2009. These foreign currency contracts were not designated as hedges andchanges in fair value of these contracts were reported in net earnings as other income (expense). For fiscal 2009, we recorded a net$8.0 million gain as other income related to these contracts and the related Euro-denominated obligation. In addition, gains on otherderivative instruments of $2.3 million were partially offset by a $1.2 million impairment charge taken on our cost method investment in anon-public company during the period. Interest income was lower in fiscal 2009 due to lower prevailing market interest rates. Interestexpense was similarly lower during fiscal 2009 driven by a decrease in the prevailing average interest rates during the year related to ourvariable-interest rate borrowings.Fiscal 2008 Compared to Fiscal 2007The increase in interest income for fiscal 2008 compared to fiscal 2007 was primarily due to higher cash balances, partially offsetby lower interest rates during fiscal 2008 compared to fiscal 2007. The increase in interest expense was mainly due to the increase in ourterm loan 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, and the amortizationof debt 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.Provision for Income TaxesThe following table shows the provision for income taxes and the effective income tax rate (in thousands of dollars, exceptpercentages): % % Change Change Fiscal Fiscal Fiscal 2009 vs 2008 vs 2009 2008 2007 2008 2007 Income tax provision $40.4 $14.6 $22.5 176.7% (35.1)%Effective income tax rate 143.3% (93.8)% 265.1% 31 Table of ContentsFiscal 2009 Compared to Fiscal 2008Our effective income tax rate was 143.3% and (93.8)% for fiscal 2009 and 2008, respectively. The increase in the rate was dueprimarily to the increase in our valuation allowance with respect to certain deferred tax assets. This was partially offset by an $8.0 millioncharge recorded in the first quarter of fiscal 2009 upon our election to treat the eScription acquisition as an asset purchase. This charge infiscal 2009 represented the reversal of tax benefits associated with a Massachusetts state tax law enactment recorded in the fourth quarterof fiscal 2008 when the eScription acquisition was treated as a stock purchaseFiscal 2008 Compared to Fiscal 2007The effective income tax rate was (93.8)% and 265.1% for fiscal 2008 and 2007, respectively. The decrease in the effective tax ratewas due primarily to the $20.4 million tax benefit associated with the enactment of the Massachusetts state tax law enactment, whichimpacted the tax rate applied to certain deferred tax liabilities associated with intangible assets and results in these liabilities being taxed ata lower effective tax rate when reversed in future periods. This benefit was partially offset by changes in the valuation allowance withrespect to certain deferred tax assets.Our utilization of deferred tax assets that were acquired in a business combination (primarily net operating loss carryforwards) willreduce goodwill, intangible assets, and to the extent remaining, the provision for income taxes, until our adoption of the businesscombination accounting guidance in ASC 805 on October 1, 2009; after which time the reductions in the allowance, if any, will berecorded as a tax benefit in the statement of operations. Our establishment of new deferred tax assets as a result of operating activitiesrequires the establishment of valuation allowances based upon “more likely than not” realization criteria. The establishment of a valuationallowance 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.LIQUIDITY AND CAPITAL RESOURCESCash and cash equivalents totaled $527.0 million as of September 30, 2009, an increase of $265.5 million as compared to$261.5 million as of September 30, 2008. Our working capital was $376.6 million as of September 30, 2009 as compared to$133.5 million as September 30, 2008. As of September 30, 2009, our total accumulated deficit was $247.3 million. We do not expect ouraccumulated deficit to impact our future ability to operate the business given our strong cash and operating cash flow positions, andbelieve our current cash and cash equivalents on-hand are sufficient to meet our operating needs for at least the next twelve months.Cash provided by operating activitiesFiscal 2009 compared to Fiscal 2008Cash provided by operating activities for fiscal 2009 was $258.7 million, an increase of $62.5 million, or 32%, as compared tocash provided by operating activities of $196.2 million for fiscal 2008. The increase was primarily driven by the following factors: • an increase in cash from accounts payable and accrued expenses of $47.8 million primarily attributable to the timing of cashpayments under our normal operating cycles; • an increase in cash resulting from a decrease in net loss, exclusive of non-cash adjustment items, of approximately $65.7 millionmainly attributable to improvement in our operating margins, as well as the decrease in cash interest expense on our variable ratedebt attributable to lower variable interest rates during fiscal 2009; • a decrease in cash of $10.1 million from prepaid expenses and other assets attributable to individually insignificant fluctuationsin prepaid expenses related to our normal operations; and32 Table of Contents • a decrease in cash of $28.5 million from accounts receivable primarily attributable to the significant collection of acquiredunbilled accounts receivable during fiscal 2008 and the timing of cash collections.Fiscal 2008 compared to Fiscal 2007Cash provided by operating activities for fiscal 2008 was $196.2 million, an increase of $89.8 million, or 84%, as compared tocash provided by operating activities of $106.4 million for fiscal 2007. The net increase was primarily driven by the following factors: • a decrease in cash from accounts payable and accrued expenses of $46.2 million, primarily attributable to the timing of cashpayments under our normal operating cycles; • an increase in cash resulting from a decrease in our net loss, exclusive of non-cash adjustment items, of approximately$46.7 million mainly attributable to improvements in our operating margins, offset by an increase in cash interest expenseresulting from our term loan and convertible notes being outstanding for the full fiscal 2008; • an increase in cash of $9.3 million resulting from increased deferred revenue; and • an increase in cash of $76.3 million from accounts receivable primarily attributable to the significant collection of acquiredunbilled accounts receivable and the timing of cash collections during fiscal 2008.Cash used in investing activitiesFiscal 2009 compared to Fiscal 2008Cash used in investing activities for fiscal 2009 was $184.6 million, a decrease of $261.5 million, or 59%, as compared to cashused in investing activities of $446.1 million for fiscal 2008. The net decrease was primarily driven by the following factors: • a decrease in cash payments related to acquisitions of $293.4 million, primarily driven by the cash payment of $330.9 million toacquire eScription in May 2008; and • an increase of $29.4 million in cash payments to acquire speech-related patent portfolios and a royalty-free paid-up perpetuallicense to speech-related source code.Fiscal 2008 compared to Fiscal 2007Cash used in investing activities for fiscal 2008 was $446.1 million, a decrease of $131.6 million, or 23%, as compared to cashused in investing activities of $577.7 million for fiscal 2007. The decrease was primarily driven by the following factors: • a decrease of $171.8 million in cash payments related to acquisitions, primarily driven by the cash payments of $469.5 millionfor Tegic and VoiceSignal in fiscal 2007 compared to $330.9 million to acquire eScription in fiscal 2008; and • an increase of $29.0 million in cash payments for third party licenses and capitalized patent defense costs.Cash provided by financing activitiesFiscal 2009 compared to Fiscal 2008Cash provided by financing activities for fiscal 2009 was $189.4 million, a decrease of $137.7 million, or 42%, as compared tocash provided by financing activities of $327.1 million for fiscal 2008. The change was primarily driven by the following factors: • a decrease of $135.0 million in cash proceeds from the sale of our common stock. During fiscal 2009, we sold 17.4 millionshares of our common stock and warrants to purchase 3.9 million shares of our common stock for net proceeds of$175.1 million as compared to a sale of 19.2 million shares of our common stock33 Table of Contents and warrants to purchase 3.7 million shares of our common stock for net proceeds of $330.6 million during fiscal 2008; • a decrease of $6.6 million in cash payments to net share settle employee equity awards, due to a decrease in the intrinsic value ofthe shares vested as a result of the overall decrease in our stock price in fiscal 2009 as compared to fiscal 2008; and • a decrease of $8.3 million in cash proceeds from the issuance of common stock upon exercise of employee stock options andpursuant to our employee stock purchase plan, due to a decrease in the number of options exercised during fiscal 2009 ascompared to fiscal 2008.Fiscal 2008 compared to Fiscal 2007Cash provided by financing activities for fiscal 2008 was $327.1 million, a decrease of $214.4 million, or 40%, as compared tocash provided by financing activities of $541.5 million for fiscal 2007. The change was primarily driven by the following factors: • an increase of $330.6 million in cash proceeds from the sale of our common stock. During fiscal 2008, we sold 19.2 millionshares of our common stock and warrants to purchase 3.7 million shares of our common stock for net proceeds of$330.6 million. There were no corresponding issuances of common stock during fiscal 2007; • a decrease of $551.4 million in cash received from new borrowings. In fiscal 2007, we received proceeds from our Credit Facilityand the issuance of our 2.75% Convertible Senior Debentures, while we did not raise any significant funds through borrowingsin fiscal 2008; and • an increase of $18.7 million related to deferred acquisition payments made in fiscal 2007 for an acquisition consummated infiscal 2005., and not made in fiscal 2008. We did not make any deferred payments of this nature in fiscal 2008.Credit Facilities and Debt2.75% Convertible DebenturesOn August 13, 2007, we 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. Total proceeds, net of debt discount of $7.5 million anddeferred debt issuance costs of $1.1 million, were $241.4 million. The 2027 Debentures bear an interest rate of 2.75% per annum,payable semi-annually in arrears beginning on February 15, 2008, and mature on August 15, 2027 subject to the right of the holders ofthe 2027 Debentures to require us to redeem the 2027 Debentures on August 15, 2014, 2017 and 2022. The related debt discount and debtissuance costs are being amortized to interest expense using the effective interest rate method through August 2014. As of September 30,2009 and 2008, the ending unamortized discount was $5.2 million and $6.3 million, respectively, and the ending unamortized deferreddebt issuance costs were $0.7 million and $0.8 million, respectively. The 2027 Debentures are general senior unsecured obligations,ranking equally in right of payment to all of our existing and future unsecured, unsubordinated indebtedness and senior in right ofpayment to any indebtedness that is contractually subordinated to the 2027 Debentures. The 2027 Debentures are effectively subordinatedto our secured indebtedness to the extent of the value of the collateral securing such indebtedness and are structurally subordinated toindebtedness and other liabilities of our subsidiaries. If converted, the principal amount of the 2027 Debentures is payable in cash andany amounts payable in excess of the $250 million principal amount, will (based on an initial conversion rate, which represents an initialconversion price of $19.47 per share, subject to adjustment as defined) be paid in cash or shares of our common stock, at our election,only in the following circumstances and to the following extent: (i) on any date during any fiscal quarter beginning after September 30,2007 (and only during such fiscal quarter) if the closing sale price of our common stock was more than 120% of the then currentconversion price for at least 20 trading days in the period of the 30 consecutive trading days ending on the last trading day of the previousfiscal quarter; (ii) during the five consecutive business-day period following any five consecutive trading-day period in which the tradingprice for $1,000 principal amount of the Debentures for each day during such five trading-day period was less than 98% of the closingsale price of our common stock multiplied34 Table of Contentsby the then current conversion rate; (iii) upon the occurrence of specified corporate transactions, as described in the indenture for the 2027Debentures; and (iv) at the option of the holder at any time on or after February 15, 2027. Additionally, we may redeem the 2027Debentures, in whole or in part, on or after August 20, 2014 at par plus accrued and unpaid interest; each holder shall have the right, atsuch holder’s option, to require us to repurchase 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, we will pay cash and shares of our common stock (or, at our election, cash inlieu of some or all of such common stock), if any. If we undergo a fundamental change (as described in the indenture for the 2027Debentures) prior to maturity, holders will have the option to require us to repurchase all or any portion of their debentures for cash at aprice equal to 100% of the principal amount of the debentures to be purchased plus any accrued and unpaid interest, including anyadditional interest to, but excluding, the repurchase date. As of September 30, 2009, no conversion triggers were met. If the conversiontriggers were met, we could be required to repay all or some of the principal amount in cash prior to the maturity date.Credit FacilityWe have a credit facility which consists of a $75 million revolving credit line including letters of credit, a $355 million term loanentered into on March 31, 2006, a $90 million term loan entered into on April 5, 2007 and a $225 million term loan entered into onAugust 24, 2007 (the “Credit Facility”). The term loans are due March 2013 and the revolving credit line is due March 2012. As ofSeptember 30, 2009, $650.3 million remained outstanding under the term loans, there were $16.2 million of letters of credit issued underthe revolving credit line and there were no other outstanding borrowings under the revolving credit line.The Credit Facility contains covenants, including, among other things, covenants that restrict our ability and those of oursubsidiaries to incur certain additional indebtedness, create or permit liens on assets, enter into sale-leaseback transactions, make loans orinvestments, sell assets, make certain acquisitions, pay dividends, or repurchase stock. The agreement also contains events of default,including failure to make payments of principal or interest, failure to observe covenants, breaches of representations and warranties,defaults under certain other material indebtedness, failure to satisfy material judgments, a change of control and certain insolvencyevents. As of September 30, 2009, we were in compliance with the covenants under the Credit Facility.Borrowings under the 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% per annum) or(b) LIBOR (equal to (i) the British Bankers’ Association Interest Settlement Rates for deposits in U.S. dollars divided by (ii) one minusthe statutory reserves applicable to such borrowing). The applicable margin for term loan borrowings under the Credit Facility rangesfrom 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-basedborrowings, depending on our leverage ratio. The applicable margin for revolving loan borrowings under the Credit Facility ranges from0.50% to 1.25% per annum with respect to base rate borrowings and from 1.50% to 2.25% per annum with respect to LIBOR-basedborrowings, depending upon our leverage ratio. As of September 30, 2009, our applicable margin for the term loan was 1.00% for baserate borrowings and 2.00% for LIBOR-based borrowings. We are required to pay a commitment fee for unutilized commitments under therevolving credit facility at a rate ranging from 0.375% to 0.50% per annum, based upon our leverage ratio. As of September 30, 2009, thecommitment fee rate was 0.375% and the effective interest rate was 2.27%.We capitalized debt issuance costs related to the Credit Facility and are amortizing the costs to interest expense using the effectiveinterest rate method through March 2012 for costs associated with the revolving credit facility and through March 2013 for costsassociated with the term loan. As of September 30, 2009 and 2008, the ending unamortized deferred financing fees were $7.7 million and$10.0 million, respectively, and are included in other assets in the accompanying consolidated balance sheet.The Credit Facility is subject to repayment in four equal quarterly installments of 1% per annum ($6.7 million per year, notincluding interest, which is also payable quarterly), and an annual excess cash flow sweep, as defined in the Credit Facility, which ispayable beginning in the first quarter of each fiscal year, beginning in fiscal 2008, based on the excess cash flow generated in the previousfiscal year. No payment under the excess cash flow sweep provision was due in the first quarter of either fiscal 2009 or fiscal 2010 asthere was no excess cash flow generated35 Table of Contentsin either of the respective prior fiscal years. We will continue to evaluate the extent to which a payment is due in the first quarter of futurefiscal years based on excess cash flow generation. At the current time, we are unable to predict the amount of the outstanding principal, ifany, that we may be required to repay in future fiscal years pursuant to the excess cash flow sweep provisions. Any term loan borrowingsnot paid through the baseline repayment, the excess cash flow sweep, or any other mandatory or optional payments that we may make,will be repaid upon maturity. If only the baseline repayments are made, the annual aggregate principal amount of the term loans repaidwould be as follows (in thousands):Year Ending September 30, Amount 2010 $6,700 2011 6,700 2012 6,700 2013 630,163 Total $650,263 Our obligations under the Credit Facility are unconditionally guaranteed by, subject to certain exceptions, each of our existing andfuture direct and indirect wholly-owned domestic subsidiaries. The Credit Facility and the guarantees thereof are secured by first priorityliens and security interests in the following: 100% of the capital stock of substantially all of our domestic subsidiaries and 65% of theoutstanding voting equity interests and 100% of the non-voting equity interests of first-tier foreign subsidiaries, all our material tangibleand intangible assets and those of the guarantors, and any present and future intercompany debt. The Credit Facility also containsprovisions for mandatory prepayments of outstanding term loans upon receipt of the following, and subject to certain exceptions: 100% ofnet cash proceeds from asset sales, 100% of net cash proceeds from issuance or incurrence of debt, and 100% of extraordinary receipts.We may voluntarily prepay borrowings under the Credit Facility without premium or penalty other than breakage costs, as defined withrespect to LIBOR-based loans.We believe that cash flows from future operations in addition to cash and cash equivalents 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 at least the next twelve months. We also believe that in the event future operating results are not as planned, that wecould take actions, including restructuring actions and other cost reduction initiatives, to reduce operating expenses to levels which, incombination with expected future revenue, will continue to generate sufficient operating cash flow. In the event that these actions are noteffective in generating operating cash flows we may be required to issue equity or debt securities on terms that may be less favorable.36 Table of ContentsOff-Balance Sheet Arrangements, Contractual Obligations, Contingent Liabilities and CommitmentsContractual ObligationsThe following table outlines our contractual payment obligations as of September 30, 2009 (in millions): Payments Due by Fiscal Year Ended September 30, 2011 2013 Contractual Obligations Total 2010 and 2012 and 2014 Thereafter Credit Facility(2) $650.3 $6.7 $13.4 $630.2 $— 2.75% Convertible Senior Debentures(1) 250.0 — — 250.0 — Interest payable under Credit Facility(2) 50.8 14.7 29.0 7.1 — Interest payable under 2.75% Convertible Senior Debentures(3) 34.5 6.9 13.8 13.8 — Lease obligations and other liabilities: — Operating leases 118.2 18.4 33.1 27.5 39.2 Other lease obligations associated with the closing of duplicatefacilities related to restructurings and acquisitions(4) 8.6 4.2 4.0 0.4 — Pension, minimum funding requirement(5) 6.8 1.4 2.7 2.7 — Purchase commitments(6) 1.9 1.9 — — — Other long-term liabilities assumed(7) 47.7 13.5 26.3 4.6 3.3 Total contractual cash obligations $1,168.8 $67.7 $122.3 $936.3 $42.5 (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, 2009 related to the Credit Facility excluding theeffect 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 facilities that were part of restructuring plans entered into in fiscal 2005,2008 and 2009. As of September 30, 2009, total gross lease obligations are $3.0 million and are included in the contractualobligations herein. The remaining $5.6 million in obligations represent contractual lease commitments associated with theimplemented plans to eliminate duplicate facilities in conjunction with our acquisitions. As of September 30, 2009, we have subleasedcertain of the facilities to unrelated third parties with total sublease income of $3.0 million through fiscal 2013.(5)Our U.K. pension plan has a minimum funding requirement of £859,900 ($1.4 million based on the exchange rate at September 30,2009) for each of the next 5 years, through fiscal 2014.(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 $47.7 million. As of September 30, 2009, 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$14.5 million, which ranges from $1.5 million to $3.2 million on an annualized basis through 2016.As a result of our adoption of FIN 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB StatementNo. 109 (FIN 48), now referred to as ASC 740-10, on October 1, 2007, our gross liability for unrecognized tax benefits wasapproximately $2.5 million. The gross liability as of September 30, 2009 was37 Table of Contents$12.1 million. We do not expect a significant change in the amount of unrecognized tax benefits within the next 12 months. We estimatethat approximately $1.1 million of this amount may be paid within the next year and we are currently unable to reasonably estimate thetiming 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 SNAPin, we agreed to make contingent earn-out payments of up to $45.0 million in cash, to bepaid, if at all, based on the business achieving certain performance targets that are measurable from the acquisition date to December 31,2009. Additionally, we would be required to issue earn-out consideration to SNAPin option holders. This option earn-out consideration, ifearned, is payable at our sole discretion in cash, stock or additional options to purchase common stock. The total value of this optionearn-out consideration may aggregate up to $2.5 million, which will be recorded as compensation expense over the service period, ifearned. These earn-out payments, if any would be payable upon the final measurement of the performance targets. As of September 30,2009, we have recorded approximately $12.9 million related to the contingent earn-out provisions as additional purchase price.In connection with our acquisition of PSRS, a deferred cash payment of €44.3 million ($64.6 million based on the exchange rate asof September 30, 2009) was due per the asset purchase agreement on September 21, 2009. We paid the deferred acquisition payment onOctober 22, 2009. The purchase price was finalized in November 2009 based on a final working capital adjustment agreed between usand the former shareholder of PSRS, reducing the final purchase price by €1.4 million ($2.1 million based on exchange rate atSeptember 30, 2009), reflective of the amount agreed to be paid to us by the former shareholder of PSRS.In connection with our acquisition of Multi-Vision, we agreed to make contingent earn-out payments of up to $15.0 million, payablein stock, or cash, solely at our discretion, relating to certain provisions as described in the share purchase agreement. Two-thirds of theearn-out is conditioned on performance targets and continued employment; accordingly, up to $10.0 million of any earn-out payments thatbecome payable will be recorded to compensation expense, and up to $5.0 million, the portion of the prospective earn-out attributablesolely to performance targets, will be recorded as additional purchase price and allocated to goodwill. As of September 30, 2009, we havenot recorded any obligation or compensation expense relative to these measures.In connection with our acquisition of Vocada, we agreed to make contingent earn-out payments of up to an additional $21.0 millionupon the achievement of certain financial targets measured over defined periods through December 31, 2010, in accordance with themerger agreement. Payments, if any, will be made in the form of cash or shares of our common stock, at our sole discretion. We havenotified the former shareholders of Vocada that the financial targets for certain periods were not achieved. The former shareholders ofVocada have requested additional information regarding this determination. We are currently in discussions with the former shareholdersof Vocada regarding this matter. As of September 30, 2009, we have not recorded any obligation relative to these measures.In connection with our acquisition of Commissure, we agreed to make contingent earn-out 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. Payments, if any, may be made in the form of cash or shares of our common stock, at our sole discretion. We have notifiedthe former shareholders of Commissure that the financial targets for fiscal year ended September 30, 2008, were not achieved and therelated contingent earn-out payment was not earned. Through September 30, 2009, we have not recorded any obligation relative to thesemeasures.In connection with our acquisition of Phonetic Systems Ltd. (“Phonetic”) in February 2005, we agreed to make contingent earn-outpayments of $35.0 million upon achievement of certain established financial and performance targets, in accordance with the mergeragreement. We have notified the former shareholders of Phonetic that the financial and performance targets were not achieved. Accordingly,we have not recorded any obligations relative to38 Table of Contentsthese measures as of September 30, 2009. The former shareholders of Phonetic have objected to this determination and have filed forarbitration.Financial InstrumentsWe use financial instruments to manage our interest rate and foreign exchange risk. We follow Statement of Financial AccountingStandards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, amended by SFAS No. 138,Accounting for Certain Derivative Instruments and Certain Hedging Activities, now referred to as Financial Accounting StandardsBoard (“FASB”) Accounting Standards Codification (“ASC”) 815 (“ASC 815”), for certain designated forward contracts and interestrate swaps.To manage the interest rate exposure on our variable-rate borrowings, we use interest rate swaps to convert specific variable-rate debtinto fixed-rate debt. As of September 30, 2009, we have two outstanding interest rate swaps designated as cash flow hedges with anaggregate notional amount of $200 million. The interest rates on these swaps are 2.7% and 2.1%, plus the applicable margin for the CreditFacility, and they expire in October 2010 and November 2010, respectively. As of September 30, 2009 and September 30, 2008, theaggregate cumulative unrealized losses related to these swaps, and a previous swap that matured on March 31, 2009, were $4.0 millionand $0.9 million, respectively.On December 31, 2008, we entered into foreign currency contracts to hedge exposure on the variability of cash flows in Canadiandollars. These contracts expired in September 2009 and were designated as cash flow hedges. The impact of these settled contracts onresults of operations and other comprehensive income are detailed in the Notes to our Consolidated Financial Statements. We have noforeign currency contracts designated as cash flow hedges outstanding at September 30, 2009.We have foreign currency contracts that are not designated as hedges. Changes in fair value of foreign currency contracts notqualifying as hedges are reported in earnings as part of other income (expense), net. During the three months ended December 31, 2008,we entered into foreign currency forward contracts to offset foreign currency exposure on the deferred acquisition payment of €44.3 millionrelated to our acquisition of PSRS, resulting in a net gain of $8.0 million in other income (expense).In June 2009, we acquired certain intangible assets and issued 1,809,353 shares of our common stock, valued at $25.0 million, aspart of the total consideration. We also issued an additional 315,790 shares of our common stock, valued at $4.5 million, in June 2009as a prepayment for professional services. These shares issued are subject to security price guarantees which are accounted for asderivatives, and are being accounted for separately from their host agreements due to the determination that such instruments would not beconsidered equity instruments if freestanding. The security price guarantees require a payment from, either, us to the third party or fromthe third party to us based upon the difference between the price of our common stock on the issue date and an average price of ourcommon stock approximately six months following the issue date. For the fiscal year ended September 30, 2009, increases in fair value of$2.3 million related to these security price guarantees are reported in earnings as non-operating income within other income (expense), net.In October 2009, we entered into a five-year joint research collaboration with a third party and made payments related to the firstyear of service consisting of 1,047,120 shares of our common stock valued at $16.0 million. These shares issued are subject to securityprice guarantees of the same nature as those described above.Pension PlansWe assumed the assets and obligations related to certain significant defined benefit pension plans in connection with our acquisitionof Dictaphone, 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. These plans require periodic cash contributions. The Canadian plan isfully funded and expected to remain fully funded during fiscal 2010, without additional funding by us. In fiscal 2009, total cash fundingfor the UK pension plan was $1.3 million. For the UK pension plan, we have a minimum funding requirement of £859,900(approximately $1.4 million based on the exchange rate at September 30, 2009) for each of the next five years, through fiscal 2014.39 Table of ContentsOff-Balance Sheet ArrangementsThrough September 30, 2009, 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 softwareapplications; the valuation of goodwill, intangible assets and tangible long-lived assets; accounting for business combinations; share-based payments; valuation of derivative instruments; accounting for income taxes and related valuation allowances; and losscontingencies. Our management bases its estimates on historical experience, market participant fair value considerations and various otherfactors that are believed 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 our financial condition and results ofoperations and require our most difficult and subjective judgments.Revenue Recognition. We derive revenue from the following sources: (1) software license agreements, including royalty and otherusage-based arrangements, (2) post-contract customer support, (3) fixed and variable fee hosting arrangements and (4) professionalservices. Our revenue recognition policies for these revenue streams are discussed below.The sale and/or license of software products and technology is deemed to have occurred when a customer either has taken possessionof the related software or technology or has the contractual right to take possession of the software or technology at its sole discretion andwithout undue economic cost or burden. In select situations, we sell or license intellectual property in conjunction with, or in place of,embedding our intellectual property in software. We recognize revenue from the sale or license of software products and licensing oftechnology when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable and(iv) collectibility is probable. Vendor-specific objective evidence (“VSOE”) of fair value for software and software-related services existswhen a company can support what the fair value of its software and/or software-related services is based on evidence of the prices chargedby the company when the same elements are sold separately. VSOE of fair value is required, generally, in order to separate the accountingfor various elements in a software and related services arrangement. We have, in general, established VSOE of fair value of our post-contract customer support (“PCS”), professional services, and training.Revenue from royalties on sales of our software products by original equipment manufacturers (“OEMs”), where no services areincluded, is recognized in the quarter earned so long as we have been notified by the OEM that such royalties are due, and provided thatall 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. Revenue from PCS is recognized ratably on astraight-line basis over the term that the maintenance service is provided.Non-software revenue, such as arrangements containing hosting services where the customer does not take possession of thesoftware at the outset of the arrangement and has no contractual right to do so, is recognized 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.For revenue arrangements with multiple elements that are not considered to be software or software-related, we allocate anarrangement’s fees into separate units of accounting based on fair value. We generally support fair value of our deliverables based uponthe prices we charge when we sell similar elements separately.40 Table of ContentsRevenue from products offered on a subscription and/or hosted, on-demand basis is recognized in the period the services areprovided, based on a fixed minimum fee and/or variable fees based on the volume of activity. Variable subscription and hosting revenueis recognized as we are notified by the customer or through management reports that such revenue is due, provided that all other revenuerecognition 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 we provide professional services considered essential to the functionality of the software, we recognize revenue from theprofessional services as well as any related software licenses on a percentage-of-completion basis whereby the arrangement consideration isrecognized as the services are performed as measured by an observable input. In these circumstances, we separate license revenue fromprofessional service revenue for income statement presentation by classifying the fair value of professional service revenue as professionalservice revenue and the residual portion as license revenue. We generally determine the percentage-of-completion by comparing the laborhours incurred to-date to the estimated total labor hours required to complete the project. We consider labor hours to be the most reliable,available measure of progress on these projects. Adjustments to estimates to complete are made in the periods in which facts resulting in achange become known. When the estimate indicates that a loss will be incurred, such loss is recorded in the period identified. Significantjudgments and estimates are involved in determining the percent complete of each contract. Different assumptions could yield materiallydifferent 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, provided all other revenue recognition criteria are met. Certain distributors and value-added resellers have been granted rights ofreturn for as long as the distributors or resellers hold the inventory. We cannot estimate historical returns from these distributors andresellers; and therefore, cannot use such estimates as the basis upon which to estimate future sales returns. As a result, we recognizerevenue from sales to these distributors and resellers when the products are sold through to retailers and end-users.When products are sold directly to end-users, we make an estimate of sales returns based on historical experience. The provision forthese estimated returns is recorded as a reduction of revenue and accounts receivable at the time that the related revenue is recorded. Ifactual returns differ significantly from our estimates, such differences could have a material impact on our results of operations for theperiod in which the actual returns become known.When maintenance and support contracts renew automatically, we provide a reserve based on historical experience for contractsexpected to be cancelled for non-payment. All known and estimated cancellations are recorded as a reduction to revenue and accountsreceivable.We record consideration given to a reseller as a reduction of revenue to the extent we have recorded cumulative revenue from thecustomer or reseller. However, when we receive an identifiable benefit in exchange for the consideration, and can reasonably estimate thefair value of the benefit received, the consideration is recorded as an operating expense.We record reimbursements received for out-of-pocket expenses as revenue, with offsetting costs recorded as cost of revenue.Out-of-pocket expenses generally include, but are not limited to, expenses related to transportation, lodging and meals.We record shipping and handling costs billed to customers as revenue with offsetting costs recorded as cost of revenue.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.Business Combinations. We determine and allocate the purchase price of an acquired company to the tangible and intangible assetsacquired and liabilities assumed as well as to in-process research and development as41 Table of Contentsof the business combination date. The purchase price allocation process requires us to use significant estimates and assumptions,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; • probability of required payment under contingent consideration provisions; • estimated income tax assets and liabilities assumed from the acquiree; and • estimated fair value of pre-acquisition contingencies assumed from the acquiree.In fiscal 2010, we will adopt the business combinations accounting guidance in FASB ASC 805 [formerly referred to as SFASNo. 141(Revised), Business Combinations (SFAS 141R)]. Refer to Recently Issued Accounting Standards below for additionalinformationWhile we use our best estimates and assumptions as a part of the purchase price allocation process to accurately value assetsacquired and liabilities assumed at the business combination date, our estimates and assumptions are inherently uncertain and subject torefinement. As a result, during the purchase price allocation period, which is generally one year from the business combination date, werecord adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Generally, with the exceptionof unresolved income tax matters, subsequent to the purchase price allocation period any adjustment to assets acquired or liabilitiesassumed is included in operating results in the period in which the adjustment is determined. For changes in the valuation of intangibleassets between preliminary and final purchase price allocation, the related amortization is adjusted on a prospective basis.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 recorded as of the acquisition date.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 one42 Table of Contentsyear of the acquisition date). To estimate restructuring expenses, management utilizes assumptions of the number of employees that wouldbe involuntarily terminated and of future costs to operate and eventually vacate duplicate facilities. Estimated restructuring expenses maychange 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.Goodwill, Intangible and Other Long-Lived Assets and Impairment Assessments. We have significant long-lived tangible andintangible assets, including goodwill and intangible assets with indefinite lives, which are susceptible to valuation adjustments as a resultof changes in various factors or conditions. The most significant long-lived tangible and intangible assets are licensed technology, patentsand core technology, completed technology, customer relationships, fixed assets and tradenames. All finite-lived intangible assets areamortized based upon patterns in which the economic benefits are expected to be utilized. The values of intangible assets determined inconnection with a business combination, with the exception of goodwill, were initially determined by a risk-adjusted, discounted cashflow approach. We assess the potential impairment of intangible and fixed assets whenever events or changes in circumstances indicatethat the carrying values may not be recoverable. Goodwill and indefinite-lived intangible assets are assessed for potential impairment atleast annually, but also whenever events or changes in circumstances indicate the carrying values may not be recoverable. Factors weconsider important, which could trigger 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; 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.We test goodwill and intangible assets with indefinite lives for impairment on an annual basis as of July 1, and between annual testsif indicators of potential impairment exist. The impairment test for goodwill and intangible assets with indefinite lives compares the fairvalue of identified reporting unit(s) to its (their) carrying amount to assess whether such assets are impaired. We have determined thatbeginning in fiscal 2009, we have three reporting units based on the evolution during the current fiscal year of the level of informationprovided to, and review thereof, by our core market management. Our three reporting units correspond to our three core market groups.Prior to fiscal 2009, we concluded that we only had one reporting unit based on the same criteria. The estimated fair values of thereporting units for the annual goodwill impairment test were determined based on estimates of those reporting units’ enterprise values as ifthey were standalone operations as a function of trailing-twelve-month (“TTM”) revenues and adjusted earnings before interest, taxes,depreciation and amortization (“EBITDA”) as compared to companies comparable to each of the reporting units on a standalone basis.The carrying values of the reporting units were determined based on an allocation of our assets and liabilities through specific allocationof certain assets and liabilities, including goodwill, to the reporting units and an apportionment method based on relative size of thereporting units’ revenues and operating expenses compared to the Company as a whole. Certain corporate assets that are not instrumentalto the reporting units’ operations and would not be transferred to hypothetical purchasers of the reporting units were excluded from thereporting units’ carrying values. Key estimates and judgments inherent to the analysis were the determination of TTM revenue andEBITDA multiples used in estimating the fair values of the reporting units and the allocation methods used to determine the carryingvalues of the reporting units. Intangible43 Table of Contentsassets with indefinite lives are not amortized, but are required to be evaluated periodically to ensure that their current fair value exceeds thestated book value. Based on our assessments, we have not had any impairment charges during our history as a result of our impairmentevaluation of goodwill and other indefinite-lived intangible assets. Significant adverse changes in our future revenues and/or adjustedEBITDA results, or significant degradation in the enterprise values of comparable companies within our core markets, could result in thedetermination that all or a portion of our goodwill is impaired. However, as of our fiscal 2009 annual impairment assessment date, ourestimated fair values of our reporting units significantly exceeded their carrying values.We periodically review long-lived assets other than goodwill or indefinite-lived intangible assets for impairment whenever events orchanges in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives ofthose assets are no longer appropriate. Each impairment test is based on a comparison of the undiscounted cash flows to the recordedcarrying value for the asset or asset group. Asset groups utilized in this analysis are identified as the lowest level grouping of assets forwhich largely independent cash flows can be identified. If impairment is indicated, the asset or asset group is written down to itsestimated fair value.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.Accounting for Share-Based Payments. We account for share-based awards to employees and directors, including grants ofemployee stock options, purchases under employee stock purchase plans, awards in the form of restricted shares (“Restricted Stock”)and awards in the form of units of stock purchase rights (“Restricted Units”) through recognition of the fair value of the share-basedawards as a charge against earnings in the form of stock-based compensation expense. We recognize stock-based compensation expenseover the requisite service period. The Restricted Stock and Restricted Units are collectively referred to as “Restricted Awards.” Determiningthe fair value of share-based awards at the grant date requires judgment, including estimating expected dividends, share price volatilityand the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-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 its foreign subsidiaries, which we consider to be indefinitely reinvested outside of theU.S.We make judgments regarding the realizability of our deferred tax assets. The balance sheet carrying value of our net deferred taxassets is based on whether we believe that it is more likely than not that we will generate sufficient future taxable income to realize thesedeferred tax assets after consideration of all available evidence. We regularly review our deferred tax assets for recoverability consideringhistorical profitability, projected future taxable income, and the expected timing of the reversals of existing temporary differences and taxplanning strategies.Valuation allowances have been established for U.S. deferred tax assets, which we believe do not meet the “more likely than not”criteria for recognition. If we are subsequently able to utilize all or a portion of the deferred tax assets for which a valuation allowance hasbeen established, then we may be required to recognize these deferred tax assets through the reduction of the valuation allowance whichcould result in a material benefit to our results of operations in the period in which the benefit is determined, excluding the recognition ofthe portion of the valuation allowance which relates to net deferred tax assets acquired in a business combination or created as a result ofshare-based payments or other equity transactions where prevailing guidance requires the change in valuation allowance44 Table of Contentsto be traced forward. The recognition of the portion of the valuation allowance which relates to net deferred tax assets resulting from share-based payments or other qualifying equity transactions will be recorded as additional paid-in-capital; the recognition of the portion of thevaluation allowance which relates to net deferred tax assets acquired in a business combination will reduce goodwill, intangible assets,and to the extent remaining, the provision for income taxes, until our adoption of the business combination accounting guidance in ASC805 on October 1, 2009; after which time the reductions in the allowance, if any, will be recorded as a benefit in the statement ofoperations.We establish reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement ofuncertain tax positions. Under the comprehensive model, reserves are established when we have determined that it is more likely than notthat a tax position will or will not be sustained and at the greatest amount for which the result is more likely than not.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 19 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.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTSIn September 2009, the Emerging Issues Task Force (“EITF”) ratified EITF Issue No. 08-1, Revenue Arrangements with MultipleDeliverables (“EITF 08-1”). EITF 08-1, which has not yet been codified in the FASB Accounting Standards Codification (“theCodification” or “ASC”), supersedes EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, now referred to asASC 605-25-50-1. EITF 08-1 eliminates the residual method of accounting for non-software arrangements, as well as the associatedrequirements for establishing vendor objective evidence of fair value. The residual method is replaced in EITF 08-1 by the estimatedselling price method whereby revenue in a multiple-element arrangement is allocated to each element based on its estimated selling price.Estimating selling price is established through a hierarchy starting with vendor-specific objective evidence (“VSOE”) of fair value,following by third-party evidence, and lastly by any reasonable, objective estimate of the selling price were the element to be sold on astandalone basis. Estimates of selling price must consider both entity-specific factors and market conditions. EITF 08-1 is appliedprospectively to all revenue transactions entered into, or materially modified, after June 15, 2010. Early adoption is permitted if adoptedas of the beginning of an entity’s fiscal year and no prior interim period financial statements from that fiscal year have already beenissued or the entity retrospectively applies the provisions of this EITF issue to its previously-issued current fiscal year interim financialstatements. We currently do not expect that the adoption of EITF 08-1 will have a material impact on our consolidated financialstatements.In September 2009, the EITF ratified EITF Issue No. 09-3, Applicability of AICPA Statement of Position 97-2 to CertainArrangements That Include Software Elements (“EITF 09-3”). EITF 09-3, which has not yet been codified in the Codification, appliesto multiple-element arrangements that contain both software and hardware elements, and amends the scope of AICPA Statement of Position(“SOP”) No. 97-2, Software Revenue Recognition (“SOP 97-2”), now referred to as ASC 985-605, to exclude tangible productscontaining software and non-software components that together function to deliver the product’s essential functionality from the scope ofASC 985-605. EITF 09-3 is applied prospectively to all revenue transactions entered into, or materially modified, after June 15, 2010.Early adoption is permitted only when EITF 08-1 is also early adopted as of the same period. We are currently evaluating the potentialimpact of EITF 09-3 on our consolidated financial statements.In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of GenerallyAccepted Accounting Principles (“SFAS 168”), now referred to as ASC 105-10, Generally Accepted45 Table of ContentsAccounting Principles. This standard establishes the Codification as the sole source of authoritative accounting principles recognized bythe FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with GAAP. Rules andinterpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws remain sources ofauthoritative GAAP for SEC registrants. ASC 105-10 is effective for financial statements issued for interim and annual periods endingafter September 15, 2009. We have included references to the Codification, where appropriate, in our consolidated financial statementsand throughout this annual report on Form 10-K.In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”), now referred to as ASC 855-10. ASC 855-10incorporates accounting and disclosure requirements related to subsequent events into U.S. GAAP. The requirements of ASC 855-10 forsubsequent-events accounting and disclosure are not significantly different from those in existing auditing standards, which we havehistorically followed for financial reporting purposes. As a result, we do not believe this standard had any material impact on ourfinancial statements. We have evaluated subsequent events through the date of issuance of these consolidated financial statements, whichis November 23, 2009.In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value ofFinancial Instruments, now referred to as ASC 825-10. ASC 825-10 requires disclosures about fair value of financial instruments forinterim reporting periods of publicly traded companies as well as in annual financial statements. ASC 825-10 also requires thosedisclosures in summarized financial information at interim reporting periods. ASC 825-10 was effective for interim periods ending afterJune 15, 2009. We adopted ASC 825-10 in our third quarter fiscal 2009, and it had no material impact on our third quarter financialstatements.In April 2009, the FASB issued FSP FAS 141R-1, Accounting for Assets Acquired and Liabilities Assumed in a BusinessCombination That Arise from Contingencies (“FSP 141R-1”), the guidance from which is included in ASC 805. This FSP requiresthat assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fairvalue can be reasonably estimated. This FSP is effective for the fiscal years beginning after December 15, 2008. As this FSP essentiallyreinstates to SFAS No. 141 (Revised), Business Combinations (“SFAS 141R”), now referred to as ASC 805, the guidance foraccounting for acquired contingencies from SFAS No. 141, we do not believe FSP 141R-1 will have a material impact on our financialstatements.In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset orLiability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, now referred to as ASC 820-10. ASC820-10 provides guidance on how to determine the fair value of assets and liabilities under ASC 820 (formerly known as SFAS No. 157,Fair Value Measurements) in the current economic environment and reemphasizes that the objective of a fair value measurement remainsan exit price. If we were to conclude that there has been a significant decrease in the volume and level of activity of the asset or liability inrelation to normal market activities, quoted market values may not be representative of fair value and we may conclude that a change invaluation technique or the use of multiple valuation techniques may be appropriate. ASC 820 is effective for interim and annual periodsending after June 15, 2009. We adopted this FSP effective April 1, 2009 and such adoption has not had a material impact on ourfinancial statements, nor do we expect it to in future periods.In November 2008, the FASB ratified EITF Issue No. 08-7, Accounting for Defensive Intangible Assets, now referred to as ASC350-30-25-5. ASC 350-30-25-5 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does notintend to actively use but intends to hold to prevent its competitors from obtaining access to them. As these assets are separatelyidentifiable, they must be recognized at fair value in accordance with ASC 805 and ASC 820. Defensive intangible assets recognized arerequired to be amortized over the estimated period during which an acquirer expects to receive benefit from preventing its competitors fromobtaining access to the intangible asset. ASC 350-30-25-5 is effective for fiscal years beginning on or after December 15, 2008. The effectof adopting ASC 350-30-25-5 on our consolidated results of operations and financial condition will be largely dependent on the size andnature of any business combinations and asset acquisitions that we may complete after September 30, 2009.In June 2008, the EITF ratified EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed toan Entity’s Own Stock, now referred to as ASC 815-40-15. ASC 815-40-15 provides guidance46 Table of Contentsin assessing whether derivative instruments meet the criteria in paragraph 11(a) of SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities, now referred to as ASC 815, for being considered indexed to an entity’s own common stock. ASC815-40-15 is effective for fiscal years beginning after December 15, 2008. We have completed our evaluation of the impact of ASC815-40-15 and believe the impact will be immaterial based on the nature of our derivative and hedging activities.In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments that May be Settled in Cash uponConversion, now referred to as ASC 470-20. ASC 470-20 requires companies to separately account for the liability (debt) and equity(conversion option) components of convertible debt instruments that require or permit settlement in cash upon conversion in a manner thatreflects the issuers’ nonconvertible debt borrowing rate at the time of issuance. ASC 470-20 is effective for fiscal years beginning afterDecember 15, 2008 and may not be adopted early. ASC 470-20 must be applied retrospectively to all periods presented. We havecompleted our evaluation of the adoption of this standard. We expect the adoption of this standard to result in additional quarterly non-cash interest expense of between $1.8 million and $2.2 million from adoption through fiscal 2014.In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, now referred to as ASC350-30-65-1. It amends the factors that should be considered in developing renewal or extension assumptions used to determine the usefullife of a recognized intangible asset under SFAS No. 142, Goodwill and Intangible Assets, now referred to as ASC 350. ASC350-30-65-1 is effective for fiscal years beginning after December 15, 2008 and may not be adopted early. We are continuing to evaluatethe potential impact of ASC 350-30-65-1.In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157, now referred to as ASC820-10-15-1A, which delays the effective date of ASC 820 for nonfinancial assets and nonfinancial liabilities, except for certain itemsthat are recognized or disclosed at fair value in the financial statements on a recurring basis. ASC 820-10-15-1A defers our adoption ofthese remaining provisions of ASC 820 to the first quarter of fiscal 2010. We do not believe the adoption of the remaining portions of ASC820 will have a material impact on our financial statements.In December 2007, the FASB issued SFAS 141R, now referred to as ASC 805. ASC 805 supersedes the previous accountingguidance related to business combinations, including the measurement of acquirer shares issued in consideration for a businesscombination, the recognition of and subsequent accounting for contingent consideration, the recognition of acquired in-process researchand development, the accounting for acquisition-related restructurings, the treatment of acquisition-related transaction costs and therecognition of changes in the acquirer’s income tax valuation allowance. The guidance is applied prospectively from the date of acquisitionwith minor exception related to income tax contingencies from companies acquired prior to the adoption date. ASC 805 is effective forfiscal years beginning after December 15, 2008 and may not be adopted early. The effect of adopting ASC 805 on our consolidatedresults of operations and financial condition will be largely dependent on the size and nature of any business combinations that we maycomplete after September 30, 2009; however we expect to write-off transaction costs of approximately $2.2 million that are capitalized asof September 30, 2009 related to pending acquisitions that were not consummated prior to our adoption date of October 1, 2009.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 payable47 Table of Contentsbalances reflected on our balance sheet. Therefore, the change in the value of the U.S. dollar compared to foreign currencies will haveeither a positive or negative effect on our financial position and results of operations. Historically, our primary exposure has related totransactions denominated in the Euro, British Pound, Canadian Dollar, Japanese Yen, Indian Rupee 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, 2009 would not have a material impact on our revenue, operating results or cash flows.Periodically, we enter into forward exchange contracts to hedge against foreign currency fluctuations. These contracts may or maynot be designated as cash flow hedges for accounting purposes. We have no foreign currency contracts designated as cash flow hedgesoutstanding at September 30, 2009. The notional contract amount of outstanding foreign currency exchange contracts not designated ascash flow hedges was €44.3 million at September 30, 2009. Based on the nature of the transaction for which the contracts werepurchased, a hypothetical change of 10% in exchange rates would not have a material impact on our financial results. During fiscal 2009and 2008, we recorded foreign exchange gains (losses) of $7.0 million and ($0.3) 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 theCredit Facility.At September 30, 2009, we held approximately $527.0 million of cash and cash equivalents primarily consisting of cash andmoney-market funds. Due to the low current market yields and the short-term nature of our investments, a hypothetical change in marketrates of one percentage point would not have a material effect on the fair value of our portfolio or results of operations.At September 30, 2009, our total outstanding debt balance exposed to variable interest rates was $650.3 million. To partially offsetthis variable interest rate exposure, we use interest rate swaps to convert specific variable-rate debt into fixed-rate debt. As of September 30,2009, we have two outstanding interest rate swaps designated as cash flow hedges with an aggregate notional amount of $200.0 million.The interest rates on these swaps are 2.7% and 2.1%, plus the applicable margin for the Credit Facility, and they expire in October 2010and November 2010, respectively. As of September 30, 2009 and September 30, 2008, the aggregate cumulative unrealized losses relatedto these derivatives were $4.0 million and $0.9 million, respectively. A hypothetical change in market rates would have a significantimpact on interest expense and amounts payable relating to the $450.3 million of debt that is not offset by the interest rate swaps.Assuming a one percentage point increase in interest rates, our interest expense relative to our outstanding debt would increase$4.5 million per annum.Item 8. Financial Statements and Supplementary DataNuance Communications, Inc. Consolidated Financial Statements48 Table of ContentsNUANCE COMMUNICATIONS, INC.INDEX TO FINANCIAL STATEMENTS PageReports of Independent Registered Public Accounting Firm 50 Consolidated Statements of Operations 52 Consolidated Balance Sheets 53 Consolidated Statements of Stockholders’ Equity and Comprehensive Loss 54 Consolidated Statements of Cash Flows 55 Notes to Consolidated Financial Statements 56 49 Table 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. as of September 30, 2009 and2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of thethree years in the period ended September 30, 2009. These financial statements are the responsibility of the Company’s management. Ourresponsibility 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overallfinancial 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, 2009 and 2008, and the results of its operations and its cash flows for each of the threeyears in the period ended September 30, 2009, in conformity with accounting principles generally accepted in the United States ofAmerica.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, 2009, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations (COSO), and our report datedNovember 25, 2009 expressed an unqualified opinion thereon./s/ BDO SEIDMAN, LLPBDO Seidman, LLPBoston, MassachusettsNovember 25, 200950 Table 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, 2009, 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.In our opinion, Nuance Communications, Inc. maintained, in all material respects, effective internal control over financial reportingas of September 30, 2009, based on the COSO criteria.We 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, 2009 and 2008, 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 30,2009 and our report dated November 25, 2009 expressed an unqualified opinion thereon./s/ BDO SEIDMAN, LLPBDO Seidman, LLPBoston, MassachusettsNovember 25, 200951 Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended September 30, 2009 2008 2007 (In thousands, except per share amounts) Revenue: Product and licensing $373,367 $414,360 $311,847 Professional services and hosting 411,363 305,540 165,520 Maintenance and support 165,622 148,562 124,629 Total revenue 950,352 868,462 601,996 Cost of revenue: Product and licensing 37,255 45,746 43,162 Professional services and hosting 254,777 214,031 114,228 Maintenance and support 29,129 31,477 27,461 Amortization of intangible assets 38,390 24,389 13,090 Total cost of revenue 359,551 315,643 197,941 Gross profit 590,801 552,819 404,055 Operating expenses: Research and development 119,434 114,986 80,024 Sales and marketing 219,226 231,244 184,948 General and administrative 112,068 105,910 75,564 Amortization of intangible assets 76,978 58,245 24,596 In-process research and development — 2,601 — Restructuring and other charges (credits), net 5,520 7,219 (54)Total operating expenses 533,226 520,205 365,078 Income from operations 57,575 32,614 38,977 Other income (expense): Interest income 3,562 8,032 5,991 Interest expense (40,103) (55,196) (36,501)Other income (expense), net 7,155 (964) 20 Income (loss) before income taxes 28,189 (15,514) 8,487 Provision for income taxes 40,391 14,554 22,502 Net loss $(12,202) $(30,068) $(14,015)Net loss per share: Basic and diluted $(0.05) $(0.14) $(0.08)Weighted average common shares outstanding: Basic and diluted 253,644 209,801 176,424 See accompanying notes.52 Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED BALANCE SHEETS September 30, September 30, 2009 2008 (In thousands, except per share amounts) ASSETSCurrent assets: Cash and cash equivalents $527,038 $261,540 Marketable securities — 56 Accounts receivable, less allowances for doubtful accounts of $6,833 and $6,925 199,548 203,542 Acquired unbilled accounts receivable 9,171 14,457 Inventories, net 8,525 7,152 Prepaid expenses and other current assets 51,545 28,536 Total current assets 795,827 515,283 Land, building and equipment, net 53,468 46,485 Goodwill 1,891,003 1,655,773 Intangible assets, net 706,805 585,023 Other assets 52,511 43,635 Total assets $3,499,614 $2,846,199 LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities: Current portion of long-term debt and capital leases $6,862 $7,006 Contingent and deferred acquisition payments 91,431 113,074 Accounts payable 59,574 31,517 Accrued expenses and other current liabilities 104,819 102,099 Accrued business combination costs 12,144 9,166 Deferred maintenance revenue 84,607 80,521 Unearned revenue and customer deposits 59,788 38,381 Total current liabilities 419,225 381,764 Long-term portion of debt and capital leases 888,611 894,184 Long-term portion of accrued business combination costs 24,904 32,012 Deferred revenue, net of current portion 33,904 18,134 Deferred tax liability 56,346 46,745 Other liabilities 73,186 48,452 Total liabilities 1,496,176 1,421,291 Commitments and contingencies (Notes 3, 5, and 19) Stockholders’ equity: Series B preferred stock, $0.001 par value; 15,000 shares authorized; 3,562 shares issued and outstanding(liquidation preference $4,631) 4,631 4,631 Common stock, $0.001 par value; 560,000 shares authorized; 280,647 and 232,592 shares issued and276,935 and 229,370 shares outstanding 281 232 Additional paid-in capital 2,254,511 1,658,512 Treasury stock, at cost (3,712 and 3,222 shares) (16,214) (16,070)Accumulated other comprehensive income 7,567 12,739 Accumulated deficit (247,338) (235,136)Total stockholders’ equity 2,003,438 1,424,908 Total liabilities and stockholders’ equity $3,499,614 $2,846,199 See accompanying notes.53 Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS Accumulated Additional Other Total Preferred Stock Common Stock Paid-In Treasury Stock Comprehensive Accumulated Stockholders’ Comprehensive Shares Amount Shares Amount Capital Shares Amount Income Deficit Equity Loss Balance at October 1, 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 ofcommon stock at 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 connectionwith acquisitions 1,400,091 1 (1) — Repurchase of shares (261,422) — (3,178) (3,178) Issuance of common stock in connection with exercise ofwarrants 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 ofcommon stock at 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 equityofferings, net of 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 connectionwith acquisitions 1,765,017 2 (2) — Vested options for the purchase of common stock,assumed in connection 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-retirementbenefits (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 Issuance of common stock under employee stock-basedcompensation plans 3,722,505 5 19,832 19,837 Issuance of restricted stock 2,945,149 3 (3) — Cancellation of restricted stock, and repurchase ofcommon stock at cost for employee tax withholding (885,944) (1) (10,401) 14,654 (143) (10,545) Share-based payments 71,407 71,407 Excess tax benefit from share-based payment plans 733 733 Issuance of common stock in connection with financing,net of expenses 17,395,626 17 175,029 175,046 Issuance of common stock in connection with warrantexercises, net of issuance costs 4,574,718 5 20,520 20,525 Issuance of common stock in connection with acquisitions 19,196,229 19 268,669 474,558 (1) 268,687 Issuance of common stock to escrow agent in connectionwith acquisitions 1,106,657 1 (1) — Vested options for the purchase of common stock,assumed in connection with acquisitions 11,523 11,523 Payments for escrow, make-whole and earn-outsettlements 38,691 38,691 Comprehensive loss: Net loss (12,202) (12,202) $(12,202) Unrealized gains on cash flow hedge derivatives andinvestments (3,103) (3,103) (3,103) Foreign currency translation adjustment 729 729 729 Unrealized losses on pensions (2,798) (2,798) (2,798) Comprehensive loss $(17,374) Balance at September 30, 2009 3,562,238 $4,631 280,647,312 $281 $2,254,511 3,711,531 $(16,214) $7,567 $(247,338) $2,003,438 See accompanying notes.54 Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended September 30, 2009 2008 2007 (In thousands) Cash flows from operating activities Net loss $(12,202) $(30,068) $(14,015)Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation of property and equipment 18,691 16,366 12,148 Amortization of intangible assets 115,368 82,634 37,685 In-process research and development — 2,601 — Bad debt provision 1,823 4,173 2,449 Stock-based compensation 71,407 68,631 48,135 Gain on foreign currency forward contracts (8,049) — — Deferred tax provision 25,718 491 14,068 Other 5,450 7,007 4,634 Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable 33,481 62,034 (14,217)Inventories (1,368) 1,125 (624)Prepaid expenses and other assets (12,659) (2,546) (4,413)Accounts payable 26,582 (11,946) 10,736 Accrued expenses and other liabilities (5,007) (14,251) 9,233 Deferred maintenance revenue, unearned revenue and customer deposits (546) 9,948 603 Net cash provided by operating activities 258,689 196,199 106,422 Cash flows from investing activities Capital expenditures (19,512) (17,716) (12,656)Payments for acquisitions, net of cash acquired (99,120) (392,527) (564,295)Payment for equity investment (159) (2,172) — Payments for capitalized patent costs and licensing agreements (65,875) (36,479) (7,501)Proceeds from maturities of marketable securities 56 2,577 5,714 Change in restricted cash balances — 238 1,023 Net cash used in investing activities (184,610) (446,079) (577,715)Cash flows from financing activities Payments of debt and capital leases (6,999) (7,771) (6,768)Deferred acquisition payments — — (18,650)Proceeds from credit facility and convertible debentures, net of discount and issuance costs — — 551,447 Proceeds from issuance of common stock and common stock warrants, net of issuance costs 195,571 330,603 — Purchase of treasury stock (144) (652) (2,559)Repurchase of shares — — (3,178)Payments on other long-term liabilities (9,180) (11,379) (11,419)Excess tax benefits from share-based awards 733 5,200 4,172 Proceeds from issuance of common stock from employee stock options and purchase plan 19,837 28,140 30,199 Cash used to net share settle employee equity awards (10,402) (17,002) (1,758)Net cash provided by financing activities 189,416 327,139 541,486 Effects of exchange rate changes on cash and cash equivalents 2,003 (54) 1,808 Net increase in cash and cash equivalents 265,498 77,205 72,001 Cash and cash equivalents at beginning of year 261,540 184,335 112,334 Cash and cash equivalents at end of year $527,038 $261,540 $184,335 See accompanying notes.55 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. Organization and PresentationNuance Communications, Inc. (“we,” “Nuance,” or “the Company”) is a leading provider of speech, imaging and keypad solutionsfor businesses, organizations and consumers around the world. Our technologies, applications and services make the user experiencemore compelling by transforming the way people interact with devices and systems, and how they create, share and use documents. Oursolutions are used every day by millions of people and thousands of businesses for tasks and services such as requesting informationfrom a phone-based self-service solution, dictating medical records, searching the mobile Web by voice, entering a destination into anavigation system, or working with PDF documents. Our solutions help make these interactions, tasks and experiences more productive,compelling and efficient. We leverage our global professional services organization and our extensive network of partners to design anddeploy innovative solutions for businesses and organizations around the globe. We market and distribute our products through a globalnetwork of resellers, including system integrators, independent software vendors, value-added resellers, hardware vendors,telecommunications carriers and distributors, and also sell directly through a dedicated sales force and through our e-commerce website.We were incorporated in 1992 as Visioneer, Inc. In 1999, we changed our name to ScanSoft, Inc., and changed our ticker symbolto SSFT. In October 2005, we changed our name to Nuance Communications, Inc. and changed our ticker symbol to NUAN inNovember 2005.We have built a portfolio of speech solutions through both internal development and acquisitions, and expect to continue to pursueopportunities to broaden our solutions and customer base through acquisitions. Significant business acquisitions during fiscal 2009,2008 and 2007 were as follows: • October 1, 2008 — SNAPin, Inc. (“SNAPin”) • September 26, 2008 — Philips Speech Recognition Systems GMBH, a business unit of Royal Philips Electronics (“PSRS”); • May 20, 2008 — eScription, Inc. (“eScription”); • November 26, 2007 — Viecore, Inc. (“Viecore”); • August 24, 2007 — Voice Signal Technologies, Inc. (“VoiceSignal”); • August 24, 2007 — Tegic Communications, Inc. (“Tegic”); • April 24, 2007 — BeVocal, Inc. (“BeVocal”); and • March 26, 2007 — Bluestar Resources Limited, the parent of Focus Enterprises Limited and Focus India Private Limited(collectively “Focus”).The results of operations from the acquired businesses have been included in our consolidated financial statements from theirrespective acquisition dates. See Note 3 for additional disclosure related to each of these acquisitions.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, we evaluate our estimates, assumptions and judgments. The most important of these relate to revenue recognition; theallowance for doubtful accounts and sales returns; accounting for patent legal defense costs; the costs to develop, and estimates of theexpected useful lives of, custom software applications; the valuation of goodwill, intangible assets and tangible56 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)long-lived assets; accounting for business combinations; accounting for stock-based compensation; accounting for long-term facilityobligations; the valuation of derivative instruments; accounting for income taxes and related valuation allowances; and loss contingencies.We base our estimates on historical experience, market participant fair value considerations and various other factors that are believed tobe reasonable under the circumstances. Actual amounts could differ significantly from these estimates.Basis of ConsolidationThe consolidated financial statements include our accounts and those of our wholly-owned domestic and foreign subsidiaries.Intercompany transactions and balances have been eliminated. The accounts, results of operations and cash flows of acquired companiesare included from their respective acquisition dates.ReclassificationCertain amounts presented in prior periods’ consolidated financial statements have been reclassified to conform to the currentperiods’ presentation. Proceeds from employee stock options and purchase plans and cash used to net-share settle employee equity awardsare now presented as two separate line items in the consolidated Statements of Cash Flows, whereas previously they were presented withinnet proceeds from issuance of common stock under employee share-based payment plans. The current portion of our deferred tax assethas been included in the prepaid expenses and other current assets line item whereas previously it was presented as a separate line item.Revenue RecognitionWe derive revenue from the following sources: (1) software license agreements, including royalty and other usage-basedarrangements, (2) post-contract customer support, (3) fixed and variable fee hosting arrangements and (4) professional services. Ourrevenue recognition policies for these revenue streams are discussed below.The sale and/or license of software products and technology is deemed to have occurred when a customer either has taken possessionof the related software or technology or has the contractual right to take possession of the software or technology at its sole discretion andwithout undue economic cost or burden. In select situations, we sell or license intellectual property in conjunction with, or in place of,embedding our intellectual property in software. We recognize revenue from the sale or license of software products and licensing oftechnology when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable and(iv) collectibility is probable. Vendor-specific objective evidence (“VSOE”) of fair value for software and software-related services existswhen a company can support what the fair value of its software and/or software-related services is based on evidence of the prices chargedwhen the same elements are sold separately. VSOE of fair value is required, generally, in order to separate the accounting for variouselements in a software and related services arrangement. We, in general, have established VSOE of fair value of post-contract customersupport (“PCS”), professional services, and training.Revenue from royalties on sales of our software products by original equipment manufacturers (“OEMs”), where no services areincluded, is recognized in the quarter earned so long as we have been notified by the OEM that such royalties are due, and provided thatall 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. Revenue from PCS is generally recognizedratably on a straight-line basis over the term that the maintenance service is provided.Non-software revenue, such as arrangements containing hosting services where the customer does not take possession of thesoftware at the outset of the arrangement and has no contractual right to do so, is recognized 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.57 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)For revenue arrangements with multiple elements that are not considered to be software or software-related, we allocate anarrangement’s fees into separate units of accounting based on fair value. We generally support fair value of our deliverables based uponthe prices we charge when we sell similar elements separately.Revenue from products offered on a subscription and/or hosted, on-demand basis is recognized in the period the services areprovided, based on a fixed minimum fee and/or variable fees based on the volume of activity. Variable subscription and hosting revenueis recognized as we are notified by the customer or through management reports that such revenue is due, provided that all other revenuerecognition 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 we provide professional services considered essential to the functionality of the software, we recognize revenue from theprofessional services as well as any related software licenses on a percentage-of-completion basis whereby the arrangement consideration isrecognized as the services are performed as measured by an observable input. In these circumstances, we separate license revenue fromprofessional service revenue for income statement presentation by classifying the fair value of professional service revenue as professionalservice revenue and the residual portion as license revenue. We generally determine the percentage-of-completion by comparing the laborhours incurred to-date to the estimated total labor hours required to complete the project. We consider labor hours to be the most reliable,available measure of progress on these projects. Adjustments to estimates to complete are made in the periods in which facts resulting in achange become known. When the estimate indicates that a loss will be incurred, such loss is recorded in the period identified. Significantjudgments and estimates are involved in determining the percent complete of each contract. Different assumptions could yield materiallydifferent 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, provided all other revenue recognition criteria are met. Certain distributors and value-added resellers have been granted rights ofreturn for as long as the distributors or resellers hold the inventory. We cannot estimate historical returns from these distributors andresellers to have a basis upon which to estimate future sales returns. As a result, we recognize revenue from sales to these distributors andresellers when the products are sold through to retailers and end-users.When products are sold directly to end-users, we make an estimate of sales returns based on historical experience. The provision forthese estimated returns is recorded as a reduction of revenue and accounts receivable at the time that the related revenue is recorded. Ifactual returns differ significantly from our estimates, such differences could have a material impact on our results of operations for theperiod in which the actual returns become known.When maintenance and support contracts renew automatically, we provide a reserve based on historical experience for contractsexpected to be cancelled for non-payment. All known and estimated cancellations are recorded as a reduction to revenue and accountsreceivable.We record consideration given to a reseller as a reduction of revenue to the extent we have recorded cumulative revenue from thecustomer or reseller. However, when we receive an identifiable benefit in exchange for the consideration, and can reasonably estimate thefair value of the benefit received, the consideration is recorded as an operating expense.We record reimbursements received for out-of-pocket expenses as revenue, with offsetting costs recorded as cost of revenue.Out-of-pocket expenses generally include, but are not limited to, expenses related to transportation, lodging and meals.We record shipping and handling costs billed to customers as revenue with offsetting costs recorded as cost of revenue.58 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Business CombinationsWe determine and allocate the purchase price of an acquired company to the tangible and intangible assets acquired and liabilitiesassumed as well as to in-process research and development as of the business combination date. Results of operations and cash flows ofacquired companies are included from the date of acquisition. The purchase price allocation process requires us to use significantestimates and assumptions, 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; • probability of required payment under contingent consideration provisions; • estimated income tax assets and liabilities assumed from the acquiree; and • estimated fair value of pre-acquisition contingencies assumed from the acquiree.While we use our best estimates and assumptions as a part of the purchase price allocation process to accurately value assetsacquired and liabilities assumed at the business combination date, our estimates and assumptions are inherently uncertain and subject torefinement. As a result, during the purchase price allocation period, which is generally one year from the business combination date, werecord adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Generally, with the exceptionof unresolved income tax matters, subsequent to the purchase price allocation period any adjustment to assets acquired or liabilitiesassumed is included in operating results in the period in which the adjustment is determined. For changes in the valuation of intangibleassets between preliminary and final purchase price allocation, the related amortization is adjusted on a prospective basis.In fiscal 2010, we will adopt the business combinations accounting guidance in Financial Accounting Standards Board (“FASB”)Accounting Standards Codification (“ASC”) 805 [formerly referred to as Statement of Financial Accounting Standards (“SFAS”)No. 141(Revised), Business Combinations (“SFAS 141R”)]. Refer to Recently Issued Accounting Standards below for additionalinformation.Goodwill and Indefinite-Lived Intangible AssetsGoodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangibleassets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but rather are required to be evaluated at leastannually to ensure that their current fair value exceeds their carrying value.The carrying amounts of these assets are reviewed for impairment at least annually or whenever events or changes in circumstancesindicate that the carrying value of these assets may not be recoverable. Our annual impairment assessment date is July 1 of each fiscalyear. Goodwill is evaluated for impairment based on comparison of the fair value of our reporting units to their recorded carrying values.We have determined that beginning in fiscal 2009, we have three reporting units based on the level of information provided to, and reviewthereof, by our core market management. The three determined reporting units are our three core market groups. Prior to fiscal 2009, weconcluded that we were comprised of only one reporting unit. The fair values of the reporting units for the annual impairment assessmentwere determined based on estimates of those reporting units’ enterprise values as a function59 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of trailing-twelve-month (“TTM”) revenues and EBITDA as compared to companies comparable to each of the reporting units on astandalone basis. The carrying values of the reporting units were determined based on an allocation of the Company’s assets andliabilities through specific allocation of certain assets and liabilities to the reporting units and an apportionment method based on relativesize of the reporting units’ revenues and operating expenses compared to the Company as a whole. Certain corporate assets that are notinstrumental to the reporting units’ operations and would not be transferred to hypothetical purchasers of the reporting units were excludedfrom the reporting units’ carrying values. Indefinite-lived intangibles are evaluated for impairment through comparison of the fair value ofthe assets to their net book value. No impairments of goodwill or indefinite-lived intangibles have been recorded in fiscal 2009, 2008 or2007.Long-Lived AssetsOur long-lived assets consist principally of acquired intangible assets and land, buildings and equipment. Land, buildings andequipment are stated at cost. Buildings and equipment are depreciated over their estimated useful lives. Leasehold improvements aredepreciated over the shorter of the related lease term or the estimated useful life. Costs of computer software developed or obtained forinternal use are depreciated over the estimated useful life of the software. Depreciation is computed using the straight-line method. Costs ofsignificant improvements on existing software are capitalized and amortized over the remaining useful life of the related software. Repairand maintenance costs are expensed as incurred. The cost and related accumulated depreciation of sold or retired assets are removed fromthe accounts and any gain or loss is included in operations.We include in our amortizable intangible assets those intangible assets acquired in our business and asset acquisitions, includingcertain technology that is licensed from third parties. We amortize acquired intangible assets with finite lives over the estimated economiclives of the assets, generally using the straight-line method except where the pattern of the expected economic benefit is readily identifiable,primarily customer relationship intangibles, whereby amortization follows that pattern. Each period, we evaluate the estimated remaininguseful life of acquired and licensed intangible assets, as well as land, buildings and equipment, to determine whether events or changes incircumstances warrant a revision to the remaining period of depreciation or amortization.We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset orasset group may not be recoverable. We assess the recoverability of the assets based on the undiscounted future cash flows the assets areexpected to generate and recognize an impairment loss when estimated undiscounted future cash flows expected to result from the use ofthe assets plus net proceeds expected from disposition of the assets, if any, are less than the carrying value of the assets. If an asset orasset group is deemed to be impaired, the amount of the impairment loss, if any, represents the excess of the asset or asset group’scarrying value compared to its estimated fair value.We conducted a long-lived asset impairment analysis at the beginning of the fourth quarter of fiscal 2009 and concluded that ourlong-lived assets were not impaired. In fiscal 2008, we recorded impairment charges of $3.9 million resulting from the identification ofcertain specific acquired intangible assets that were no longer being utilized or providing economic benefit, of which $0.3 million wasincluded in cost of revenue from amortization of intangible assets, and $3.6 million was included in amortization of intangible assetswithin operating expenses. There were no impairment charges for long-lived assets recorded in fiscal 2007.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.60 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Marketable Securities and Minority InvestmentsMarketable Securities: Investments are classified as available-for-sale and are recorded on the balance sheet at fair value withunrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of tax.Minority Investment: We record investments in other companies where we do not have a controlling interest or significant influencein the equity investment at cost within other assets in our consolidated balance sheet.We review all of our investments for impairment whenever estimated declines in fair value are deemed to be other-than-temporary,reducing the carrying value of such investments to their estimated fair value at that time.Allowances against Accounts ReceivableAllowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for the estimated probable losses onuncollectible accounts receivable. The allowance is based upon the credit worthiness of our customers, our historical experience, the age ofthe receivable and current market and economic conditions. Receivables are written off against these allowances in the period they aredetermined to be uncollectible.Allowance for Sales Returns: We maintain an allowance for sales returns from customers for which we have the ability to estimatereturns based on historical experience. The returns allowance is recorded as a reduction in revenue and accounts receivable at the time therelated revenue is recorded. Receivables are written off against the allowance in the period the return is received.For the years ended September 30, 2009, 2008 and 2007, the allowances against accounts receivables were as follows (inthousands): Allowance for Allowance for Doubtful Accounts Sales Returns Balance at October 1, 2006 $4,106 $6,304 Bad debt expenses 2,449 — Write-offs, net of recoveries (400) — Reductions (additions) made to revenue, net — 1,019 Balance at September 30, 2007 6,155 7,323 Bad debt expenses 4,173 — Write-offs, net of recoveries (3,403) — Reductions (additions) made to revenue, net — (960)Balance at September 30, 2008 6,925 6,363 Bad debt expenses 1,823 — Write-offs, net of recoveries (1,915) — Reductions (additions) made to revenue, net — (257)Balance at September 30, 2009 $6,833 $6,106 InventoriesInventories are stated at the lower of cost, computed using the first-in, first-out method, or market. We regularly review inventoryquantities on hand and record a provision for excess and/or obsolete inventory primarily based on future purchase commitments with oursuppliers, and the estimated utility of our inventory as well as other factors including technological changes and new productdevelopment.61 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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 CostsSoftware development costs related to software that is or will be sold or licensed externally to third-parties, or for which a substantiveplan exists to sell or license such software in the future, incurred subsequent to the establishment of technological feasibility, but prior tothe general release of the product, are capitalized and amortized to cost of revenue over the estimated useful life of the related products. Wehave determined that technological feasibility is reached shortly before the general release of our software products. Costs incurred aftertechnological feasibility is established have not been material, and accordingly, we have expensed the internal costs relating to researchand development when incurred.Capitalized Patent Defense CostsWe monitor the anticipated outcome of legal actions, and if we determine that the success of the defense of a patent is probable, andso long as we believe that the future economic benefit of the patent will be increased, we capitalize external legal costs incurred in thedefense of these patents, up to the level of the expected increased future economic benefit. If changes in the anticipated outcome occur, wewrite-off any capitalized costs in the period the change is determined. Upon successful defense of the patent, the amounts previouslycapitalized are amortized over the remaining life of the patent. As of September 30, 2009 and 2008, capitalized patent defense costsrecorded in other assets totaled $6.8 million and $6.7 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 our products, subject to defined criteria. Cooperative advertising obligationsare accrued and the costs expensed at the same time the related revenue is recognized. Cooperative advertising expenses are recorded asexpense to the extent that an advertising benefit separate from the revenue transaction can be identified and the cash paid does not exceedthe fair value of that advertising benefit received. Any excess of cash paid over the fair value of the advertising benefit received is recordedas a reduction in revenue. We incurred advertising costs of $15.8 million, $20.9 million and $19.2 million for fiscal 2009, 2008 and2007, 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. We do not provide for U.S. incometaxes on the undistributed earnings of our foreign subsidiaries, which we consider to be indefinitely reinvested outside of the U.S.We make judgments regarding the realizability of our deferred tax assets. The balance sheet carrying value of our net deferred taxassets is based on whether we believe that it is more likely than not that we will generate sufficient future taxable income to realize thesedeferred tax assets after consideration of all available evidence. We regularly review our deferred tax assets for recoverability consideringhistorical profitability, projected future taxable income, and the expected timing of the reversals of existing temporary differences and taxplanning strategies.Valuation allowances have been established for U.S. deferred tax assets, which we believe do not meet the “more likely than not”criteria for recognition. If we are subsequently able to utilize all or a portion of the deferred62 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)tax assets for which a valuation allowance has been established, then we may be required to recognize these deferred tax assets through thereduction of the valuation allowance which could result in a material benefit to its results of operations in the period in which the benefit isdetermined, 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 or other equity transactions where prevailing guidance requires thechange in valuation allowance to be traced forward through stockholders’ equity. The recognition of the portion of the valuation allowancewhich relates to net deferred tax assets resulting from share-based payments or other qualifying equity transactions will be recorded asadditional paid-in-capital; the recognition of the portion of the valuation allowance which relates to net deferred tax assets acquired in abusiness combination will reduce goodwill, intangible assets, and to the extent remaining, the provision for income taxes, until ouradoption of the business combination accounting guidance in ASC 805 on October 1, 2009; after which time the reductions in theallowance, if any, will be recorded as a benefit in the statement of operations.We establish reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement ofuncertain tax positions. Under the comprehensive model, reserves are established when we have determined that it is more likely than notthat a tax position will or will not be sustained and at the greatest amount for which the result is more likely than not.Comprehensive LossTotal comprehensive loss, net of taxes, was approximately $17.4 million, $32.3 million and $4.7 million for fiscal 2009, 2008 and2007, respectively. Comprehensive loss consists of net loss, current period foreign currency translation adjustments, unrealized losses oncash flow hedge derivatives, and unrealized gains (losses) on pensions. For the purposes of comprehensive loss disclosures, we do notrecord tax provisions or benefits for the net changes in the foreign currency translation adjustment, as we intend to reinvest undistributedearnings in our foreign subsidiaries permanently.The components of accumulated other comprehensive income, reflected in the Consolidated Statements of Stockholders’ Equity andComprehensive Loss, consisted of the following (in thousands): 2009 2008 2007 Foreign currency translation adjustment $15,874 $15,145 $11,854 Net unrealized losses on cash flow hedge derivatives (3,982) (879) (925)Net unrealized gains (losses) on pensions (4,325) (1,527) 4,050 $7,567 $12,739 $14,979 Concentration of RiskFinancial instruments that potentially subject us to significant concentrations of credit risk principally consist of cash, cashequivalents, and trade accounts receivable. We place our cash and cash equivalents with financial institutions with high credit ratings. Aspart of our cash and investment management processes, we perform periodic evaluations of the credit standing of the financial institutionswith whom we maintain deposits, and have not recorded any credit losses to-date. For trade accounts receivable, we perform ongoingcredit evaluations of our customers’ financial condition and limit the amount of credit extended when deemed appropriate. AtSeptember 30, 2009 and 2008, no customer accounted for greater than 10% of our net accounts receivable balance. No customercomposed more than 10% of revenue for fiscal 2009, 2008 and 2007.63 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Fair Value of Financial InstrumentsFinancial instruments including cash equivalents, marketable securities, investments, accounts receivable, and derivativeinstruments, are carried in the financial statements at amounts that approximate their fair value based on the short maturities of thoseinstruments. Refer to Note 11 for discussion of the fair value of our long-term debt.Foreign Currency TranslationWe have significant foreign operations and transact 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 re-measured 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 average exchange rates ineffect during each fiscal month during the year. The effects of foreign currency translation adjustments are included as a component ofaccumulated other comprehensive income in the accompanying consolidated balance sheets. Foreign currency transaction gains (losses)included in net loss for fiscal 2009, 2008, and 2007 were $7.0 million, $(0.3) million, and $0.8 million, respectively.Financial Instruments and Hedging ActivitiesWe utilize derivative instruments in our business combination and asset acquisition arrangements, as well as to hedge specificfinancial risks such as interest rate and foreign exchange risk. We do not engage in speculative hedging activity. In order for us to accountfor a derivative instrument as a hedge, specific criteria must be met, including: (i) ensuring at the inception of the hedge that formaldocumentation exists for both the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedgeand (ii) at the inception of the hedge and on an ongoing basis, the hedging relationship is expected to be highly effective in achievingoffsetting changes in fair value attributed to the hedged risk during the period that the hedge is designated. Further, an assessment ofeffectiveness is required whenever financial statements or earnings are reported. Absent meeting these criteria, changes in fair value arerecognized in other income (expense), net, in the consolidated statements of operations. Once the underlying forecasted transaction isrealized, the gain or loss from the derivative designated as a hedge of the transaction is reclassified from accumulated other comprehensiveincome (loss) to the statement of operations, in the appropriate revenue or expense caption. Any ineffective portion of the derivativesdesignated as cash flow hedges is recognized in current earnings.Accounting for Share-Based PaymentsWe account for share-based payments to employees and directors, including grants of employee stock options, purchases underemployee stock purchase plans, awards in the form of restricted shares (“Restricted Stock”) and awards in the form of units of stockpurchase rights (“Restricted Units”) through recognition of the fair value of the share-based payments as a charge against earnings. Werecognize stock-based compensation expense over the requisite service period. The Restricted Stock and Restricted Units are collectivelyreferred to as “Restricted Awards.”Net Income (Loss) Per ShareWe compute net income (loss) per share in accordance with the Two-Class Method. Under the two-class method, basic net incomeper share is computed by dividing the net income available to common stockholders by the weighted-average number of common sharesoutstanding during the period. Net losses are not allocated to preferred stockholders. We have determined that our outstanding Series Bconvertible preferred stock represents a participating security and as such shares thereof are excluded from basic earnings per share.64 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Diluted net income per share is computed using the more dilutive of (a) the two-class method, or (b) the if-converted method. Weallocate net income first to preferred stockholders based on dividend rights and then to common and preferred stockholders based onownership 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 underearn-out agreements once earned, warrants, and potential issuance of stock upon conversion of convertible debentures. On August 13,2007, we issued $250.0 million of 2.75% convertible debentures which are considered Instrument C securities due to the fact that onlythe excess of the conversion value on date of conversion can be paid in our common shares; the principal portion of the conversion mustbe paid in cash. Therefore, only the shares of common stock potentially issuable with respect to the excess of the conversion value over itsprincipal amount, if any, is considered as dilutive potential common shares for purposes of calculating diluted net income per share. Theconversion value for the convertible debentures was less than the principal amount since its issuance date and no shares were assumed tobe 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 31.6 million shares, 33.1 million shares and 26.3 million shares for theyears ended September 30, 2009, 2008 and 2007, respectively, have been excluded from the computation of diluted net loss per sharebecause their inclusion would be anti-dilutive.Recently Issued Accounting StandardsIn September 2009, the Emerging Issues Task Force (“EITF”) ratified EITF Issue No. 08-1, Revenue Arrangements with MultipleDeliverables (“EITF 08-1”). EITF 08-1, which has not yet been codified in the FASB Accounting Standards Codification (“theCodification” or “ASC”), supersedes EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, now referred to asASC 605-25-50-1. EITF 08-1 eliminates the residual method of accounting for non-software arrangements, as well as the associatedrequirements for establishing vendor objective evidence of fair value. The residual method is replaced in EITF 08-1 by the estimatedselling price method whereby revenue in a multiple-element arrangement is allocated to each element based on its estimated selling price.Estimating selling price is established through a hierarchy starting with vendor-specific objective evidence of fair value, following bythird-party evidence, and lastly by any reasonable, objective estimate of the selling price were the element to be sold on a standalone basis.Estimates of selling price must consider both entity-specific factors and market conditions. EITF 08-1 is applied prospectively to allrevenue transactions entered into, or materially modified, after June 15, 2010. Early adoption is permitted if adopted as of the beginningof an entity’s fiscal year and no prior interim period financial statements from that fiscal year have already been issued or the entityretrospectively applies the provisions of this EITF issue to its previously-issued current fiscal year interim financial statements. Wecurrently do not expect that the adoption of EITF 08-1 will have a material impact on our consolidated financial statements.In September 2009, the EITF ratified EITF Issue No. 09-3, Applicability of AICPA Statement of Position 97-2 to CertainArrangements That Include Software Elements (“EITF 09-3”). EITF 09-3, which has not yet been codified in the Codification, appliesto multiple-element arrangements that contain both software and hardware elements, and amends the scope of AICPA Statement of Position(“SOP”) No. 97-2, Software Revenue Recognition, now referred to as ASC 985-605, to exclude tangible products containing softwareand non-software components that together function to deliver the product’s essential functionality from the scope of ASC 985-605.EITF 09-3 is applied prospectively to all revenue transactions entered into, or materially modified, after June 15, 2010. Early adoption ispermitted only when EITF 08-1 is also early adopted as of the same period. We are currently evaluating the potential impact of this EITFissue on our consolidated financial statements.In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of GenerallyAccepted Accounting Principles (“SFAS 168”), now referred to as ASC 105-10, Generally Accepted Accounting Principles. Thisstandard establishes the Codification as the sole source of authoritative65 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements inconformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federalsecurities laws remain sources of authoritative GAAP for SEC registrants. ASC 105-10 is effective for financial statements issued forinterim and annual periods ending after September 15, 2009. We have included references to the Codification, where appropriate, in ourconsolidated financial statements.In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”), now referred to as ASC 855-10. ASC 855-10incorporates accounting and disclosure requirements related to subsequent events into U.S. GAAP. The requirements of ASC 855-10 forsubsequent-events accounting and disclosure are not significantly different from those in existing auditing standards, which we havehistorically followed for financial reporting purposes. As a result, we do not believe this standard had any material impact on ourfinancial statements. We have evaluated subsequent events through the date of issuance of these consolidated financial statements, whichis November 25, 2009.In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value ofFinancial Instruments, now referred to as ASC 825-10. ASC 825-10 requires disclosures about fair value of financial instruments forinterim reporting periods of publicly traded companies as well as in annual financial statements. ASC 825-10 also requires thosedisclosures in summarized financial information at interim reporting periods. ASC 825-10 was effective for interim periods ending afterJune 15, 2009. We adopted ASC 825-10 in our third quarter fiscal 2009, and it had no material impact on our third quarter financialstatements.In April 2009, the FASB issued FSP FAS 141R-1, Accounting for Assets Acquired and Liabilities Assumed in a BusinessCombination That Arise from Contingencies (“FSP 141R-1”), the guidance from which is included in ASC 805. This FSP requiresthat assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value, if fairvalue can be reasonably estimated. This FSP is effective for the fiscal years beginning after December 15, 2008. As this FSP essentiallyreinstates to SFAS No. 141 (Revised), Business Combinations (“SFAS 141R”), now referred to as ASC 805, the guidance foraccounting for acquired contingencies from SFAS No. 141, we do not believe FSP 141R-1 will have a material impact on our financialstatements.In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset orLiability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, now referred to as ASC 820-10. ASC820-10 provides guidance on how to determine the fair value of assets and liabilities under ASC 820 (formerly known as SFAS No. 157,Fair Value Measurements) in the current economic environment and reemphasizes that the objective of a fair value measurement remainsan exit price. If we were to conclude that there has been a significant decrease in the volume and level of activity of the asset or liability inrelation to normal market activities, quoted market values may not be representative of fair value and we may conclude that a change invaluation technique or the use of multiple valuation techniques may be appropriate. ASC 820 is effective for interim and annual periodsending after June 15, 2009. We adopted ASC 820-10 effective April 1, 2009 and such adoption has not had a material impact on ourfinancial statements, nor do we expect it to in future periods.In November 2008, the EITF ratified EITF Issue No. 08-7, Accounting for Defensive Intangible Assets, now referred to as ASC350-30-25-5. ASC 350-30-25-5 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does notintend to actively use but intends to hold to prevent its competitors from obtaining access to them. As these assets are separatelyidentifiable, they must be recognized at fair value in accordance with ASC 805 and ASC 820. Defensive intangible assets recognized arerequired to be amortized over the estimated period during which an acquirer expects to receive benefit from preventing its competitors fromobtaining access to the intangible asset. ASC 350-30-25-5 is effective for fiscal years beginning on or after December 15, 2008. The effectof adopting ASC 350-30-25-5 on our consolidated results of operations and66 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)financial condition will be largely dependent on the size and nature of any business combinations and asset acquisitions that we maycomplete after September 30, 2009.In June 2008, the EITF ratified EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed toan Entity’s Own Stock, now referred to as ASC 815-40-15. ASC 815-40-15 provides guidance in assessing whether derivativeinstruments meet the criteria in paragraph 11(a) of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, nowreferred to as ASC 815, for being considered indexed to an entity’s own common stock. ASC 815-40-15 is effective for fiscal yearsbeginning after December 15, 2008. We have completed our evaluation of the impact of ASC 815-40-15 and believe the impact will beimmaterial based on the nature of our derivative and hedging activities.In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments that May be Settled in Cash uponConversion, now referred to as ASC 470-20. ASC 470-20 requires companies to separately account for the liability (debt) and equity(conversion option) components of convertible debt instruments that require or permit settlement in cash upon conversion in a manner thatreflects the issuers’ nonconvertible debt borrowing rate at the time of issuance. ASC 470-20 is effective for fiscal years beginning afterDecember 15, 2008 and may not be adopted early. ASC 470-20 must be applied retrospectively to all periods presented. We havecompleted our evaluation of the adoption of this standard. We expect the adoption of this standard to result in additional quarterly non-cash interest expense of between $1.8 million and $2.2 million from adoption through fiscal 2014.In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, now referred to as FASBASC 350-30-65-1. It amends the factors that should be considered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under SFAS No. 142, Goodwill and Intangible Assets, now referred to as ASC 350. ASC350-30-65-1 is effective for fiscal years beginning after December 15, 2008 and may not be adopted early. We are continuing to evaluatethe potential impact of ASC 350-30-65-1.In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157, now referred to as ASC820-10-15-1A, which delays the effective date of ASC 820 for non-financial assets and non-financial liabilities, except for certain itemsthat are recognized or disclosed at fair value in the financial statements on a recurring basis. ASC 820-10-15-1A defers our adoption ofthese remaining provisions of ASC 820 to the first quarter of fiscal 2010. We do not believe the adoption of the remaining portions of ASC820 will have a material impact on our financial statements.In December 2007, the FASB issued SFAS 141R, now referred to as ASC 805. ASC 805 supersedes the previous accountingguidance related to business combinations, including the measurement of acquirer shares issued in consideration for a businesscombination, the recognition of and subsequent accounting for contingent consideration, the recognition of acquired in-process researchand development, the accounting for acquisition-related restructurings, the treatment of acquisition-related transaction costs and therecognition of changes in the acquirer’s income tax valuation allowance. The guidance is applied prospectively from the date of acquisitionwith minor exception related to income tax contingencies from companies acquired prior to the adoption date. ASC 805 is effective forfiscal years beginning after December 15, 2008 and may not be adopted early. The effect of adopting ASC 805 on our consolidatedresults of operations and financial condition will be largely dependent on the size and nature of any business combinations that we maycomplete after September 30, 2009; however we expect to write-off transaction costs of approximately $2.2 million that are capitalized asof September 30, 2009 related to pending acquisitions that were not consummated prior to our adoption date of October 1, 2009.67 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)3. Business Acquisitions2009 AcquisitionsAcquisition of SNAPinOn October 1, 2008, we acquired all of the outstanding capital stock of SNAPin, a developer of self-service software for mobiledevices, to expand our Mobile-Enterprise offerings. The acquisition was a taxable event.In connection with our acquisition of SNAPin, we agreed to make a contingent earn-out payment of up to $45.0 million in cash to bepaid, if at all, based on the business achieving certain performance targets that are measurable from the acquisition date to December 31,2009. Additionally, we would be required to issue earn-out consideration to SNAPin option holders. This option earn-out consideration, ifearned, is payable at our sole discretion, in cash, stock or additional options to purchase common stock. The total value of this optionearn-out consideration may aggregate up to $2.5 million which will be recorded as compensation expense over the service period, ifearned. These earn-out payments, if any, would be payable upon the final measurement of the performance targets. As of September 30,2009, we have recorded approximately $12.9 million related to the contingent earn-out provisions as additional purchase price.A summary of the purchase price allocation for the acquisition of SNAPin is as follows (in thousands):Total purchase consideration: Common stock(a) $166,253 Stock options and restricted stock units assumed 11,523 Contingent earn-out consideration 12,941 Transaction costs 2,825 Total purchase consideration $193,542 Allocation of the purchase consideration: Current assets $6,084 Other assets 2,972 Deferred tax asset(c) 2,327 Identifiable intangible assets 60,900 Goodwill 153,299 Total assets acquired 225,582 Current liabilities (2,191)Deferred tax liability(c) (2,327)Deferred revenue(b) (27,522)Total liabilities assumed (32,040)Net assets acquired $193,542 (a)Approximately 9.5 million shares of our common stock valued at $15.81 per share were issued at closing and 1.1 million sharesvalued at $14.11 per share were issued upon release of shares held in escrow.(b)We assumed significant legal performance obligations related to acquired customer contracts. We estimate the fair market value ofthe obligations based on expected costs we will incur to fulfill the obligation plus a normal profit margin. The fair value of the legalperformance obligations remaining to be delivered on these customer contracts was approximately $53.4 million and the remainingcash to be collected on these contracts was approximately $25.9 million at the date of acquisition.68 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)(c)We recorded a deferred tax liability as a result of purchase accounting associated with SNAPin. This results in an increase of the netdeferred tax asset and a reduction of the corresponding valuation allowance in the consolidated group. Therefore, there is no impacton goodwill related to the deferred tax liability.We assumed vested and unvested stock options that were converted into options to purchase 1,258,708 shares of our commonstock and restricted stock units that were converted into 299,446 shares of our common stock. The fair value of the assumed vestedstock options and restricted stock units as of the date of acquisition are included in the purchase price above. The fair value of theassumed vested stock options was calculated under the Black-Scholes option pricing model, with the following weighted-averageassumptions: dividend yield of 0.0%; expected volatility of 55.5%; average risk-free interest rate of 2.8%; and an expected term of4.8 years. Assumed unvested stock options and restricted stock units as of the date of acquisition will be recorded as stock-basedcompensation expense over the requisite service period as disclosed in Note 18.The following are the identifiable intangible assets acquired and their respective weighted average useful lives (table in thousands): Weighted Average Amount Life (In years) Customer relationships $21,200 10.8 Core and completed technology 39,000 10.0 Non-compete agreements 700 4.0 Total $60,900 Third and Fourth Quarter AcquisitionsDuring the third and fourth quarters of fiscal 2009, we acquired several businesses primarily to expand our product offeringswithin our core markets. The pro forma effect of these acquisitions on our previously reported financial results is immaterial and is notincluded in our pro forma financial results as disclosed in Note 4. The results of operations of these acquisitions are included in ourfiscal 2009 financial statements since their respective acquisition dates. In the aggregate, the purchase price for these acquisitions wasapproximately $121.2 million, net of cash assumed of $36.8 million. The gross purchase price consisted of the issuance of 6.4 millionshares of our common stock valued at $80.8 million, $68.0 million in cash and $9.2 million for transaction costs. $8.9 million in cashin aggregate has been placed in escrow related to two of the acquisitions and has been excluded from the total purchase consideration untilthe escrow contingencies have been satisfied. In allocating the total purchase consideration for these acquisitions based on estimated fairvalues, we have preliminarily recorded $47.2 million of goodwill, $85.0 million of identifiable intangible assets, and $25.8 million innet assets (resulting primarily from cash assumed; acquired unbilled receivables, net of liabilities assumed including contingencies;deferred income taxes; and restructuring). We have assumed a $5.0 million tax contingency established for uncertain foreign tax positionsrelating to one of the acquisitions. The preliminary allocations of the purchase consideration were based upon preliminary or finalvaluations and our estimates and assumptions remain subject to change. Intangible assets acquired included primarily core and completedtechnology and customer relationships with weighted average useful lives of 9.6 years.2008 AcquisitionsAcquisition of PSRSOn September 26, 2008, we acquired PSRS, a business unit of Royal Philips Electronics, a provider of speech recognitionsolutions, primarily in the European healthcare market, for total consideration of $101.8 million, consisting of: net cash consideration of€66.0 million, which equated to $96.6 million based on the exchange rate as69 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of the acquisition date, and transaction costs of $4.2 million. The acquisition was a taxable event. $34.4 million was paid at theacquisition date and the remaining deferred acquisition payment of €44.3 million ($64.6 million based on the exchange rate as ofSeptember 30, 2009) was due per the asset purchase agreement on September 21, 2009. We paid the deferred acquisition payment onOctober 22, 2009. The purchase price was finalized in November 2009 based on a final working capital adjustment agreed between usand the former shareholder of PSRS, reducing the final purchase price by €1.4 million ($2.1 million based on the exchange rate as ofSeptember 30, 2009), reflective of the amount agreed to be paid to us by the former shareholder of PSRS.A summary of the purchase price allocation for the acquisition of PSRS is as follows (in thousands):Total purchase consideration: Cash $99,006 Transaction costs 4,167 Total purchase consideration $103,173 Allocation of the purchase consideration: Cash $2,374 Accounts receivable 8,223 Other assets 4,641 Identifiable intangible assets 54,099 In-process research and development 2,601 Goodwill 55,773 Total assets acquired 127,711 Accounts payable and accrued expenses (5,757)Other liabilities (18,781)Total liabilities assumed (24,538)Net assets acquired $103,173 Other assets include refundable research and development credits, refundable value added tax payments, prepaid expenses andinventory. Other liabilities assumed primarily relate to deferred tax liabilities, statutory benefits due to PSRS employees and deferredrevenue. The in-process research and development of $2.6 million was expensed at the time of acquisition as the related projects had notyet reached technological feasibility and it was deemed that the research and development in-progress had no alternative future uses.The following are the identifiable intangible assets acquired and their respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $45,197 9.0 Core and completed technology 7,924 6.7 Tradename 978 9.0 Total $54,099 70 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Acquisition of Multi-VisionOn July 31, 2008, we 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 $10.5 million, which included 0.5 million shares of our common stock valued at $15.59 per share. The acquisition wasa taxable event.We may also be required to issue up to an additional $15.0 million, payable in stock, or cash, solely at our discretion, relating toearn-out provisions as described in the share purchase agreement. Two-thirds of the earn-out is conditioned on performance targets andcontinued employment; accordingly, up to $10.0 million of any earn-out payments that become payable will be recorded to compensationexpense, and up to $5.0 million, the portion of the prospective earn-out attributable solely to performance targets, will be recorded asadditional purchase price and allocated to goodwill. As of September 30, 2009, we have not recorded any obligation or relatedcompensation expense relative to these measures.The purchase price allocation for the acquisition of Multi-Vision is as follows (in thousands):Total purchase consideration: Cash $1,000 Common stock issued 8,348 Debt assumed 331 Transaction costs 845 Total purchase consideration $10,524 Allocation of the purchase consideration: Accounts receivable and acquired unbilled accounts receivable $2,330 Other assets 1,234 Identifiable intangible assets 9,630 Goodwill 2,585 Total assets acquired 15,779 Accounts payable and accrued expenses (1,886)Other liabilities (3,369)Total liabilities assumed (5,255)Net assets acquired $10,524 Other liabilities include deferred tax liabilities and deferred revenue.The following are the identifiable intangible assets acquired and their 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 71 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Acquisition of eScriptionOn May 20, 2008, we acquired all of the outstanding capital stock of eScription, a provider of hosted and premises-based computer-aided medical transcription solutions, for total purchase consideration of $412.1 million, which included 0.2 million shares of ourcommon stock valued at $17.98 per share issued at closing and 0.7 million shares valued at $12.34 per share and 0.3 million sharesvalued at $13.77 issued in fiscal 2009 upon release of shares held in escrow. During the second quarter of fiscal 2009, we elected to treatthis acquisition as an asset purchase under provisions contained in the Internal Revenue Code. See Note 21 for further discussion of thiselection.A summary of the purchase price allocation for the acquisition of eScription is as follows (in thousands):Total purchase consideration: Cash $354,071 Common stock issued 16,162 Stock options and restricted stock units assumed 32,606 Transaction costs 9,295 Total purchase consideration $412,134 Allocation of the purchase consideration: Cash $4,520 Accounts receivable and acquired unbilled accounts receivable 9,838 Other assets 6,282 Property and equipment 2,758 Identifiable intangible assets 157,700 Goodwill 237,846 Total assets acquired 418,944 Accounts payable and accrued expenses (4,730)Other liabilities (2,080)Total liabilities assumed (6,810)Net assets acquired $412,134 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.We assumed vested and unvested stock options for the purchase of 2,846,118 shares of Nuance common stock, and restrictedstock units that may convert to 806,044 shares of Nuance common stock, in connection with our acquisition of eScription. These stockoptions and restricted stock units are governed by the original agreements under which they were issued under the eScription StockOption Plan, but are now exercisable for, or will vest into, shares of Nuance common stock. Assumed vested stock options and restrictedstock units as of the date of acquisition are included in the purchase price above. The fair value of the assumed vested stock options iscalculated under the Black-Scholes option pricing model, with the following weighted-average assumptions: dividend yield of 0.0%,expected volatility of 50.8%, average risk-free interest rate of 2.3% and an expected term of 1.9 years. Assumed unvested stock optionsand restricted stock units as of the date of acquisition will be recorded as stock-based compensation expense over the requisite serviceperiod as disclosed in Note 18.72 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their 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, we acquired all of the outstanding capital stock of Viecore, a consulting and systems integration firm, fortotal purchase consideration of approximately $112.4 million, which included 4.4 million shares of our common stock valued at $21.01per share issued at closing and 0.6 million shares valued at $9.05 per share issued in fiscal 2009 upon release of shares held in escrow.The acquisition was a non-taxable event.A summary of the purchase price allocation for the acquisition of Viecore is as follows (in thousands):Total purchase consideration: Common stock issued $98,405 Cash 8,874 Transaction costs 4,695 Debt assumed 384 Total purchase consideration $112,358 Allocation of the purchase consideration: Cash $5,491 Accounts receivable 13,848 Acquired unbilled accounts receivable 19,151 Other assets 1,529 Property and equipment 1,327 Identifiable intangible assets 22,770 Goodwill 79,421 Total assets acquired 143,537 Accounts payable and accrued expenses (7,438)Deferred revenue (23,741)Total liabilities assumed (31,179)Net assets acquired $112,358 73 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their 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, we acquired all of the outstanding capital stock of Vocada, a provider of software and services for managingcritical medical test results for total purchase consideration of approximately $22.4 million, which included 0.8 million shares of ourcommon stock valued at $20.47 per share issued at closing and 0.1 million shares valued at $10.36 per share issued in fiscal 2009 uponrelease of shares held in escrow. The acquisition was a non-taxable event.In connection with our acquisition of Vocada, we agreed to make contingent earn-out 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 our common stock, at our sole discretion. We have notifiedthe former shareholders of Vocada that the financial targets for certain periods were not achieved. The former shareholders of Vocada haverequested additional information regarding this determination. We are currently in discussions with the former shareholders of Vocadaregarding this matter. As of September 30, 2009, we have not recorded any obligation relative to these measures.A summary of the purchase price allocation for the acquisition of Vocada is as follows (in thousands):Total purchase consideration: Common stock issued $18,320 Cash 3,186 Transaction costs 910 Total purchase consideration $22,416 Allocation of the purchase consideration: Accounts receivable and acquired unbilled accounts receivable $2,964 Other assets 429 Identifiable intangible assets 5,930 Goodwill 15,292 Total assets acquired 24,615 Accounts payable and other liabilities (305)Deferred revenue (1,894)Total liabilities assumed (2,199)Net assets acquired $22,416 74 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their 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 2007 AcquisitionsAcquisition of CommissureOn September 28, 2007, we acquired all of the outstanding capital stock of Commissure, a medical imaging software company thatprovides speech-enabled radiology workflow optimization and data analysis solutions for total purchase consideration of approximately$27.2 million, which included 1.2 million shares of our common stock valued at $19.49 per share issued at closing and 0.2 millionshares valued at $9.63 per share issued in fiscal 2009 upon release of shares held in escrow. The acquisition was a non-taxable event.The merger agreement includes a contingent earn-out payment of up to $8.0 million upon the achievement of certain financial targetsfor fiscal years 2008, 2009 and 2010. Payments, if any, may be made in the form of cash or shares of our common stock, solely at ourdiscretion. We have notified the former shareholders of Commissure that the financial targets for the fiscal year ended September 30,2008, were not achieved and the related contingent earn-out payment was not earned. Through September 30, 2009, we have not recordedany obligation relative to the Commissure transaction earn-out provisions.A summary of the purchase price allocation for the acquisition of Commissure is as follows (in thousands):Total purchase consideration: Common stock issued $24,974 Transaction costs 2,260 Total purchase consideration $27,234 Allocation of the purchase consideration: Current assets $3,493 Identifiable intangible assets 5,650 Goodwill 21,310 Total assets acquired 30,453 Total liabilities assumed (3,219)Net assets acquired $27,234 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.75 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their respective 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, we acquired all of the outstanding capital stock of VoiceSignal, a software company that provides speechtechnology for cell phones and other mobile devices for total purchase consideration of approximately $319.3 million, which included5.8 million shares of our common stock valued at $15.57 per share issued at closing. The acquisition was a taxable event.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 3,838 Identifiable intangible assets 71,700 Goodwill 228,170 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.76 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their respective 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, we acquired all of the outstanding capital stock of Tegic, a developer of embedded software for mobile devicesfor total purchase consideration of $268.3 million. The acquisition was a taxable event.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 $58,607 Other assets 548 Identifiable intangible assets 52,490 Goodwill 164,984 Total assets acquired 276,629 Accounts payable and accrued expenses (3,919)Other liabilities (4,406)Total liabilities assumed (8,325)Net assets acquired $268,304 Other liabilities include deferred tax liabilities and deferred revenue.The following are the identifiable intangible assets acquired and their respective 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 77 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Acquisition of BeVocalOn April 24, 2007, we acquired all of the outstanding capital stock of BeVocal, a provider of on-demand self-service customer caresolutions that address the unique business requirements of the mobile communications market and its customers for total purchaseconsideration of $187.8 million, which included 7.0 million shares of our common stock valued at $14.96 per share issued at closing.In connection with this acquisition, 1.2 million shares of our common stock were placed into escrow to satisfy any indemnificationclaims. In August 2009, 0.8 million of the escrow shares, worth $9.2 million, were released to the former BeVocal shareholders insettlement of all outstanding claims between the former BeVocal shareholders and us and accounted for as an increase to the BeVocalpurchase price. The acquisition was a non-taxable event.Under the terms of the merger agreement, we agreed to make contingent earn-out 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 earn-out payments was furtherconditioned on continued employment provisions. During the three months ended December 31, 2008, we paid to the former shareholdersof BeVocal, Inc. $46.1 million to satisfy our contingent earn-out obligations, of which $40.2 million was paid in cash, $5.9 million waspaid in stock at that time, and an additional $3.0 million is being disbursed to BeVocal option holders through April 2011. $40.0 millionof the total earn-out payment has been recorded as an increase to purchase price and the remaining $9.1 million has been recorded tocompensation expense from the date of acquisition through September 30, 2009.A summary of the purchase price allocation for the acquisition of BeVocal is as follows (in thousands):Total purchase consideration: Common stock issued $113,649 Cash 30,000 Contingent earn-out consideration 40,025 Transaction costs 4,161 Total purchase consideration $187,835 Allocation of the purchase consideration: Cash $9,266 Accounts receivable and acquired unbilled accounts receivable 11,018 Other assets 5,152 Identifiable intangible assets 41,200 Goodwill 148,711 Total assets acquired 215,347 Accounts payable and accrued expenses (24,215)Deferred revenue (3,297)Total liabilities assumed (27,512)Net assets acquired $187,835 78 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their 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, we acquired all of the outstanding capital stock of Focus, which provides medical transcription services withoperations in the United States and India for total purchase consideration of $58.7 million. The acquisition was a taxable event.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 The following are the identifiable intangible assets acquired and their 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 79 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Acquisition of MVCOn December 29, 2006, we acquired all of the outstanding capital stock of Mobile Voice Control, Inc. (“MVC”), a provider ofspeech-enabled mobile search and messaging services, for total purchase consideration of $20.7, which included 0.8 million shares of ourcommon stock valued at $8.3 million. The acquisition was a non-taxable eventUnder the agreement, we agreed to make additional earn-out payments of up to 1,700,839 shares of our common stock uponachievement of established targets. 566,946 of these shares were apportioned to calendar 2007 targets, and 1,133,893 shares to calendar2008 targets. During fiscal 2008, we amended the earn-out provisions set forth in the merger agreement such that the former shareholdersof MVC were eligible to earn the remaining calendar 2007 earn-out amount, consisting of 188,962 shares, if certain conditions were metat December 31, 2008. As of December 31, 2008, we determined that the full 188,962 shares had been earned. The total value of theshares was $3.0 million, of which $1.0 million was recorded to goodwill as incremental purchase price during fiscal 2008, and theremaining $2.0 million was amortized as compensation expense from May 2008 to December 2008. In November 2008, a secondamendment to the merger agreement was signed pursuant to which the earn-out period for the calendar 2008 earn-out was extended, suchthat 377,964 and 755,929 shares could now be earned based on the achievement of calendar 2008 and 2009 targets, respectively. Thestock payments, if any, that are made based on the provisions of this second amendment will be recorded to goodwill, as incrementalpurchase price. We notified the former shareholders of MVC that the financial targets for calendar 2008 were not achieved and the377,964 shares were not earned. As of September 30, 2009, we have not recorded any obligation relative to the second amendment.A summary of the purchase price allocation for the acquisition of MVC, including the impact of certain components of the earn-out,as amended, is as follows (in thousands):Total purchase consideration: Common stock issued $8,300 Contingent earn-out 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 80 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their 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 4. Pro Forma Results (Unaudited)The following table shows unaudited pro forma results of operations as if we had acquired SNAPin and our other materialacquisitions from fiscal 2008 (PSRS, eScription, Inc., and Viecore, Inc.) on October 1, 2007 (table in thousands, except per share data): 2009 2008 Revenue $950,352 $946,028 Net loss $(12,202) $(73,869)Net loss per share $(0.05) $(0.33)We have not furnished pro forma financial information relating to the Vocada, Multi-Vision, or our immaterial fiscal 2009acquisitions because such information is not material, individually or in the aggregate, to our financial results. The unaudited pro formaresults of operations are not necessarily indicative of the actual results that would have occurred had the transactions actually taken placeat the beginning of the periods indicated.5. Contingent Acquisition PaymentsContingent acquisition payment arrangements related to acquisitions completed during fiscal 2009, 2008, or 2007 are discussedabove in Note 3. However, we remain party to certain contingent consideration arrangements relative to acquisitions completed prior tothose fiscal years. Those arrangements are discussed below.Earn-out PaymentsIn connection with our acquisition of Phonetic Systems Ltd. (“Phonetic”) in February 2005, a deferred payment of $17.5 millionwas due and paid to the former shareholders of Phonetic on February 1, 2007. We also agreed to make contingent earn-out payments of$35.0 million upon achievement of certain established financial and performance targets, in accordance with the merger agreement. Wehave notified the former shareholders of Phonetic that the financial and performance targets were not achieved. Accordingly, we have notrecorded any obligations relative to these measures as of September 30, 2009. The former shareholders of Phonetic have objected to thisdetermination and have filed for arbitration.Escrow and Holdback ArrangementsIn connection with certain of our acquisitions, we have placed either cash or shares of our common stock in escrow to satisfy anyclaims we may have. If no claims are made, the escrowed amounts will be released to the former shareholders of the acquired companies.Generally, we cannot make a determination, beyond a reasonable doubt, whether the escrow will become payable to the formershareholders of these companies until the escrow period has expired. Accordingly these amounts have been treated as contingent purchaseprice until it is determined81 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)that the escrow will be payable, at which time the escrowed amounts may be recorded as additional purchase price and allocated togoodwill.The following table summarizes the terms of the escrow arrangements that were not released as of September 30, 2009 (table inthousands): Initially Scheduled Escrow Share Payment — Release Date Cash Payment Number of Shares Focus(a) March 26, 2008 $5,800 n/a eScription(b) May 20, 2009 n/a 103 SNAPin(c) October 1, 2009 n/a 1,107 X-Solutions December 10, 2010 1,050 n/a eCopy December 30, 2010 7,800 n/a Total $14,650 1,210 Discussion of amounts held in escrow following their initially scheduled release date:(a)We filed a claim against the Focus Infomatics, Inc. escrow related to the breach of certain representations and warranties made in theshare purchase agreement. We determined that the entire escrow would be paid to either satisfy liabilities indemnified under theagreement or paid to the former shareholders. Accordingly, an amount equal to the escrow was recorded as additional purchase priceduring fiscal 2008. The escrow was released in October 2009.(b)We filed a claim against the escrow related to the breach of certain representations and warranties made in the merger agreement.1.0 million shares held in escrow were released during fiscal 2009. We expect the remaining amount to remain in escrow until thesettlement of the contingent liabilities is finalized.(c)We released these shares in October 2009.In connection with the escrow relating to the eScription acquisition, we guaranteed a minimum market value of $17.7954 per sharewhen the escrow shares are released. If the market value was less than $17.7954 per share on the date of release, we would be required topay the difference, if any, and limited to $5.0 million, in cash. In May 2009, upon release of all but 103,000 of the escrow shares, whichremain in escrow at September 30, 2009, we paid the maximum $5.0 million cash payment to the former shareholders of eScription. Thispayment was recorded as a reduction to additional paid-in-capital.82 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)6. Goodwill and Intangible AssetsThe changes in the carrying amount of goodwill for fiscal years 2009 and 2008, are as follows (in thousands):Balance as of October 1, 2007 $1,249,642 Goodwill acquired 355,648 Escrow amounts released 30,000 Purchase price increases due to earn-out achievements 12,501 Purchase accounting adjustments 3,327 Effect of foreign currency translation 4,655 Balance as of September 30, 2008 $1,655,773 Goodwill acquired 200,501 Escrow amounts released 30,869 Purchase accounting adjustments 4,956 Effect of foreign currency translation (1,096)Balance as of September 30, 2009 $1,891,003 Purchase accounting adjustments recorded in fiscal 2009 consisted primarily of the following increases: $18.9 million of additionalpurchase price upon our election to treat our acquisition of eScription as an asset purchase under Section 338(h)(10) of the InternalRevenue Code of 1986 (as amended) and $10.8 million related to the recording of contingent liabilities assumed; partially offset by thefollowing decreases: a $9.7 million reversal of assumed deferred tax liabilities as a result of our election to treat eScription as an assetpurchase, $5.8 million related to the utilization of acquired net operating losses from acquisitions, a $6.3 million adjustment to deferredtaxes, and a $4.7 million decrease in accrued transaction costs.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 our acquisition of Focus. In addition,we increased goodwill by $2.8 million to correct an error in the acquired balance sheet of Dictaphone for contractual liabilities to a certaincustomer, incurred prior to the acquisition date of March 31, 2006. These increases to goodwill were partially offset by decreases whichincluded $23.8 million of additional acquired unbilled accounts receivable identified in connection with the acquisition of Tegic, and by$16.6 million related to the utilization of acquired deferred tax assets in connection with certain of our prior acquisitions.83 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Intangible assets consist of the following as of September 30, 2009 and 2008, which includes $112.7 million and $33.5 million oflicensed technology, respectively (table in thousands, except for years): September 30, 2009 Weighted Average Gross Carrying Accumulated Net Carrying Remaining Amount Amortization Amount Life (Years) Customer relationships $565,654 $(159,150) $406,504 7.3 Technology and patents 341,504 (83,882) 257,622 6.8 Tradenames, trademarks, and other 17,543 (5,374) 12,169 3.8 Non-competition agreements 5,707 (2,997) 2,710 2.3 Subtotal 930,408 (251,403) 679,005 7.1 Tradename, indefinite life 27,800 — 27,800 n/a Total $958,208 $(251,403) $706,805 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, trademarks, and other 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 7.5 Tradename, indefinite life 27,800 — 27,800 n/a Total $738,656 $(153,633) $585,023 In June 2009, we acquired a royalty free paid-up perpetual source and object code license from a third party for $20.0 million incommon stock. The estimated useful life of this license is 7 years and this asset has been included within the technology and patentsgrouping above. Also in June 2009, we amended the December 2008 agreement discussed below and entered into a joint marketing andselling agreement with the same third party and paid $7.0 million, consisting of $2.0 million in cash and $5.0 million in common stock.We have capitalized the $7.0 million payment as an intangible asset, included in the tradenames, trademarks, and other grouping above,and assigned a useful life of 3 years, commensurate with the legal term of the rights in the arrangement. In addition to the $7.0 millionpaid in June, we also agreed to pay an additional $13.0 million, payable in common stock or cash at our option, upon the third partymeeting certain performance criteria under the agreement by October 31, 2009. We are currently in the process of evaluating whether suchperformance criteria were met.In December 2008, we acquired a speech-related patent portfolio from the same third party and a royalty free paid-up perpetuallicense providing us with access to, and use of, the third party’s speech-related source code for an aggregate purchase price of$50.0 million. These assets are included within the technology and patents asset grouping above. The weighted average useful life relatedto these acquired assets is 8.7 years. We agreed to pay an additional license fee of up to $20.0 million if certain revenue growth targets aremet in calendar 2009. Any additional license fee was to be payable in cash or stock at our sole discretion on March 1, 2010. In June2009, this additional license fee provision was amended, and as a result we no longer have any amounts due under this agreement.84 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Amortization expense for acquired technology and patents is included in the cost of revenue from amortization of intangible assets inthe accompanying statements of operations and amounted to $38.4 million, $24.4 million and $13.1 million in fiscal 2009, 2008 and2007, respectively. Amortization expense for customer relationships; tradenames, trademarks, and other; and non-competition agreementsis included in operating expenses and was $77.0 million, $58.2 million and $24.6 million in fiscal 2009, 2008 and 2007, respectively.Estimated amortization expense for each of the five succeeding years as of September 30, 2009, is as follows (in thousands): Other Cost of Operating Year Ending September 30, Revenue Expenses Total 2010 $45,512 $80,657 $126,169 2011 44,112 72,584 116,696 2012 40,345 63,799 104,144 2013 34,849 53,020 87,869 2014 28,017 46,736 74,753 Thereafter 64,787 104,587 169,374 Total $257,622 $421,383 $679,005 7. Accounts ReceivableAccounts receivable, excluding acquired unbilled accounts receivable, consisted of the following (in thousands): September 30, September 30, 2009 2008 Trade accounts receivable $197,176 $200,892 Unbilled accounts receivable under long-term contracts 15,311 15,938 Gross accounts receivable 212,487 216,830 Less — allowance for doubtful accounts (6,833) (6,925)Less — allowance for sales returns (6,106) (6,363)Accounts receivable, net $199,548 $203,542 8. Inventories, netInventories, net of allowances, consisted of the following (in thousands): September 30, September 30, 2009 2008 Components and parts $6,479 $4,429 Inventory at customers 967 1,585 Finished products 1,079 1,138 $8,525 $7,152 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.85 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)9. Land, Building and Equipment, NetLand, building and equipment, net at September 30, 2009 and 2008 were as follows (in thousands): September 30, September 30, Useful Life 2009 2008 (In years) Land — $2,400 $2,400 Building 30 5,117 5,117 Machinery and equipment 3-5 5,558 4,435 Computers, software and equipment 3-5 75,586 60,679 Leasehold improvements 2-7 15,073 13,491 Furniture and fixtures 5 10,366 9,071 Construction in progress n/a 4,266 — Subtotal 118,366 95,193 Less: accumulated depreciation (64,898) (48,708)Land, building and equipment, net $53,468 $46,485 At September 30, 2009, construction in progress related to the build-out of hosted data centers. There were no corresponding ongoingprojects at September 30, 2008. Depreciation expense, associated with building and equipment, for fiscal 2009, 2008 and 2007 was$18.7 million, $16.4 million and $12.1 million, respectively.10. Accrued Expenses and Other Current LiabilitiesAccrued expenses consisted of the following (in thousands): September 30, September 30, 2009 2008 Compensation $52,600 $45,316 Professional fees 8,945 5,009 Acquisition costs and liabilities 8,522 14,167 Cost of revenue related liabilities 7,585 6,596 Income taxes payable 7,185 16,047 Sales and other taxes payable 5,913 2,179 Sales and marketing incentives 4,413 4,705 Deferred tax liability 1,614 — Other 8,042 8,080 Total $104,819 $102,099 86 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)11. Credit Facilities and DebtAt September 30, 2009 and 2008, we had the following borrowing obligations (in thousands): September 30, September 30, 2009 2008 2.75% Convertible Debentures, net of unamortized discount of $5.2 million and $6.3 million,respectively $244,777 $243,699 Credit Facility 650,263 656,963 Obligations under capital leases 307 489 Other 126 39 Total long-term debt 895,473 901,190 Less: current portion 6,862 7,006 Non-current portion of long-term debt $888,611 $894,184 The estimated fair value of our long-term debt approximated $893.2 million at September 30, 2009 and $786.9 million atSeptember 30, 2008. These fair value amounts represent the value at which our lenders could trade our debt within the financial markets,and do not represent the settlement value of these long-term debt liabilities to us at each reporting date. The fair value of these long-termdebt issues will continue to fluctuate each period based on fluctuations in market interest rates, and these fluctuations may have little tono correlation to our outstanding debt balances. The increase in fair value from September 30, 2008 to September 30, 2009 is attributableto the general improvements in the debt markets. The term loan portion of our Credit Facility is traded and the fair values are based upontraded prices as of the reporting dates. The fair values of the 2.75% Convertible Debentures at each respective reporting date wereestimated using the averages of the September 30, 2009 and September 30, 2008 bid and ask trading quotes. We had no outstandingbalance on the revolving credit line portion of our Credit Facility. Our capital lease obligations and other debt are not traded and the fairvalues of these instruments are assumed to approximate their carrying values as of September 30, 2009 and September 30, 2008.2.75% Convertible DebenturesOn August 13, 2007, we 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. Total proceeds, net of debt discount of $7.5 million anddeferred debt issuance costs of $1.1 million, were $241.4 million. The 2027 Debentures bear an interest rate of 2.75% per annum,payable semi-annually in arrears beginning on February 15, 2008, and mature on August 15, 2027 subject to the right of the holders ofthe 2027 Debentures to require us to redeem the 2027 Debentures on August 15, 2014, 2017 and 2022. The related debt discount and debtissuance costs are being amortized to interest expense using the effective interest rate method through August 2014. As of September 30,2009 and 2008, the ending unamortized discount was $5.2 million and $6.3 million, respectively, and the ending unamortized deferreddebt issuance costs were $0.7 million and $0.8 million, respectively. The 2027 Debentures are general senior unsecured obligations,ranking equally in right of payment to all of our existing and future unsecured, unsubordinated indebtedness and senior in right ofpayment to any indebtedness that is contractually subordinated to the 2027 Debentures. The 2027 Debentures are effectively subordinatedto our secured indebtedness to the extent of the value of the collateral securing such indebtedness and are structurally subordinated toindebtedness and other liabilities of our subsidiaries. If converted, the principal amount of the 2027 Debentures is payable in cash andany amounts payable in excess of the $250 million principal amount, will (based on an initial conversion rate, which represents an initialconversion price of $19.47 per share, subject to adjustment) be paid in cash or shares of our common stock, at our election, only in thefollowing circumstances and to the following extent: (i) on any date during any fiscal quarter beginning after September 30, 2007 (andonly during such fiscal quarter) if the closing sale price of our common stock was more than 120% of the then current conversion pricefor at least 20 trading days in the period of the 30 consecutive trading days ending on the last trading day of the87 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)previous fiscal quarter; (ii) during the five consecutive business-day period following any five consecutive trading-day period in whichthe trading price for $1,000 principal amount of the Debentures for each day during such five trading-day period was less than 98% ofthe closing sale price of our common stock multiplied by the then current conversion rate; (iii) upon the occurrence of specified corporatetransactions, as described in the indenture for the 2027 Debentures; and (iv) at the option of the holder at any time on or afterFebruary 15, 2027. Additionally, we may redeem the 2027 Debentures, in whole or in part, on or after August 20, 2014 at par plusaccrued and unpaid interest; each holder shall have the right, at such holder’s option, to require us to repurchase all or any portion of the2027 Debentures held by such holder on August 15, 2014, August 15, 2017 and August 15, 2022. Upon conversion, we will pay cashand 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, 2009, 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.Credit FacilityWe entered into a credit facility which consists of a $75 million revolving credit line including letters of credit, a $355 million termloan entered into on March 31, 2006, a $90 million term loan entered into on April 5, 2007 and a $225 million term loan entered into onAugust 24, 2007 (the “Credit Facility”). The term loans are due March 2013 and the revolving credit line is due March 2012. As ofSeptember 30, 2009, $650.3 million remained outstanding under the term loans, there were $16.2 million of letters of credit issued underthe revolving credit line and there were no other outstanding borrowings under the revolving credit line.The Credit Facility contains covenants, including, among other things, covenants that restrict our ability and those of oursubsidiaries to incur certain additional indebtedness, create or permit liens on assets, enter into sale-leaseback transactions, make loans orinvestments, sell assets, make certain acquisitions, pay dividends, or repurchase stock. The agreement also contains events of default,including failure to make payments of principal or interest, failure to observe covenants, breaches of representations and warranties,defaults under certain other material indebtedness, failure to satisfy material judgments, a change of control and certain insolvencyevents. As of September 30, 2009, we were in compliance with the covenants under the Credit Facility.Borrowings under the 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% per annum) or(b) LIBOR (equal to (i) the British Bankers’ Association Interest Settlement Rates for deposits in U.S. dollars divided by (ii) one minusthe statutory reserves applicable to such borrowing). The applicable margin for term loan borrowings under the Credit Facility rangesfrom 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-basedborrowings, depending on our leverage ratio. The applicable margin for the revolving loan borrowings under the Credit Facility rangesfrom 0.50% to 1.25% per annum with respect to base rate borrowings and from 1.50% to 2.25% per annum with respect to LIBOR-basedborrowings, depending upon our leverage ratio. As of September 30, 2009, the applicable margin for the term loan was 1.00% for base rateborrowings and 2.00% for LIBOR-based borrowings. We are required to pay a commitment fee for unutilized commitments under therevolving credit facility at a rate ranging from 0.375% to 0.50% per annum, based upon our leverage ratio. As of September 30, 2009, thecommitment fee rate was 0.375% and the effective interest rate was 2.27%.We capitalized debt issuance costs related to the Credit Facility and are amortizing the costs to interest expense using the effectiveinterest rate method through March 2012 for costs associated with the revolving credit facility and through March 2013 for costsassociated with the term loan. As of September 30, 2009 and 2008, the ending88 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)unamortized deferred financing fees were $7.7 million and $10.0 million, respectively, and are included in other assets in theaccompanying consolidated balance sheet.The Credit Facility is subject to repayment in four equal quarterly installments of 1% per annum ($6.7 million per year, notincluding interest, which is also payable quarterly), and an annual excess cash flow sweep, as defined in the Credit Facility, which ispayable beginning in the first quarter of each fiscal year, beginning in fiscal 2008, based on the excess cash flow generated in the previousfiscal year. No payment under the excess cash flow sweep provision was due in the first quarter of either fiscal 2009 or fiscal 2010 asthere was no excess cash flow generated in either of the respective prior fiscal years. We will continue to evaluate the extent to which apayment is due in the first quarter of future fiscal years based on excess cash flow generation. At the current time, we are unable to predictthe amount of the outstanding principal, if any, that may be required to be repaid in future fiscal years pursuant to the excess cash flowsweep provisions. Any term loan borrowings not paid through the baseline repayment, the excess cash flow sweep, or any othermandatory or optional payments that we may make, will be repaid upon maturity. If only the baseline repayments are made, the annualaggregate principal amount of the term loans repaid would be as follows (in thousands):Year Ending September 30, Amount 2010 $6,700 2011 6,700 2012 6,700 2013 630,163 Total $650,263 Our obligations under the Credit Facility are unconditionally guaranteed by, subject to certain exceptions, each of our existing andfuture direct and indirect wholly-owned domestic subsidiaries. The Credit Facility and the guarantees thereof are secured by first priorityliens and security interests in the following: 100% of the capital stock of substantially all of our domestic subsidiaries and 65% of theoutstanding voting equity interests and 100% of the non-voting equity interests of first-tier foreign subsidiaries, all our material tangibleand intangible assets and those of the guarantors, and any present and future intercompany debt. The Credit Facility also containsprovisions for mandatory prepayments of outstanding term loans upon receipt of the following, and subject to certain exceptions: 100% ofnet cash proceeds from asset sales, 100% of net cash proceeds from issuance or incurrence of debt, and 100% of extraordinary receipts.We may voluntarily prepay borrowings under the Credit Facility without premium or penalty other than breakage costs, as defined withrespect to LIBOR-based loans.12. Financial Instruments and Hedging ActivitiesInterest Rate Swap AgreementsTo manage the interest rate exposure on our variable-rate borrowings, we use interest rate swaps to convert specific variable-rate debtinto fixed-rate debt. As of September 30, 2009, we have two outstanding interest rate swaps designated as cash flow hedges with anaggregate notional amount of $200 million. The interest rates on these swaps are 2.7% and 2.1%, plus the applicable margin for the CreditFacility, and they expire in October 2010 and November 2010, respectively. As of September 30, 2009 and September 30, 2008, theaggregate cumulative unrealized losses related to these swaps, and a previous swap that matured on March 31, 2009, were $4.0 millionand $0.9 million, respectively and were included in accumulated other comprehensive income (loss) in the accompanying balance sheets.Forward Currency Contracts Designated as Cash Flow HedgesOn December 31, 2008, we entered into foreign currency contracts to hedge exposure on the variability of cash flows in Canadiandollars. These contracts expired in September 2009 and were designated as cash flow hedges.89 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The impact of these settled contracts on results of operations and other comprehensive income are detailed in the tables below. We have noforeign currency contracts designated as cash flow hedges outstanding at September 30, 2009.Other Derivative ActivitiesWe have foreign currency contracts that are not designated as hedges. Changes in fair value of foreign currency contracts notqualifying as hedges are reported in earnings as part of other income (expense), net. During the three months ended December 31, 2008,we entered into foreign currency forward contracts to offset foreign currency exposure on the deferred acquisition payment of €44.3 millionrelated to our acquisition of PSRS, resulting in a net gain of $8.0 million in other income (expense). The foreign currency contractsmatured and were settled on October 22, 2009.In June 2009, we acquired certain intangible assets and issued 1,809,353 shares of our common stock, valued at $25.0 million, aspart of the total consideration. We also issued an additional 315,790 shares of our common stock, valued at $4.5 million, in June 2009as a prepayment for professional services. These shares issued are subject to security price guarantees which are accounted for asderivatives, and are being accounted for separately from their host agreements due to the determination that such instruments would not beconsidered equity instruments if freestanding. The security price guarantees require a payment from either us to the third party, or fromthe third party to us based upon the difference between the price of our common stock on the issue date and an average price of ourcommon stock approximately six months following the issue date. For the fiscal year ended September 30, 2009, increases in fair value of$2.3 million related to these security price guarantees are reported in earnings as non-operating income within other income (expense), net.In October 2009, we entered into a five-year joint research collaboration with a third party and made payments consisting of1,047,120 shares of our common stock valued at $16.0 million. These shares issued are subject to a security price guarantee of the samenature as those described above.The following table provides a quantitative summary of the fair value of our hedged and non-hedged derivative instruments as ofSeptember 30, 2009 and September 30, 2008 (table in thousands): Fair Value September 30, September 30, Description Balance Sheet Classification 2009 2008 Derivatives Not Designated as Hedges: Foreign currency contracts Prepaid expenses and other current assets $8,682 $— Security Price Guarantees Prepaid expenses and other current assets 2,299 — Net asset (liability) value of non-hedged derivative instruments $10,981 $— Derivatives Designated as Hedges: Interest rate swaps Accrued expenses and other current liabilities $— $(879)Interest rate swaps Other long-term liabilities (3,982) — Net asset (liability) value of hedged derivative instruments $(3,982) $(879)90 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following tables summarize the activity of derivative instruments for fiscal 2009 and 2008 (tables in thousands):Derivatives Designated as Hedges for the Fiscal Year Ended September 30, Amount of Gain (Loss) Location and Amount of Gain (Loss) Reclassified from Recognized in OCI Accumulated OCI into Income (Effective Portion) 2009 2008 2009 2008Foreign currency contracts $— $— N/A $— $— Interest rate swaps $(3,103) $50 N/A $— $— Derivatives Not Designated as Hedges Amount of Gain (Loss) Recognized in Income Fiscal Year Ended Location of Gain (Loss) September 30, Recognized in Income 2009 2008 Foreign currency contracts Other income (expense), net $8,682 $— Security price guarantees Other income (expense), net $2,299 $— 13. Fair Value MeasuresWe adopted the provisions of SFAS No. 157, Fair Value Measurements (SFAS 157), now referred to as ASC 820, relative tofinancial instruments on October 1, 2008. ASC 820 defines fair value, establishes a framework for measuring fair value, and enhancesdisclosures about fair value measurements. Fair value is defined as the price that would be received for an asset, or paid to transfer aliability, in an orderly transaction between market participants at the measurement date. Valuation techniques must maximize the use ofobservable inputs and minimize the use of unobservable inputs.ASC 820 establishes a value hierarchy based on three levels of inputs, of which the first two are considered observable and the thirdis considered unobservable: • Level 1. Quoted prices for identical assets or liabilities in active markets which we can access. • Level 2. Observable inputs other than those described as Level 1. • Level 3. Unobservable inputs.91 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Assets and liabilities measured at fair value on a recurring basis at September 30, 2009 consisted of (table in thousands): September 30, 2009 Level 1 Level 2 Level 3 Total Assets: Money market funds(a) $403,250 $— $— $403,250 US government agency securities(a) 10,013 — — 10,013 Foreign currency exchange contracts(b) — 8,682 — 8,682 Security price guarantees(d) — 2,299 — 2,299 Total assets at fair value $413,263 $10,981 $— $424,244 Liabilities: Interest rate swaps(c) $— $3,982 $— $3,982 Total liabilities at fair value $— $3,982 $— $3,982 (a)Money market funds and US government agency securities, included in cash and cash equivalents in the accompanying balancesheet, are valued at quoted market prices in active markets.(b)The fair value of our foreign currency exchange contracts is the intrinsic value of the contracts based on observable inputs forsimilar derivative instruments in active markets or quoted prices for identical or similar instruments in markets that are not activeor are directly or indirectly observable.(c)The fair values of the interest rate swaps are estimated using discounted cash flow analyses that factor in observable market inputssuch as LIBOR — based yield curves, forward rates, and credit spreads.(d)The fair values of the security price guarantees are determined using a Black-Scholes model, derived from observable inputs suchas US treasury interest rates, our common stock price, and the volatility of our common stock. The valuation model values both theput and call components of the guarantees simultaneously, with the net value of those components representing the fair value of eachinstrument.Items Measured at Fair Value on a Nonrecurring BasisCertain assets, including our cost-method investments, are measured at fair value on a nonrecurring basis when indicators ofimpairment are identified and such indicators appear to be other than temporary. These assets are recognized at fair value when they aredeemed to be other-than-temporarily impaired. During the fourth quarter 2009, we recognized a $1.2 million impairment of our cost-method investment in a non-public company, representing the deficiency in the estimated fair value of our investment based on a quoted-price methodology as compared to its carrying value. This impairment charge was recorded as a non-operating loss in our fiscal 2009consolidated statement of operations. We did not record any impairment charges for these assets during fiscal 2008 or 2007. Subsequentto September 30, 2009, we entered into an additional cost-method investment of a non-public company for approximately $15.0 million.14. Accrued Business Combination CostsWe have, in connection with certain of our business combinations, incurred restructuring costs. Restructuring costs are typicallycomprised of severance costs, costs of consolidating duplicate facilities and contract termination costs. Restructuring expenses are basedupon plans that have been committed to by management, but are generally subject to refinement during the purchase price allocationperiod (generally within one year of the acquisition date). In addition to plans resulting from the business combination, we havehistorically acquired companies who have previously established restructuring charges relating to lease exit costs. Regardless of the originof the lease exit92 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)costs, we are required to make assumptions relating to sublease terms, sublease rates and discount rates. We base our estimates andassumptions on the best information available at the time of the obligation having arisen. These estimates are reviewed and revised asfacts and circumstances dictate, with any changes being recorded to goodwill or restructuring and other charges (credits), net. Changes inthese estimates could have a material effect on the amount accrued on the balance sheet. Discussed in detail below are two individuallysignificant facilities which were abandoned by the acquired company prior to our acquisition of the company, and for which theobligations to the lessors, we have assumed.In connection with the acquisitions of SpeechWorks International, Inc. in August 2003 and Former Nuance in September 2005, weassumed two individually significant lease obligations that were abandoned prior to the acquisition dates. These obligations expire in2016 and 2012, respectively, and the fair value of the obligations, net of estimated sublease income, was recognized as liabilities assumedby us in the allocation of the final purchase price. The net payments have been discounted in calculating the fair value of theseobligations, and the discount is being accreted through the term of the lease. Cash payments net of sublease receipts are presented as cashused in financing activities on the consolidated statements of cash flows.Additionally, we have implemented restructuring plans to eliminate duplicate facilities, personnel or assets in connection withbusiness combinations. These costs are recognized as liabilities assumed, and accordingly are included in the allocation of the purchaseprice, generally resulting in an increase to the recorded amount of the goodwill.The activity for the years ended September 30, 2009, 2008 and 2007, relating to all facilities and personnel recorded in accruedbusiness combination costs, is as follows (in thousands): Facilities Personnel Total Balance at October 1, 2006 $59,221 $844 $60,065 Charged to goodwill 542 1,484 2,026 Charged to restructuring and other charges, net — — — 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 Charged to goodwill 2,689 6,391 9,080 Charged to restructuring and other charges, net 111 — 111 Charged to interest expense 1,677 — 1,677 Cash payments, net of sublease receipts (11,104) (3,894) (14,998)Balance at September 30, 2009 $34,551 $2,497 $37,048 93 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued) September 30, September 30, 2009 2008 Reported as: Current $12,144 $9,166 Long-term 24,904 32,012 Total $37,048 $41,178 15. Restructuring and Other Charges, netFiscal 2009In fiscal 2009, we recorded restructuring and other charges of $5.4 million, of which $5.3 million related to the elimination ofapproximately 220 personnel across multiple functions within our company.Fiscal 2008In fiscal 2008, we recorded restructuring and other charges of $7.0 million, of which $4.2 million related to the elimination ofapproximately 155 personnel across multiple functions, $1.4 million related to a non-recurring, adverse ruling arising from a vendor’sclaims of underpayment of historical royalties for technology discontinued in 2005 and $1.4 million related to the consolidation orelimination of excess facilities.The following table sets forth the fiscal 2009, 2008 and 2007 accrual activity relating to restructuring and other charges (inthousands): Personnel Facilities Other Total Balance at October 1, 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 Restructuring and other charges (credits), net 5,283 95 31 5,409 Non-cash adjustment — — — — Cash payments (5,042) (544) (1,396) (6,982)Balance at September 30, 2009 $607 $310 $28 $945 16. Supplemental Cash Flow InformationCash paid for Interest and Income Taxes:During fiscal 2009, 2008 and 2007, we made cash payments for interest totaling $33.9 million, $50.0 million and $31.4 million,respectively.During fiscal 2009, 2008 and 2007, total net cash paid for income taxes were $18.0 million, $5.6 million and $3.5 million,respectively.94 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Non Cash Investing and Financing Activities:During fiscal 2009, 2008 and 2007, we issued shares of our common stock in connection with several of our business and assetacquisitions, including shares initially held in escrow. Note 3 details the shares of our common stock, including per share prices thereof,issued in fiscal 2009, 2008, and 2007 to complete each of our business acquisitions during those years. Note 6 details the sameinformation with regard to our fiscal 2009 intangible asset acquisitions. We did not complete any significant asset acquisitions in fiscal2008 or 2007.17. Stockholders’ EquityPreferred StockWe are authorized to issue up to 40,000,000 shares of preferred stock, par value $0.001 per share. We have designated100,000 shares as Series A Preferred Stock and 15,000,000 shares as Series B Preferred Stock. In connection with the acquisition ofScanSoft from Xerox Corporation (“Xerox”), we issued 3,562,238 shares of Series B Preferred Stock to Xerox. On March 19, 2004, weannounced that Warburg Pincus, a global private equity firm, had agreed to purchase all outstanding shares of our stock held by XeroxCorporation for approximately $80 million, including the 3,562,238 shares of Series B Preferred Stock. The Series B Preferred Stock isconvertible into shares of common stock on a one-for-one basis. The Series B Preferred Stock has a liquidation preference of $1.30 pershare plus all declared but unpaid dividends. The holders of Series B Preferred Stock are entitled to non-cumulative dividends at the rateof $0.05 per annum per share, payable when, and if, declared by the Board of Directors. To date, no dividends have been declared by theBoard of Directors. Holders of Series B Preferred Stock have no voting rights, except those rights provided under Delaware law. Theundesignated shares of preferred stock will have rights, preferences, privileges and restrictions, including voting rights, dividend rights,conversion rights, redemption privileges and liquidation preferences, as shall be determined by the Board of Directors upon issuance ofthe preferred stock. We have reserved 3,562,238 shares of our common stock for issuance upon conversion of the Series B PreferredStock. Other than the 3,562,238 shares of Series B Preferred Stock that are issued and outstanding, there are no other shares of preferredstock issued or outstanding as of September 30, 2009 or September 30, 2008.Common Stock and Common Stock WarrantsUnderwritten Public Offerings in Fiscal 2008On June 4, 2008, we completed an underwritten public offering in which we sold 5,575,000 shares of our common stock. Grossproceeds were $100.1 million, and the net proceeds after underwriting commissions and other offering expenses were $99.8 million.On December 21, 2007, we completed an underwritten public offering in which we sold 7,823,000 shares of our common stock.Gross proceeds from this sale were $136.9 million, and the net proceeds after underwriting commissions and other offering expenses were$130.3 million.Private Placements of SecuritiesOn January 13, 2009, we entered into a purchase agreement by and among us, Warburg Pincus Private Equity X, L.P. and WarburgPincus X Partners L.P. (together, “Warburg Pincus X”), pursuant to which Warburg Pincus X agreed to purchase, and we agreed to sell,17,395,626 shares of our common stock at a purchase price of $10.06 per share and warrants to purchase 3,862,422 shares of ourcommon stock for an aggregate purchase price of $175.2 million. The warrants have an exercise price of $11.57 and a term of fouryears. On January 29, 2009, the sale of the shares and the warrants pursuant to the purchase agreement was completed.On May 20, 2008, in connection with our acquisition of eScription, we sold 5,760,369 shares of our common stock for a purchaseprice of $100.0 million, and warrants to purchase 3,700,000 shares of our common stock for a95 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)purchase price of $0.5 million, pursuant to the terms of a purchase agreement dated April 7, 2008 with Warburg Pincus Private EquityVIII, L.P. and certain of its affiliated entities (collectively “Warburg Pincus”) (the “Purchase Agreement”). The warrants have an exerciseprice of $20.00 per share and a term of four years. Warburg Pincus also agreed not to sell any shares of our common stock for a period ofsix months from the closing of the transaction contemplated by the Purchase Agreement.On May 5, 2005, we entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Warburg Pincuspursuant to which Warburg Pincus agreed to purchase, and we agreed to sell, 3,537,736 shares of our common stock and warrants topurchase 863,236 shares of our 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 shares and the warrants pursuant to the Securities PurchaseAgreement was completed, and on July 29, 2009, Warburg Pincus exercised all 863,236 of the above-described warrants at the statedexercise price. We also entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with Warburg Pincus pursuant towhich Warburg Pincus agreed to purchase and we agreed to sell 14,150,943 shares of our common stock and warrants to purchase3,177,570 shares of our common stock for an aggregate purchase price of $60.0 million. The warrants have an exercise price of $5.00per 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 Stock Purchase Agreement was completed. The netproceeds from these two fiscal 2005 financings were $73.9 million. On September 15, 2009, Warburg Pincus exercised all 3,177,570 ofthe above-described warrants at the stated exercise price. As a result of the exercise of these warrants and the 863,236 warrants describedabove, we issued an aggregate 4,566,538 shares of our common stock to Warburg Pincus during our fiscal fourth quarter 2009.In connection with the fiscal 2005 and fiscal 2008 offerings, we granted Warburg Pincus registration rights giving them the right torequest that we use commercially reasonable efforts to register some or all of the shares of common stock issued to them under each of theSecurities Purchase Agreement, Stock Purchase Agreement and Purchase Agreement, including shares of common stock underlying thewarrants.Other Common Stock Warrant ActivityOn November 15, 2004, in connection with the acquisition of Phonetic, we issued unvested warrants to purchase 750,000 shares ofour common stock at an exercise price of $4.46 per share that were to vest, if at all, upon the achievement of certain performance targets.Based on our assessment of the results relative to the financial and performance measures, these warrants to purchase shares of ourcommon stock have not vested and will not vest. The former shareholders of Phonetic have objected to this determination and have filedfor arbitration.In March 1999, we issued Xerox a ten-year warrant with an exercise price of $0.61 per share. This warrant is exercisable for thepurchase of 525,732 shares of our common stock. On March 19, 2004, we announced that Warburg Pincus had agreed to purchase alloutstanding shares of our stock held by Xerox Corporation, including this warrant, for approximately $80.0 million. In connection withthis transaction, Warburg Pincus acquired new warrants to purchase 2.5 million additional shares of our common stock for totalconsideration of $0.6 million. The warrants have a six-year life and an exercise price of $4.94 per share. The warrants provide the holderwith the option to exercise the warrants on a net, or cashless, basisIn connection with the acquisition of SpeechWorks in 2003, we issued a warrant to our investment banker, expiring on August 11,2011, for the purchase of 150,000 shares of our common stock at an exercise price of $3.98 per share. The warrant provides the holderwith the option to exercise the warrants on a net, or cashless, basis. The warrant became exercisable on August 11, 2005, and was valuedat its issuance at $0.2 million based upon the Black-Scholes option pricing model. In October 2006, the warrant was exercised topurchase 125,620 shares of our common stock. The holder of the warrant elected a cashless exercise resulting in a net issuance of75,623 shares of our common stock. As of September 30, 2009, a warrant to purchase 12,190 shares of our common stock remainsoutstanding.96 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)We have determined that all of our common stock warrants should be classified within the stockholders’ equity section of theaccompanying consolidated balance sheets based on the conclusion that the above-noted warrants are indexed to our common stock andare exercisable only into our common stock.18. Stock-Based CompensationWe recognize stock-based compensation expense over the requisite service period. Our share-based awards are accounted for asequity instruments. The amounts included in the consolidated statements of operations relating to stock-based compensation are asfollows (dollars in thousands): 2009 2008 2007 Cost of product and licensing $11 $18 $18 Cost of professional services, subscription and hosting 9,889 7,991 3,816 Cost of maintenance and support 743 1,278 966 Research and development 9,840 14,325 7,160 Selling and marketing 27,057 24,394 20,293 General and administrative 23,867 20,625 15,882 $71,407 $68,631 $48,135 Stock OptionsWe have share-based award plans under which employees, officers and directors may be granted stock options to purchase ourcommon stock, generally at fair market value. During fiscal 2008 and 2009, stock options have been primarily granted to seniormanagement and officers of the Company. Our plans do not allow for options to be granted at below fair market value, nor can they be re-priced at any time. Options granted under plans adopted by the Company become exercisable over various periods, typically two to fouryears and have a maximum term of ten years. We have also assumed options and option plans in connection with certain of ouracquisitions. These stock options are governed by the plans and agreements that they were originally issued under, but are nowexercisable for shares of our common stock.97 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The table below summarizes activity relating to stock options for the years ended September 30, 2009, 2008 and 2007: Weighted Weighted Average Average Remaining Aggregate Number of Exercise Contractual Intrinsic Shares Price Term Value(1) Outstanding at October 1, 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 Assumed from SNAPin 1,258,708 $3.48 Granted 1,092,000 $12.07 Exercised (2,570,999) $3.92 Forfeited (987,399) $15.44 Expired (234,958) $12.67 Outstanding at September 30, 2009 13,553,866 $7.48 3.9 years $104.3 million Exercisable at September 30, 2009 10,575,346 $6.22 3.3 years $94.0 million Exercisable at September 30, 2008 10,473,073 Exercisable at September 30, 2007 11,017,997 (1)The aggregate intrinsic value on this table was calculated based on the positive difference, if any, between the closing market value ofour common stock on September 30, 2009 ($14.96) and the exercise price of the underlying options.As of September 30, 2009, the total unamortized fair value of stock options was $22.8 million with a weighted average remainingrecognition period of 1.4 years. A summary of weighted-average grant-date (including assumed options) fair value and intrinsic value ofstock options exercised is as follows: 2009 2008 2007Weighted-average grant-date fair value per share $8.0 $14.8 $7.7 Total intrinsic value of stock options exercised (in millions) $21.0 $89.6 $62.9 98 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)We use the Black-Scholes option pricing model to calculate the grant-date fair value of an award. The fair value of the stock optionsgranted and unvested options assumed from acquisitions were calculated using the following weighted-average assumptions: 2009 2008 2007Dividend yield 0.0% 0.0% 0.0%Expected volatility 55.1% 53.9% 49.7%Average risk-free interest rate 2.7% 3.3% 4.6%Expected term (in years) 5.8 5.5 3.9 The dividend yield of zero is based on the fact that we have never paid cash dividends and have no present intention to pay cashdividends. Expected volatility is based on the historical volatility of our common stock over the period commensurate with the expectedlife of the options and the historical implied volatility from traded options with a term of 180 days or greater. The risk-free interest rate isderived from the average U.S. Treasury STRIPS rate during the period, which approximates the rate in effect at the time of grant,commensurate with the expected life of the instrument. We estimate the expected term of options granted based on historical exercisebehavior.Restricted AwardsWe are authorized to issue equity incentive awards in the form of Restricted Awards, including Restricted Units and RestrictedStock, which are individually discussed below. Unvested Restricted Awards may not be sold, transferred or assigned. The fair value ofthe Restricted Awards is measured based upon the market price of the underlying common stock as of the date of grant, reduced by thepurchase price of $0.001 per share of the awards. The Restricted Awards generally are subject to vesting over a period of two to fouryears, and may have opportunities for acceleration for achievement of defined goals. We also issued certain Restricted Awards withvesting solely dependent on the achievement of specified performance targets. The fair value of the Restricted Awards is amortized toexpense over the awards’ applicable requisite service periods 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.99 Table 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 October 1, 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 in acquisition of 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 Assumed in acquisition of SNAPin — 299,446 Granted 1,292,617 5,392,361 Earned/released (291,450) (2,865,505)Forfeited (575,018) (928,496)Outstanding at September 30, 2009 2,840,673 8,755,330 Weighted average remaining contractual term of outstanding Restricted Units 1.0 years 1.3 years Aggregate intrinsic value of outstanding Restricted Units(1) $42.5 million $131.0 million Restricted Units vested and expected to vest 2,338,422 7,521,997 Weighted average remaining contractual term of Restricted Units vested and expectedto vest 1.0 years 1.2 years Aggregate intrinsic value of Restricted Units vested and expected to vest(1) $35.0 million $112.5 million (1)The aggregate intrinsic value on this table was calculated based on the positive difference between the closing market value of ourcommon stock on September 30, 2009 ($14.96) 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, 2009, unearned stock-based compensationexpense related to all unvested Restricted Units is $123.2 million, which will, based on expectations of future performance vestingcriteria, where applicable, be recognized over a weighted-average period of 1.8 years.A summary of weighted-average grant-date fair value, including those assumed in respective periods, and intrinsic value of allRestricted Units vested is as follows: 2009 2008 2007Weighted-average grant-date fair value per share $11.39 $18.01 $14.73 Total intrinsic value of shares vested (in millions) $33.25 $55.50 $13.40 100 Table 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 October 1, 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 Granted — $— Vested (625,070) $10.90 Forfeited — $— Outstanding at September 30, 2009 — $— The purchase price for vested Restricted Stock is $0.001 per share. As of September 30, 2009, there is no unearned stock-basedcompensation expense related to unvested Restricted Stock. A summary of weighted-average grant-date fair value and intrinsic value ofRestricted Stock vested are as follows: 2009 2008 2007Weighted-average grant-date fair value per share N/A $15.89 $8.75 Total intrinsic value of shares vested (in millions) $8.65 $16.85 $5.60 In order to satisfy our employees’ withholding tax liability as a result of the vesting of Restricted Stock, we have historicallyrepurchased shares upon the employees’ vesting. Similarly, in order to satisfy our employees’ withholding tax liability as a result of therelease of our employees’ Restricted Units, we have historically cancelled a portion of the common stock upon the release. In fiscal 2009,we paid cash of $10.4 million relating to 0.9 million shares of common stock that were repurchased or cancelled. Based on our estimate ofthe Restricted Awards that will vest, or be released, in fiscal 2010, and further assuming that one-third of these Restricted Awards wouldbe repurchased or cancelled to satisfy the employee’s withholding tax liability (such amount approximating the tax rate of our employees),we would have an obligation to pay cash relating to approximately 1.8 million shares during fiscal 2010.1995 Employee Stock Purchase PlanOur 1995 Employee Stock Purchase Plan (“the Plan”), as amended and restated on April 21, 2008, authorizes the issuance of amaximum 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 closingprice on the applicable offering commencement date or 85% of the closing price on the applicable offering termination date. Stock-basedcompensation expense for the employee stock purchase plan is recognized for the fair value benefit accorded to participating employees. AtSeptember 30, 2009, 1,565,127 shares were reserved for future issuance. During fiscal 2009, 2008, and 2007, we issued 1,153,805,651,121 and 640,777 shares of common stock under this plan, respectively. The weighted average fair value of all purchase rightsgranted in fiscal 2009, 2008 and 2007, were $3.49, $5.09 and $4.51. Stock-based compensation101 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)expense related to the employee stock purchase plan was $3.7 million, $3.4 million and $2.2 million for the fiscal years ended 2009,2008 and 2007, 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: 2009 2008 2007Dividend yield 0.0% 0.0% 0.0%Expected volatility 62.1% 53.1% 44.7%Average risk-free interest rate 0.3% 2.1% 4.7%Expected term (in years) 0.5 0.5 0.5 19. Commitments and ContingenciesOperating LeasesWe have various operating leases for office space around the world. In connection with many of our acquisitions, we assumedfacility lease obligations. Among these assumed obligations are lease payments related to certain office locations that were vacated bycertain of the acquired companies prior to the acquisition date (Note 14). Additionally, certain of our lease obligations have been includedin various restructuring charges (Note 15). The following table outlines our gross future minimum payments under all non-cancelableoperating leases as of September 30, 2009 (in thousands): Operating Leases Under Other Contractual Year Ending September 30, Leases Restructuring Obligations Assumed Total 2010 $18,448 $4,196 $13,547 $36,191 2011 17,185 2,647 13,965 33,797 2012 15,880 1,352 12,314 29,546 2013 14,874 408 2,323 17,605 2014 12,631 — 2,326 14,957 Thereafter 39,225 — 3,294 42,519 Total $118,243 $8,603 $47,769 $174,615 At September 30, 2009, we have subleased certain office space that is included in the above table to third parties. Total subleaseincome under contractual terms is $17.5 million and ranges from approximately $1.5 million to $4.4 million on an annual basis throughFebruary 2016.Total rent expense charged to operations was approximately $19.6 million, $15.2 million and $9.3 million for the years endedSeptember 30, 2009, 2008 and 2007, respectively.Litigation and Other ClaimsLike many companies in the software industry, we have, from time to time been notified of claims that we may be infringing, orcontributing to the infringement of, the intellectual property rights of others. These claims have been referred to counsel, and they are invarious stages of evaluation and negotiation. If it appears necessary or desirable, we may seek licenses for these intellectual propertyrights. There is no assurance that licenses will be offered by all claimants, that the terms of any offered licenses will be acceptable to us orthat in all cases the dispute will be resolved without litigation, which may be time consuming and expensive, and may result in injunctiverelief or the payment of damages by us.102 Table 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 stock of Former Nuance, which we acquired in September 2005, betweenApril 12, 2000 and December 6, 2000. Those complaints have been consolidated into one action. The complaint generally alleges thatvarious 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 the 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, the 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, as payments, if any, were expected to be made by insurance carriers, rather than by us. On December 5, 2006, theCourt of Appeals for the Second Circuit reversed the Court’s order certifying a class in several “test cases” that had been selected by theunderwriter defendants and 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. On March 26, 2008, the Court largely denied the defendant’s motion todismiss the amended complaints. On April 2, 2009, the plaintiffs filed a motion for preliminary approval of a new proposed settlementbetween plaintiffs, the underwriter defendants, the issuer defendants and the insurers for the issuer defendants. Under the settlement,which remains subject to Court approval, the insurers would pay the full amount of the settlement attributable to Former Nuance, andFormer Nuance would not bear any financial liability. The Court issued an order granting preliminary approval of the settlement, datedJune 9, 2009, and a hearing on final approval of the settlement was held on September 10, 2009. On October 5, 2009, the court issuedan opinion granting plaintiffs’ motion for final approval of the settlement, approval of the plan of distribution of the settlement fund andcertification of the settlement classes. On October 20, 2009, a petition for permission to appeal the court’s October 5, 2009 certification ofthe settlement classes was filed in the United States Court of Appeals for the Second Circuit. Due to the inherent uncertainties of litigation,we are unable to determine the ultimate outcome or potential range of loss, if any.Vianix LLC has filed three legal actions against us, consisting of two breach of contract actions and a copyright infringement claim.It is too early for us to reach a conclusion as to the ultimate outcome or proposed settlement of these actions or to estimate the potential lossthat could result from a settlement or adverse judgment against us in these matters. However, we believe that we have substantial defensesagainst these claims, and intend to defend them vigorously.We do not believe that the final outcome of the above litigation matters will have a material adverse effect on our financial positionand results of operations. However, even if our defense is successful, the litigation could require significant management time and will becostly. Should we not prevail, our operating results, financial position and cash flows could be adversely impacted.Guarantees and OtherWe include indemnification provisions in the contracts we enter into with customers and business partners. Generally, theseprovisions require us to defend claims arising out of our products’ infringement of third-party intellectual property rights, breach ofcontractual obligations and/or unlawful or otherwise culpable conduct. The indemnity obligations generally cover damages, costs andattorneys’ fees arising out of such claims. In most, but not all, cases, our total liability under such provisions is limited to either the valueof the contract or a specified, agreed103 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)upon amount. In some cases our 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 we could be required to make under all theindemnification provisions is unlimited, we believe the estimated fair value of these provisions is minimal due to the low frequency withwhich these provisions have been triggered.We indemnify our directors and officers to the fullest extent permitted by law. These agreements, among other things, indemnifydirectors and officers for expenses, judgments, fines, penalties and settlement amounts incurred by such persons in their capacity as adirector or officer of the company, regardless of whether the individual is serving in any such capacity at the time the liability or expenseis incurred. Additionally, in connection with certain acquisitions we have agreed to indemnify the former officers and members of theboards of directors of those companies, on similar terms as described above, for a period of six years from the acquisition date. In certaincases we purchase director and officer insurance policies related to these obligations, which fully cover the six year periods. To the extentthat we do not purchase a director and officer insurance policy for the full period of any contractual indemnification, we would berequired to pay for costs incurred, if any, as described above.At September 30, 2009, we have $1.9 million of non-cancelable purchase commitments for inventory to fulfill customers’ orderscurrently scheduled in our backlog.20. Pension and Other Post-Retirement BenefitsDefined Contribution PlanWe have established a retirement savings plan under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”). The 401(k)Plan covers substantially all of our U.S. employees who meet minimum age and service requirements, and allows participants to defer aportion of their annual compensation on a pre-tax basis. Effective July 1, 2003, Company match of employee’s contributions wasestablished. We match 50% of employee contributions up to 4% of eligible salary. Employees who were hired prior to April 1, 2004 were100% vested into the plan as soon as they started to contribute to the plan. Employees hired April 1, 2004 and thereafter, vest one-third ofthe contribution annually over a three-year period. Our contributions to the 401(k) Plan totaled $3.2 million, $2.9 million and$1.8 million for fiscal 2009, 2008 and 2007, respectively.Defined Benefit Pension PlansIn accordance with the provisions set forth in ASC 715, we recognized the funded status, which is the difference between the fairvalue of plan assets and the projected benefit obligations, of our postretirement benefit plans in the consolidated balance sheets with acorresponding adjustment to accumulated other comprehensive loss, net of tax. The adjustment to accumulated other comprehensive lossat adoption represents the net unrecognized actuarial losses and unrecognized prior service costs, both of which were previously nettedagainst the plans’ funded status in our consolidated balance sheet pursuant to the provisions of SFAS No. 87, Employers’ Accountingfor Pensions, also now included, as amended, within ASC 715. These amounts will be subsequently recognized as net periodic pensionexpense.We assumed the assets and obligations related to certain significant defined benefit pension plans in connection with our acquisitionof Dictaphone, 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.104 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following table shows the changes in fiscal 2009 and 2008 in the projected benefit obligation, plan assets and funded status ofthe defined benefit pension plans (in thousands): Pension Benefits 2009 2008 Change in Benefit Obligations: Benefit obligation at beginning of period $22,408 $23,741 Service cost — — Interest cost 1,179 1,275 Plan participants’ contributions — — Curtailments — — Actuarial loss (gain) 2,752 1,245 Expenses paid — (4)Currency exchange rate changes (2,456) (2,545)Benefits paid (1,033) (1,304)Benefit obligation at end of period 22,850 22,408 Change in Plan Assets: Fair value of plan assets, beginning of period 18,397 23,366 Actual return on plan assets 1,121 (3,021)Employer contribution 958 1,371 Plan participants’ contribution — — Expenses paid — (4)Currency exchange rate changes (1,894) (2,011)Benefits paid (1,033) (1,304)Fair value of plan assets, end of period 17,549 18,397 Funded status at end of period $(5,301) $(4,011)The amounts recognized in our consolidated balance sheets consisted of the following (in thousands): Pension Benefits 2009 2008 Other assets $1,124 $1,958 Current liabilities — — Other liabilities (6,425) (5,969)Net liability recognized $(5,301) $(4,011)The amounts recognized in accumulated other comprehensive loss as of September 30, 2009 consisted of the following (inthousands): Pension Benefits Prior service cost $— Actuarial gain (loss) (4,953)Total amount recognized in accumulated other comprehensive loss $(4,953)105 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following represents the amounts included in accumulated other comprehensive loss on the consolidated balance sheet as ofSeptember 30, 2009, that we expect to recognize in earnings during fiscal 2010 (in thousands): Pension BenefitsPrior service cost $— Actuarial gain (loss) (404)The projected benefit obligations for the two defined benefit pension plans was $22.8 million at September 30, 2009.Included in the table below are the amounts relating to our UK pension plans, which have accumulated benefit obligations andprojected benefit obligations in excess of plan assets (in thousands): Pension Benefits 2009 2008Aggregate projected benefit obligations $19,967 $19,426 Aggregate accumulated benefit obligations 19,967 19,426 Aggregate fair value of plan assets 13,542 13,456 The components of net periodic benefit cost of the pension plans were as follows (in thousands): Pension Benefits 2009 2008 Service cost $— $— Interest cost 1,179 1,275 Expected return on plan assets (1,058) (1,596)Amortization of unrecognized gain (loss) 47 (103)Net periodic pension cost $168 $(424)Plan Assumptions:Weighted-average assumptions used in developing the benefit obligations and net periodic benefit cost for the pension plans were asfollows: Pension Benefits 2009 2008Discount rate 6.1% 6.2%Average compensation increase N/A(1) N/A(1)Expected rate of return on plan assets 6.7% 7.0%(1)Rate of compensation increase is not applicable as there are no active members in the plan.We considered several factors when developing the expected return on plan assets, including reviewing analysis of returns relevant tothe country where each plan is in effect, historical rates of return from investments, local actuarial projections and market outlook frominvestment managers. The expected rate of return disclosed above is the weighted average of each country’s expected return on plan assets.106 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Assets Allocation and Investment Strategy:The percentages of the fair value of pension plan assets actually allocated and targeted for allocation, by asset category, atSeptember 30, 2009 and September 30, 2008, were as follows: Actual Target Asset Category 2009 2008 2009 2008 Equity securities 62% 59% 58% 57%Debt securities 38% 41% 42% 43%Total 100% 100% 100% 100%Our investment goal for pension plan assets is designed to provide as much assurance as is possible, in our opinion, that thepension assets are available to pay benefits as they come due and minimize market risk. The expected long-term rate of return for the planassets is 6.7% for the UK pension plan and for the Canadian pension plan.Employer Contributions:We expect to contribute $1.4 million to our pension plans in fiscal 2010. Included in this contribution is a minimum fundingrequirement associated with our UK pension which requires an annual minimum payment of £859,900 (approximately $1.4 millionbased on the exchange rate at September 30, 2009) for each year through fiscal 2014.Estimated Future Benefit Payments:The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands):Year Ending September 30, Pension Benefits 2010 $1,095 2011 1,145 2012 1,168 2013 1,192 2014 1,238 Thereafter 6,018 Total $11,856 21. Income TaxesThe components of income (loss) before income taxes are as follows (in thousands): Year Ended September 30, 2009 2008 2007 Domestic $5,636 $(23,542) $(1,888)Foreign 22,553 8,028 10,375 Income (loss) before income taxes $28,189 $(15,514) $8,487 107 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The components of the income tax provision (benefit) are as follows (in thousands): Year Ended September 30, 2009 2008 2007 Current: Federal $1,119 $1,048 $1,849 State 5,439 10,782 3,880 Foreign 8,115 2,233 2,705 14,673 14,063 8,434 Deferred: Federal 14,952 20,177 11,421 State 12,740 (20,796) 1,036 Foreign (1,974) 1,110 1,611 25,718 491 14,068 Provision for income taxes $40,391 $14,554 $22,502 A reconciliation of our effective tax rate to the statutory federal rate is as follows: 2009 2008 2007 Federal statutory tax rate 35.0% 35.0% 35.0%Stock-based compensation 17.5 (30.1) 35.1 Foreign taxes (6.2) (13.8) 9.7 Foreign benefit — refundable credits — 24.9 — State tax, net of federal benefit 25.3 (48.2) 58.0 State tax law enactment, net of federal benefit 39.9 131.6 — Nondeductible expenditures 8.8 (9.3) 6.0 Change in valuation allowance 13.5 (192.2) 103.9 Executive compensation 7.6 (1.1) 20.7 Federal credits, net — 6.3 (6.4)Other 1.9 3.1 3.1 Effective income tax rate 143.3% (93.8)% 265.1%During fiscal 2009, the tax provision includes a charge of $8.0 million related to the Company’s election to treat the eScriptionacquisition as an asset purchase. Also included in the fiscal 2009 tax provision is a charge of $3.2 million as a result of theMassachusetts state tax law enactment relating to the utilization of net operating losses.During fiscal 2008, a tax benefit of $20.4 million was recorded when the tax law in Massachusetts was changed which reduced thetax rate that certain deferred tax liabilities would be taxed at when reported in the tax provision in the future. Included in this benefit is$8.0 million related to the treatment of the eScription acquisition as a stock purchase, which the Company subsequently elected to treat asan asset purchase in 2009, as noted above.The cumulative amount of undistributed earnings of our foreign subsidiaries amounted to $54.1 million at September 30, 2009. Wehave not provided any additional federal or state income taxes or foreign withholding taxes on the undistributed earnings, as such earningshave been indefinitely reinvested in the business. An estimate of the tax consequences from the repatriation of these earnings is notpracticable at this time resulting from the complexities of the utilization of foreign tax credits and other tax assets.108 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Deferred tax assets (liabilities) consist of the following at September 30, 2009 and 2008 (in thousands): 2009 2008 Deferred tax assets: Net operating loss carryforwards $225,660 $194,547 Federal and state credit carryforwards 19,241 12,600 Capitalized development costs 26,351 23,302 Accrued expenses and other reserves 51,315 75,079 Deferred revenue 14,490 13,576 Deferred compensation 18,335 15,914 Depreciation 2,955 2,988 Other 8,655 9,985 Total deferred tax assets 367,002 347,991 Valuation allowance for deferred tax assets (239,671) (182,961)Net deferred tax assets 127,331 165,030 Deferred tax liabilities: Acquired intangibles (180,148) (210,072)Net deferred tax liabilities $(52,817) $(45,042)Reported as: Current deferred tax assets(a) $1,394 $1,703 Long-term deferred tax assets(b) 3,749 — Current deferred tax liabilities(c) (1,614) — Long-term deferred tax liability(d) (56,346) (46,745)Net deferred tax liabilities $(52,817) $(45,042)(a)Included in prepaid expenses and other current assets in the consolidated balance sheets.(b)Included in other assets in the consolidated balance sheets.(c)Included in accrued expenses and other current liabilities in the consolidated balance sheets.(d)Included in deferred tax liability in the consolidated balance sheets.As of September 30, 2009, our valuation allowance for U.S. net deferred tax assets totaled $207.7 million, which consists of$156.0 million in beginning allowance, plus a $15.7 million increase to income tax provision due to increases in net deferred tax assetsin fiscal 2009 and a $36.0 million increase in valuation allowance resulting from goodwill and acquisition related adjustments. A portionof the deferred tax liabilities are created resulting from the different treatment of goodwill for book and tax purposes which cannot offsetdeferred tax assets in determining the valuation allowance.As of September 30, 2009 and 2008, $164.3 million and $124.5 million, respectively, of our valuation allowance is associated withtax assets arising from business combinations. When and if any of this valuation allowance is released, will be recorded as a benefit inthe statement of operations upon our adoption of ASC 805 on October 1, 2010.At September 30, 2009 and 2008, we had U.S. federal net operating loss carryforwards of $600.6 million and $546.4 million,respectively, of which $186.7 million and $194.9 million, respectively, relate to tax deductions from stock-based compensation. AtSeptember 30, 2009 and 2008, we had state net operating loss carryforwards of109 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)$170.2 million and $133.5 million, respectively. At September 30, 2009 and 2008, we had federal research and developmentcarryforwards of $13.0 million and $8.2 million, respectively. At September 30, 2009 and 2008, we had state research and developmentcredit carryforwards of $6.9 million and $7.1 million, respectively. The net operating loss and credit carryforwards are subject to anannual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state taxprovisions. These carryforwards will expire at various dates beginning in 2009 and extending through 2028, if not utilized.Uncertain Tax PositionsEffective October 1, 2007, we adopted the provisions of FASB Interpretation No. 48 (“FIN 48”), now referred to as ASC 740-10 andwe began establishing reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement ofuncertain tax positions. Under the comprehensive model, reserves are established when we have determined that it is more likely than notthat a tax position will or will not be sustained and at the greatest amount for which the result is more likely than not. As a result of theadoption of ASC 740-10, during fiscal 2008, we recognized an adjustment of $0.9 million in our liability for unrecognized tax benefits.The aggregate changes in the balance of our gross unrecognized tax benefits were as follows: September 30, 2009 2008 Balance, beginning of year $2.7 $2.5 Increases for tax positions taken during prior periods 3.1 — Increases for interest charges 0.5 0.2 Increases for acquisitions 6.8 — Decreases for tax settlements (1.0) — Balance, at end of year $12.1 $2.7 As of September 30, 2009, $12.1 million of the unrecognized tax benefits, if recognized, would affect our effective tax rate. We donot expect a significant change in the amount of unrecognized tax benefits within the next 12 months. We recognized interest and penaltiesrelated to uncertain tax positions in our provision for income taxes and had accrued $0.9 million of such interest and penalties as ofSeptember 30, 2009.We are subject to U.S. federal income tax, various state and local taxes, and international income taxes in numerous jurisdictions.The federal, state and foreign tax returns are generally subject to tax examinations for the tax years ended in 2005 through 2008.22. Segment and Geographic Information and Significant CustomersWe follow the provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, now referredto as ASC 280, which establishes standards for reporting information about operating segments. ASC 280 also established standards fordisclosures about products, services and geographic areas. Operating segments are defined as components of an enterprise for whichseparate financial information is available and evaluated regularly by the chief operating decision maker in deciding how to allocateresources and in assessing performance. Our chief operating decision maker (“CODM”) is the Chief Executive Officer of the Company.We have several customer-facing market groups that oversee the core markets where we conduct business. Beginning in fiscal 2009,these groups were referred to as Mobile-Enterprise, Healthcare-Dictation, and Imaging. Each of these market groups has a president whohas direct responsibility and oversight related to go-to-market110 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)strategies and plans, product management and product marketing activities. These groups do not directly manage centralized or sharedresources or the allocation decisions regarding the activities related to these functions, which include sales and sales operations, certainresearch and development initiatives, business development and all general and administrative activities. Our CODM directly overseeseach of the presidents, as well as each of the functions that provide the shared and centralized activities noted above. To manage thebusiness, allocate resources and assess performance, the CODM primarily reviews revenue data by market group, while reviewing grossmargins, operating margins, and other measures of income or loss on a consolidated basis. Thus, we have determined that we operate inone segment.The following table presents revenue information for our three core markets (in thousands): Fiscal Fiscal Fiscal 2009 2008 2007 Mobile-Enterprise $462,316 $438,785 $246,762 Healthcare-Dictation 418,373 349,744 281,290 Imaging 69,663 79,933 73,944 Total Revenue $950,352 $868,462 $601,996 No country outside of the United States provided greater than 10% of our total revenue. Revenue, classified by the major geographicareas in which our customers are located, was as follows (table in thousands): 2009 2008 2007 United States $706,858 $669,239 $471,636 International 243,494 199,223 130,360 Total $950,352 $868,462 $601,996 No country outside of the United States held greater than 10% of our long-lived or total assets. Our long-lived assets, includingintangible assets and goodwill, were located as follows (table in thousands): September 30, September 30, 2009 2008 United States $2,395,923 $2,066,106 International 307,864 264,810 Total $2,703,787 $2,330,916 23. Related PartiesA member of our Board of Directors is also a partner at Wilson Sonsini Goodrich & Rosati, Professional Corporation, a law firmthat provides professional services to us. These services may from time-to-time include contingent fee arrangements. For fiscal 2009, 2008and 2007, we paid $8.7 million, $13.1 million and $8.6 million, respectively, to Wilson Sonsini Goodrich & Rosati for professionalservices. As of September 30, 2009 and 2008, we had $1.7 million and $2.6 million, respectively, included in accounts payable andaccrued expenses to Wilson Sonsini Goodrich & Rosati.Two members of our Board of Directors are employees of Warburg Pincus, a significant shareholder. On January 29, 2009 andMay 20, 2008, we consummated stock purchase agreements with Warburg Pincus. See Note 17 for further information.111 Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)24. 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 Year2009 Total revenue $216,834 $229,145 $241,040 $263,333 $950,352 Gross margin $134,534 $140,767 $147,081 $168,419 $590,801 Net income (loss) $(24,550) $7,067 $(1,009) $6,290 $(12,202)Net income (loss) per share: Basic $(0.10) $0.03 $(0.00) $0.02 $(0.05)Diluted $(0.10) $0.03 $(0.00) $0.02 $(0.05)Weighted average common shares outstanding: Basic 236,237 250,656 260,750 266,932 253,644 Diluted 236,237 269,187 260,750 285,948 253,644 First Second Third Fourth Quarter Quarter Quarter Quarter Year2008 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 25. Subsequent EventsOn October 9, 2009, we entered into a five-year joint research collaboration with a third party to accelerate the development ofstate-of-the art speech offerings for enterprise and mobile technologies and consumer electronics. All new technologies derived from thecollaboration will be jointly-owned by the two parties. In consideration for the services from the third party in the collaboration efforts, wewill pay $80.0 million in five equal payments of $16.0 million at the beginning of each year, over the five-year period, payable in cash orour common stock, at our option. These payments will be recorded as prepaid R&D services and amortized into R&D expense ratablyover each annual period. Any payments under this arrangement made in our common stock are subject to a security price guarantee. Thesecurity price guarantee requires a payment from either us to the third party, or from the third party to us based upon the differencebetween the price of our common stock on the issue date and an average price of our common stock approximately six months followingthe issue date. On October 14, 2009, we made our first payment under the arrangement consisting of 1,047,120 shares of common stockvalued at $16.0 million.112 Table 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 reports wefile or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer andChief Financial Officer, to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief Executive Officerand Chief Financial Officer concluded that, as of September 30, 2009, our disclosure controls and procedures were effective.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, 2009, utilizing thecriteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”). Based on the results of this assessment, management (including our Chief Executive Officer and our ChiefFinancial Officer) has concluded that, as of September 30, 2009, 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, 2009 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 2009 that havematerially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.113 Table of ContentsItem 9B. Other InformationNone.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 fiscal year covered by this report, and certain information to be included in theProxy 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.Our 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 section 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 IndependenceIt is the policy of the Board that all transactions required to be reported pursuant to Item 404 of Regulation S-K be subject to approvalby the Audit Committee of the Board. In furtherance of relevant NASDAQ rules and our commitment to corporate governance, the charterof the Audit Committee provides that the Audit Committee shall review and approve any proposed related party transactions including,transactions required to be reported pursuant to Item 404 of Regulation S-K for potential conflict of interest situations. The AuditCommittee reviews the material facts of all transactions that require the committee’s approval and either approves or disapproves of thetransaction. In determining whether to approve a transaction, the Audit Committee will take into account, among other factors it deemsappropriate, whether the transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under thesame or similar circumstances.114 Table of ContentsThe additional information required by this item regarding certain relationships and related party transactions is incorporated byreference to the information set forth in the sections titled “Related Party 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.115 Table 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: November 25, 2009 /s/ Paul A. RicciPaul A. Ricci, Chief Executive Officer and Chairman of the Board(Principal Executive Officer) Date: November 25, 2009 /s/ Thomas L. BeaudoinThomas L. Beaudoin, Executive Vice President andChief Financial Officer(Principal Financial Officer) Date: November 25, 2009 /s/ Daniel D. TempestaDaniel D. Tempesta, Chief Accounting Officer andCorporate Controller(Principal Accounting Officer) Date: November 25, 2009 /s/ Robert J. FrankenbergRobert J. Frankenberg, Director Date: November 25, 2009 /s/ Patrick T. HackettPatrick T. Hackett, Director Date: November 25, 2009 /s/ William H. JanewayWilliam H. Janeway, Director Date: November 25, 2009 /s/ Katharine A. MartinKatharine A. Martin, Director Date: November 25, 2009 /s/ Mark MyersMark Myers, Director Date: November 25, 2009 /s/ Philip QuigleyPhilip Quigley, Director Date: November 25, 2009 /s/ Robert G. TeresiRobert G. Teresi, Director Table of ContentsEXHIBIT INDEX Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 2.1 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 2.2 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 2.3 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 2.4 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 2.5 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 2.6 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 2.7 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 2.8 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 2.9 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 2.10 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 7,2008. 8-K 0-27038 2.1 4/11/2008 2.11 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 10/3/2008 2.12 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, dated as ofAugust 13, 2008. 8-K 0-27038 2.1 10/3/2008 2.13 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 10/3/2008 2.14 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 2/11/2008 2.15 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 2/11/2008 2.16 Arrangement Agreement, dated as of February 26,2009, by and between Nuance Communications,Inc. and Zi Corporation. 8-K 0-27038 2.1 2/27/2009 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 2.17 Agreement and Plan of Merger, dated as ofSeptember 30, 2009, by and among NuanceCommunications, Inc., Epic AcquisitionCorporation, Epic Acquisition LLC, eCopy, Inc.,U.S. Bank National Association, as Escrow Agent,and Gary Hall, as Stockholder Representative. 8-K 0-27038 2.1 10/6/2009 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 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 4.4 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 4.5 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 4.6 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 4/11/2008 4.7 Purchase Agreement, dated as of January 13, 2009,by and among Nuance Communications, Inc. andthe Purchasers identified on Exhibit A (WarburgPincus Private Equity X, L.P. and Warburg PincusX Partners, L.P.). 8-K 0-27038 2.1 1/16/2009 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 4.8 Third Amended and Restated StockholdersAgreement, dated as of January 29, 2009, by andamong Nuance Communications, Inc., WarburgPincus Private Equity VIII, L.P., Warburg PincusNetherlands Private Equity VIII C.V. I, and WP-WPVIII Investors, L.P., Warburg Pincus PrivateEquity X, L.P. and Warburg Pincus X Partners,L.P. 10-Q 0-27038 4.1 2/9/2009 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 10.3 Caere Corporation 1992 Non-Employee Directors’Stock Option Plan.* S-8 333-33464 10.4 3/29/2000 10.4 1993 Incentive Stock Option Plan, as amended.* S-1 333-100647 10.17 10/21/2002 10.5 1995 Employee Stock Purchase Plan, as amendedand restated on April 27, 2000.* 14A 0-27038 Annex D 4/13/2004 10.6 Amended and Restated 1995 Directors’ StockOption Plan, as amended.* 14A 0-27038 10.2 3/17/2005 10.7 1997 Employee Stock Option Plan, as amended.* S-1 333-100647 10.19 10/21/2002 10.8 1998 Stock Option Plan.* S-8 333-74343 99.1 3/12/1999 10.9 Amended and Restated 2000 Stock Option Plan.* 14A 0-27038 10.1 3/17/2005 10.10 2000 NonStatutory Stock Option Plan, asamended.* S-8 333-108767 4.1 9/12/2003 10.11 ScanSoft 2003 Stock Plan.* S-8 333-108767 4.3 9/12/2003 10.12 Nuance Communications, Inc. 2001 NonstatutoryStock Option Plan.* S-8 333-128396 4.1 9/16/2005 10.13 Nuance Communications, Inc. 2000 Stock Plan.* S-8 333-128396 4.2 9/16/2005 10.14 Nuance Communications, Inc. 1998 Stock Plan.* S-8 333-128396 4.3 9/16/2005 10.15 Nuance Communications, Inc. 1994 Flexible StockIncentive Plan.* S-8 333-128396 4.4 9/16/2005 10.16 Form of Restricted Stock Purchase Agreement.* 10-K/A 0-27038 10.17 12/15/2006 10.17 Form of Restricted Stock Unit PurchaseAgreement.* 10-K/A 0-27038 10.18 12/15/2006 10.18 Form of Stock Option Agreement.* 10-K/A 0-27038 10.19 12/15/2006 10.19 2005 Severance Benefit Plan for ExecutiveOfficers.* 10-Q 0-27038 10.1 5/10/2005 10.20 Officer Short-term Disability Plan.* 10-Q 0-27038 10.2 5/10/2005 10.21 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 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 10.22 Letter, dated February 17, 2003, from the Registrantto Jeanne McCann regarding certain employmentmatters.* 10-Q 0-27038 10.1 5/15/2003 10.23 Employment Agreement, dated March 9, 2004, byand between the Registrant and John Shagoury.* 10-Q 0-27038 10.1 8/9/2004 10.24 Letter, dated May 23, 2004, from the Registrant toSteven Chambers regarding certain employmentmatters.* 10-Q 0-27038 10.2 8/9/2004 10.25 Letter dated September 25, 2006, from theRegistrant to Don Hunt regarding certainemployment matters. 10-K/A 0-27038 10.29 12/15/2006 10.26 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 10.27 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 10.28 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 10.29 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 10.30 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 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 10.31 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 10.32 Amended and Restated 2000 Stock Plan. 8-K 0-27038 10.1 3/15/2007 10.33 Letter, dated June 3, 2008, from the Registrant toThomas L. Beaudoin regarding certain employmentmatters. 10-K 0-27038 10.39 12/1/2008 10.34 Amended and Restated Employment Agreement,dated as of December 29, 2008, by and betweenNuance Communications, Inc. and Paul Ricci.* 10-Q 0-27038 10.1 2/9/2009 10.35 Amended and Restated Stock Plan.* 8-K 0-27038 99.1 2/5/2009 10.36 Amended and Restated Employment Agreement,dated as of June 23, 2009, by and between NuanceCommunications, Inc. and Paul Ricci.* 8-K 0-27038 99.1 6/26/2009 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 arrangement 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 DomesticeCopy, Inc. Delaware DomesticFocus Enterprises Limited d/b/a Focus Infomatics, Inc. Delaware DomesticJott Networks Inc. Delaware DomesticLocus Dialogue Technologies USA, Inc. Delaware DomesticMobile Voice Control LLC Delaware DomesticNuance Communications International, Inc. Delaware DomesticNuance Communications LLC Delaware DomesticNuance Services, Inc. Delaware DomesticPhonetic Systems Inc. Delaware DomesticRhetorical, Inc. Delaware DomesticSNAPin Software LLC Delaware DomesticSpeechWorks International, Inc. Delaware DomesticViecore LLC Delaware DomesticVocada LLC Delaware DomesticVoice Signal Technologies, Inc. Delaware DomesticX-Solutions North America Inc. Delaware DomesticZi Holding Corporation Delaware DomesticVoice Signal Korea, Inc. Massachusetts DomesticZi Corporation of America, Inc. Nevada DomesticViecore Federal Systems Div., Inc. New Jersey DomesticTegic Communications, Inc. Washington DomesticNuance Communications Australia Pty. Ltd. Australia InternationalNuance Communications Austria GmbH Austria InternationalSpeechMagic Holdings GmbH Austria InternationalMulti-Corp International Ltd. Barbados InternationaDictaphone NV Belgium InternationalNuance Communications International BVBA Belgium InternationalZi (Bermuda) Corporation Bermuda InternationalNuance Communications Ltd. Brazil InternationalBlueStar Options Inc. British Virgin Islands InternationalBlueStar Resources Limited British Virgin Islands InternationalSpeechWorks BVI Ltd. British Virgin Islands International845162 Alberta Ltd. Canada International1448451 Ontario Inc. Canada InternationalNuance Acquisition ULC Canada InternationalNuance Communications Canada, Inc. Canada InternationalZi Corporation Canada InternationalZi Corporation of Canada, Inc. Canada InternationalHuayu Zi Software Technology (Beijing) Co., Ltd. China InternationalNuance Software Technology (Beijing) Co., Ltd. China InternationalNuance Communications Finland OY Finland 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 InternationalNuance Communications Healthcare Germany GmbH Germany InternationalAsia Translation & Telecommunications Limited Hong Kong SAR InternationalHuayu Zi Software Technology Limited Hong Kong SAR InternationalTelecom Technology Corporation Limited Hong Kong SAR InternationalZi Corporation (H.K.) Limited Hong Kong SAR InternationalZi Corporation of Hong Kong Limited Hong Kong SAR International Subsidiary Name Jurisdiction TypeNuance Communications Hong Kong Limited Hong Kong SAR InternationalNuance Recognita Corp. Hungary InternationalFocusMT India Private Limited India InternationalNuance India Pvt. Ltd. India InternationalNuance Communications Israel, Ltd. Israel InternationalPhonetic Systems Ltd. Israel InternationalNuance Communications Italy Srl Italy InternationaleCopy K.K. Japan InternationalNuance Communications Japan K.K. Japan InternationalVoice Signal K.K. Japan InternationalNuance Communications Netherlands B.V. Netherlands InternationalX-Solutions Group B.V. Netherlands InternationalX-Solutions International B.V. Netherlands InternationalZeros Solutions B.V. Netherlands InternationalRhetorical Group plc. Scotland InternationalRhetorical Systems Limited Scotland InternationalNuance Communications Asia Pacific Pte. Ltd. Singapore InternationalNuance Communications Iberica SA Spain InternationalNuance Communications Korea Ltd. South Korea InternationalNuance Communications Sweden, A.B. Sweden InternationalZi Decuma AB Sweden InternationalNuance Communications Taiwan Taiwan InternationalDictaphone Company Limited United Kingdom InternationalDictaphone International Limited United Kingdom InternationaleCopy Ltd. United Kingdom InternationalNuance Communications UK Limited United Kingdom InternationalSNAPin Software UK 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. 333-147715, 333-142182, 333-100648, and 333-61862), and Form S-8 (Nos. 333-157579, 333-151088, 333-151087, 333-153911, 333-148684, 333-145971, 333-143465, 333-142183 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 reports dated November 25, 2009, relating to the consolidated financial statements and the effectiveness ofNuance Communications, Inc.’s internal control over financial reporting, which appears in this Form 10-K. /s/ BDO Seidman, LLP Boston, Massachusetts November 25, 2009 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 BoardNovember 25, 2009 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 Executive Vice President and Chief Financial OfficerNovember 25, 2009 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, 2009 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 BoardNovember 25, 2009 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, 2009 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 Executive Vice President and Chief Financial OfficerNovember 25, 2009

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