Nuance Communications
Annual Report 2010

Plain-text annual report

Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-K(Mark One)  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2010ORoo TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-27038NUANCE COMMUNICATIONS, INC.(Exact name of Registrant as Specified in its Charter)Delaware 94-3156479(State or Other Jurisdiction ofIncorporation or Organization) (I.R.S. EmployerIdentification No.) 1 Wayside RoadBurlington, Massachusetts(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  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 $3.8 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, 2010, was 298,191,105.DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant’s definitive Proxy Statement to be delivered to stockholders in connection with the Registrant’s 2011 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 16 Item 2. Properties 17 Item 3. Legal Proceedings 17 Item 4. [Removed and Reserved] 18 PART II Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities 19 Item 6. Selected Financial Data 20 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20 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 109 Item 9A. Controls and Procedures 109 Item 9B. Other Information 110 PART III Item 10. Directors, Executive Officers and Corporate Governance 110 Item 11. Executive Compensation 110 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related StockholderMatters 110 Item 13. Certain Relationships and Related Transactions, and Director Independence 110 Item 14. Principal Accountant Fees and Services 111 PART IV Item 15. Exhibits and Financial Statement Schedules 111 EX-21.1 EX-23.1 EX-31.1 EX-31.2 EX-32.1 EX-101 INSTANCE DOCUMENT EX-101 SCHEMA DOCUMENT EX-101 CALCULATION LINKBASE DOCUMENT EX-101 LABELS LINKBASE DOCUMENT EX-101 PRESENTATION LINKBASE DOCUMENT EX-101 DEFINITION LINKBASE DOCUMENT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: our futurerevenue, cost of revenue, research and development expense, selling, general and administrative expenses, amortization of intangibleassets and gross margin, earnings, cash flows and liquidity; our strategy relating to our core markets; the potential of future productreleases; our product development plans and investments in research and development; future acquisitions and anticipated benefits fromacquisitions; international operations and localized versions of our products; our contractual commitments; our fiscal 2011 revenue andexpense expectations and legal proceedings and litigation matters. You can identify these and other forward-looking statements by the useof 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 assumptionsunderlying or relating to any of the foregoing statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Item 1A of this Annual Report under the heading “RiskFactors.” All forward-looking statements included in this document are based on information available to us on the date hereof. We willnot undertake and specifically decline any obligation to update any forward-looking statements.Item 1. BusinessOverviewNuance Communications, Inc. is a leading provider of voice and language solutions for businesses and consumers around theworld. Our technologies, applications and services make the user experience more compelling by transforming the way people interactwith devices and systems. Our solutions are used every day by millions of people and thousands of businesses for tasks and servicessuch as requesting information from a phone-based self-service solution, dictating medical records, searching the mobile Web by voice,entering a destination into a navigation system, or working with PDF documents. Our solutions help make these interactions, tasks andexperiences 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 sell our products directly through a dedicated sales force andthrough our e-commerce website and also through a global network of resellers, including system integrators, independent softwarevendors, value-added resellers, hardware vendors, telecommunications carriers and distributors.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 four core markets; Healthcare, Mobile and Consumer, Enterprise, and Imaging, include:HealthcareThe healthcare industry is under significant pressure to streamline operations, reduce costs and improve patient care. In recentyears, healthcare organizations such as hospitals, clinics, medical groups, physicians’ offices and insurance providers have increasinglyturned to speech recognition solutions to automate manual processes such as the dictation and transcription of patient records.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. Oursolutions also enable us to accelerate future1Table of Contentsinnovation to transform the way healthcare providers document patient care, through improved interface with electronic medical recordsand extraction of clinical information to support the billing and insurance reimbursement processes. We also offer speech recognitionsolutions for radiology, cardiology, pathology and related specialties, that help healthcare providers dictate, edit and sign reports withoutmanual transcription.We utilize a focused, enterprise sales team and professional services organization to address the market and implementationrequirements of the healthcare industry. Direct distribution is supplemented by distributors and partnerships with electronic medicalrecords application providers such as Allscripts, Cerner and Epic. In some cases, our healthcare solutions are priced under a traditionalsoftware perpetual licensing model. However, certain of our healthcare solutions, in particular our transcription solution, are also offeredon an on-demand model, charged as a subscription and priced by volume of usage (such as number of lines transcribed). During fiscal2009 and 2010, we experienced a significant shift in customer preference toward our subscription pricing model. Representativecustomers include Banner Health, Cleveland Clinic, Department of Veterans Affairs, HCA, Mayo Clinic, Sutter Health, Tenet, andU.S. Army.Mobile and ConsumerToday, an increasing number of people worldwide rely on mobile devices to stay connected, informed and productive. We helpconsumers use the powerful capabilities of their phones, cars, desktop and portable computer, personal navigation devices and otherconsumer electronics by enabling the use of voice commands and enhanced text input solutions to control and interact with these devicesmore easily and naturally, and to access the array of content and services available on the Internet.Our portfolio of mobile and consumer solutions and services includes an integrated suite of voice control and text-to-speechsolutions, dictation applications, predictive text technologies, mobile messaging services and emerging services such as dictation, Websearch and voicemail-to-text. Our suite of Dragon general purpose desktop and portable computer dictation applications increasesproductivity by using speech to create documents, streamline repetitive and complex tasks, input data, complete forms and automatemanual transcription processes. In particular, we have focused in recent quarters on integrating our Dragon technology and brandinitiatives across mobile and consumer markets. We utilize a focused, enterprise sales team and professional services organization toaddress market and implementation requirements. Direct distribution is supplemented by partnerships with electronics suppliers andintegrators such as Harman Kardon and Clarion. Our solutions are used by mobile phone, automotive, personal navigation device,computer and other consumer electronic manufacturers and their suppliers, including Amazon, Apple, Audi, BMW, Ford, Garmin,HTC, LG Electronics, Mercedes Benz, Nokia, Samsung, T-Mobile and TomTom. In addition, telecommunications carriers, web searchcompanies and content providers are increasingly using our mobile search and communication solutions to offer value-added services totheir subscribers and customers. Our embedded mobile solutions are sold to automobile and device manufacturers, generally on a royaltymodel priced per device sold, and sometimes on a license model. In addition, our connected mobile services are sold throughtelecommunications carriers or directly to consumers, and generally priced on a volume of usage model (such as per subscriber or peruse). Representative connected services customers include AT&T, Motorola, Rogers, Telstra, TISA, Vodafone and Vonage.Our desktop and portable computer dictation software is currently available in eleven languages. During the fourth quarter of fiscal2010, we shipped new versions of Dragon NaturallySpeaking for Windows and also Dragon Dictate for Mac. Our desktop and portablecomputer dictation solutions are generally sold under a traditional perpetual software license model. We utilize a combination of our globalreseller network and direct sales to distribute our desktop and portable computer dictation products. Resellers include retailers such asAmazon, Best Buy and WalMart. Enterprise customers include organizations such as law firms, insurance agencies and governmentagencies. Representative customers include ATF, Exxon, FBI, IBM, Texas Dept. of Family Protective Services and Zurich.EnterpriseTo remain competitive, organizations must improve the quality of customer care while reducing costs and ensuring a positivecustomer experience. Technological innovation, competitive pressures and rapid commoditization have made it increasingly important fororganizations to achieve enduring market differentiation and secure2Table of Contentscustomer loyalty. In this environment, organizations need to satisfy the expectations of increasingly savvy and mobile consumers whodemand 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 include the use of technologies such as speechrecognition, natural language understanding, text-to-speech, biometric voice recognition and analytics to automate caller identification andauthorization, call steering, completion of tasks such as updates, purchases and information retrieval, and automated outboundnotifications. Our solutions improve the customer experience, increase the use of self-service and enable new revenue opportunities. Wecomplement our solutions and products with a global professional services organization that supports customers and partners withbusiness and systems consulting project management, user-interface design, voice science, application development and businessperformance optimization, allowing us to deliver end-to-end speech solutions and system integration for voice-enabled customer care. Inaddition, we offer solutions that can meet customer care needs through direct interaction with thin-client applications on cell phones,enabling customers to very quickly retrieve relevant information. Use of our speech-enabled and thin-client customer care solutions candramatically decrease customer care costs, in comparison to calls handled by operators.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 approximately 60 languages and dialects worldwide. In addition to our own sales and professional servicesteams, we often work closely with industry partners, including Avaya, Cisco and Genesys, that integrate our solutions into theirhardware and software platforms. Our enterprise solutions offerings include both a traditional software perpetual licensing model and anon-demand model, charged as a subscription and priced by volume of usage (such as number of minutes callers use the system ornumber of calls completed in the system). Representative customers include Bank of America, Cigna, Citibank, Disney, FedEx, UnitedAirlines and Wells Fargo.ImagingThe proliferation of the Internet, email and other networks have greatly simplified the ability to share electronic documents, resultingin an ever-growing volume of documents to be used and stored. Our PDF and document imaging solutions reduce the costs associatedwith paper documents through easy to use scanning, document management and electronic document routing solutions. We offer versionsof 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 multi-function devices, digitalcopiers, printers and scanners, on a royalty model, priced per unit sold.Research and Development/Intellectual PropertyIn recent years, we have developed and acquired extensive technology assets, intellectual property and industry expertise in voice,language and imaging that provide us with a competitive advantage in our markets. Our technologies are based on complex algorithmswhich require extensive amounts of linguistic and image data, acoustic models and recognition techniques. A significant investment incapital and time would be necessary to replicate our current capabilities.We continue to invest in technologies to maintain our market-leading position and to develop new applications. Our technologies arecovered by approximately 2,100 issued patents and 1,900 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, trade3Table of Contentssecrets, confidentiality provisions and licensing arrangements to establish and protect our intellectual property and proprietary rights. Weincurred research and development expenses of $152.1 million, $116.8 million, and $112.8 million in fiscal 2010, 2009 and 2008,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.Geographic revenue classification is based on the geographic areas in which our customers are located. For fiscal 2010, 2009 and2008, 72%, 74% and 77% of revenue was generated in the United States and 28%, 26% and 23% 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 voice, language and imaging technologies, applications and solutions are often recognized as themost innovative and proficient products in their respective categories. Our voice and language technology has industry-leadingrecognition accuracy and provides a natural, voice-enabled interaction with systems, devices and applications. Our imagingtechnology is viewed as the most accurate in the industry. Technology publications, analyst research and independentbenchmarks have consistently indicated 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 to introduce new products and solutions quickly and effectively is enhanced through our dedicated direct salesforce; our extensive global network of resellers, comprising system integrators, independent software vendors, value-addedresellers, hardware vendors, telecommunications carriers and distributors; 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 voice and language technology, which provides recognition for approximately 60 languages and dialects and natural-soundingsynthesized speech in 39 languages, and supports a broad range of hardware platforms and operating systems. Our imagingtechnology supports more 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. We support our customers in designing and building powerful, innovative applications that specificallyaddress their needs and requirements.In our core markets, we compete with companies such as Adobe, Medquist, Microsoft, Google and Transcend Services. In addition,a number of smaller companies in both speech and imaging produce technologies or products that are competitive with our solutions insome markets. In certain markets, some of our partners such as Avaya, Cisco, Genesys and Nortel develop and market products andservices that might be considered substitutes for our solutions. Current and potential competitors have established, or may establish,cooperative relationships among themselves or with third parties to increase the ability of their technologies to address the needs of ourprospective customers.Some of our competitors or potential competitors, such as Adobe, Microsoft and Google, have significantly greater financial,technical and marketing resources than we do. These competitors may be able to respond more4Table of Contentsrapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to thedevelopment, promotion and sale of their products than we do.EmployeesAs of September 30, 2010, we had approximately 6,100 full-time employees in total, including approximately 750 in sales andmarketing, approximately 1,450 in professional services, approximately 950 in research and development, approximately 550 in generaland administrative and approximately 2,400 that provide transcription and editing services. Approximately 44 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.Company 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;5Table of Contents • 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; • 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;6Table of Contents • 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; • accurate projection of revenue plans of the acquired entity in the due diligence process; • customers delaying purchases of our products pending resolution of product integration between our existing and our newlyacquired products; • entering markets or types of businesses in which we have limited experience; and • potential loss of key employees of the acquired business.As a result of these and other risks, if we are unable to successfully integrate acquired businesses, we may not realize the anticipatedbenefits from our acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired businesses andtechnologies could seriously harm our business.Accounting treatment of our acquisitions could decrease our net income or expected revenue in the foreseeable future,which could have a material and adverse effect on the market value of our common stock.Under accounting principles generally accepted in the United States of America, we record the market value of our common stock orother form of consideration issued in connection with the acquisition and, 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 are generally 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, 2010, we had identified intangible assets of approximately $685.9 million, net of accumulated amortization, and goodwillof approximately $2.1 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. As a result, the combined company may delay revenue recognitionor recognize 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 direct acquisition-related costs, such as investment banker’s, attorney’s and accountant’sfees, as well as contingent consideration to the seller, which was recorded when it was beyond a reasonable doubt that the amount waspayable, were capitalized as part of the purchase price.In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (revised 2007), “BusinessCombinations,” now referred to as FASB Accounting Standards Codification 805 (“ASC 805”), which requires an acquirer to do thefollowing: expense acquisition-related costs as incurred; reflect such payments as a reduction of cash flow from operations; recordcontingent consideration at fair value at the acquisition date with subsequent changes in fair value to be recognized in the income statementand cash flow from operations. ASC 8057Table of Contentsapplies to business combinations for which the acquisition date is on or after October 1, 2009 and could have a material impact on ourresults of operations and our financial position due to our acquisition strategy.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, 2010, we had a total of $895.1 million of gross debt outstanding,including $643.6 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 30,2010, there were $21.2 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; • place us at a competitive disadvantage compared to our competitors that have less debt; and • limit, along with the financial and other restrictive covenants related to our debt, our ability to borrow additional funds, disposeof assets 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.8Table of ContentsOur 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 $19.1 million, $19.4 million and $37.0 million for the fiscal years 2010, 2009 and 2008, 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. Additional capital, if available at all, maybe highly dilutive to existing investors or contain other unfavorable terms, such as a high interest rate and restrictive covenants.Voice and language technologies may not achieve widespread acceptance, which could limit our ability to grow our voice andlanguage business.We have invested and expect to continue to invest heavily in the acquisition, development and marketing of voice and languagetechnologies. The market for voice and language technologies is relatively new and rapidly evolving. Our ability to increase revenue in thefuture depends in large measure on the acceptance of these technologies in general and our products in particular. The continueddevelopment of the market for our current and future voice and language solutions will also depend on: • consumer and business demand for speech-enabled applications; • development by third-party vendors of applications using voice and language technologies; and • continuous improvement in voice and language technology.Sales of our voice and language products would be harmed if the market for these technologies does not continue to develop ordevelops slower than we expect, and, consequently, our business could be harmed and we may not recover the costs associated with ourinvestment in these 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 voice and language, we compete with AT&T,Microsoft, Google, and other smaller providers. Within healthcare, we compete with Medquist and other smaller providers. Withinimaging, we compete with ABBYY, Adobe, I.R.I.S. and NewSoft. In voice and language, some of our partners such as Avaya, Cisco,Edify, Genesys and Nortel develop and market products that can be considered substitutes for our solutions. In addition, a number ofsmaller companies in voice, language and imaging produce technologies or products that are in some markets competitive with oursolutions. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with thirdparties 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.9Table of ContentsSome of our customers, such as Microsoft and Google, have developed or acquired products or technologies that compete with ourproducts and technologies. These customers may give higher priority to the sale of these competitive products or technologies. To the extentthey do so, market acceptance and penetration of our products, and therefore our revenue, may be adversely affected. Our success willdepend 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 enhancements. 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 the effectiveness of our internal control over financial reporting. Any failure in the effectiveness of oursystem of internal control over financial reporting could have a material adverse impact on our ability to report our financial statements inan accurate and timely manner, could subject us to regulatory actions, civil or criminal penalties, shareholder litigation, or loss ofcustomer confidence, which could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in thereliability of our financial statements, 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 voice andlanguage products is conducted in Belgium and Canada, and a significant portion of our imaging research and development is conductedin Hungary. We also have significant research and development resources in Aachen, Germany, and Vienna, Austria. Accordingly, ourfuture results could be harmed by a variety of factors associated with international sales and operations, including: • changes in a specific country’s or region’s economic conditions; • geopolitical turmoil, including terrorism and war; • trade protection measures and import or export licensing requirements imposed by the United States or by other countries; • compliance with foreign and domestic laws and regulations; • negative consequences from changes in applicable tax laws; • difficulties in staffing and managing operations in multiple locations in many countries; • difficulties in collecting trade accounts receivable in other countries; and • less effective protection of intellectual property than in the United States.We are exposed to fluctuations in foreign currency exchange rates.Because we have international subsidiaries and distributors that operate and sell our products outside the United States, we areexposed to the risk of changes in foreign currency exchange rates. In certain circumstances,10Table of Contentswe have entered into forward exchange contracts to hedge against foreign currency fluctuations. We use these contracts to reduce our riskassociated with exchange rate movements, as the gains or losses on these contracts are intended to offset any exchange rate losses or gainson the hedged transaction. We do not engage in foreign currency speculation. Forward exchange contracts hedging firm commitmentsqualify for hedge accounting when they are designated as a hedge of the foreign currency exposure and they are effective in minimizingsuch exposure. With our increased international presence in a number of geographic locations and with international revenue and costsprojected 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 of the U.S. dollarcould adversely affect future revenue and operating results.Impairment of our intangible assets could result in significant charges that would adversely impact our future operatingresults.We have significant intangible assets, including goodwill and intangibles with indefinite lives, which are susceptible to valuationadjustments as a result of changes in various factors or conditions. The most significant intangible assets are patents and core technology,completed technology, customer relationships and trademarks. Customer relationships are amortized on an accelerated basis based uponthe pattern in which the economic benefits of customer relationships are being utilized. Other identifiable intangible assets are amortized ona straight-line basis over their estimated useful lives. We assess the potential impairment of identifiable intangible assets on an annualbasis, as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that couldtrigger an impairment of such assets, include the following: • significant underperformance relative to historical or projected future operating results; • significant changes in the manner of or use of the acquired assets or the strategy for our overall business; • significant negative industry or economic trends; • significant decline in our stock price for a sustained period; • changes in our organization or management reporting structure that 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 conducted an analysis of our compliance with the terms and conditions of certain contracts with the U.S. General ServicesAdministration (“GSA”). Based upon our analysis, we voluntarily notified GSA of non-compliance with the terms of two contracts. Thefinal resolution of this matter may adversely impact our financial position.11Table of ContentsIf we are unable to attract and retain key personnel, our business could be harmed.If any of our key employees were to leave, we could face substantial difficulty in hiring qualified successors and could experience aloss in productivity while any successor obtains the necessary training and experience. Our employment relationships are generally at-willand we have had key employees leave in the past. We cannot assure you that one or more key employees will not leave in the future. Weintend to continue to hire additional highly qualified personnel, including software engineers and operational personnel, but may not beable to attract, assimilate or retain qualified personnel in the future. Any failure to attract, integrate, motivate and retain these employeescould harm our business.Our medical transcription services may be subject to legal claims for failure to comply with laws governing the confidentialityof medical records.Healthcare professionals who use our medical transcription services deliver to us health information about their patients includinginformation that constitutes a record under applicable law that we may store on our computer systems. Numerous federal and state lawsand regulations, the common law and contractual obligations govern collection, dissemination, use and confidentiality of patient-identifiable health information, including: • state and federal privacy and confidentiality laws; • our contracts with customers and partners; • state laws regulating healthcare professionals; • Medicaid laws; and • the Health Insurance Portability and Accountability Act of 1996 and related rules proposed by the Health Care FinancingAdministration.The Health Insurance Portability and Accountability Act of 1996 establishes elements including, but not limited to, federal privacyand security standards for the use and protection of protected health information. Any failure by us or by our personnel or partners tocomply with applicable requirements may result in a material liability. 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 the 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 decline12Table of Contentscould have a material adverse effect on our results of operations and financial condition and exacerbate some of the other risk factorsdescribed herein. Our customers may defer purchases of our products, licenses, and services in response to tighter credit and negativefinancial news or reduce their demand for them. Our customers may also not be able to obtain adequate access to credit, which couldaffect their ability to make timely payments to us or ultimately cause the customer to file for protection from creditors under applicableinsolvency or bankruptcy laws. If our customers are not able to make timely 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; or • 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 proprietaryrights13Table of Contentsof others, or to defend against claims of infringement or invalidity. Litigation, regardless of the outcome, can be very expensive and candivert 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.We may incur substantial costs enforcing or acquiring intellectual property rights and defending against third-party claimsas a result of litigation or other proceedings.In connection with the enforcement of our own intellectual property rights, the acquisition of third-party intellectual property rights,or disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been,are currently, and may in the future be, subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes andlitigation are typically very costly and can be disruptive to our business operations by diverting the attention and energy of managementand key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in anyongoing or future litigation and disputes. In addition, we may incur significant costs in acquiring the necessary third party intellectualproperty rights for use in our products. Third party intellectual property disputes could subject us to significant liabilities, require us toenter into royalty and licensing arrangements on unfavorable terms, prevent us from manufacturing or licensing certain of our products,cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments withour customers including contractual provisions under various license arrangements. Any of these could seriously harm our business.Our software products may have bugs, which could result in delayed or lost revenue, expensive correction, liability to ourcustomers and claims against us.Complex software products such as ours may contain errors, defects or bugs. Defects in the solutions or products that we developand sell to our customers could require expensive corrections and result in delayed or lost revenue, adverse customer reaction and negativepublicity about us or our products and services. Customers who are not satisfied with any of our products may also bring claims againstus for damages, which, even if unsuccessful, would likely be time-consuming to defend, and could result in costly litigation andpayment of damages. Such claims could harm our reputation, financial results and competitive position.Risks Related to our Corporate Structure, Organization and Common StockThe holdings of our largest stockholder may enable it to influence matters requiring stockholder approval.As of September 30, 2010, Warburg Pincus, a global private equity firm, beneficially owned approximately 24% of our outstandingcommon stock, including warrants exercisable for up to 7,562,422 shares of our common stock, and 3,562,238 shares of ouroutstanding Series B Preferred Stock, each of which is convertible into one share of our common stock. Because of its large holdings ofour capital stock relative to other stockholders, this stockholder has a strong influence over matters requiring approval by ourstockholders.14Table of ContentsThe 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 our 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.Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Actof 2002, new regulations promulgated by the Securities and Exchange Commission and the rules of The Nasdaq Global Select Market,are resulting in increased general and administrative expenses for companies such as ours. These new or changed laws, regulations andstandards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as newguidance is provided by regulatory and governing bodies, which could result in higher costs necessitated by ongoing revisions todisclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As aresult, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result inincreased general and administrative expenses and a diversion of management time and attention from revenue-generating activities tocompliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended byregulatory or governing bodies, our business may be harmed.Future sales of our common stock in the public market could adversely affect the trading price of our common stock andour ability to raise funds in new stock offerings.Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, couldadversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings ofequity or equity-related securities. In connection with past acquisitions, we issued a substantial number of shares of our common stockas transaction consideration. We may continue to issue equity securities for future acquisitions, which would dilute existing stockholders,perhaps significantly depending on the terms of such acquisitions. For example, we issued, and registered for resale, approximately2.3 million shares of our common stock in connection with our December 2009 acquisition of SpinVox. No prediction can be made as tothe effect, if any, that future sales of shares of common stock, or the availability of shares of common stock for future sale, will have onthe trading price of our common stock.We have implemented anti-takeover provisions, which could discourage or prevent a takeover, even if an acquisition would bebeneficial to our stockholders.Provisions of our certificate of incorporation, bylaws and Delaware law, as well as other organizational documents could make itmore difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include: • authorized “blank check” preferred stock; • prohibiting cumulative voting in the election of directors; • limiting the ability of stockholders to call special meetings of stockholders;15Table of Contents • 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.16Table of ContentsItem 2. PropertiesOur corporate headquarters and administrative, sales, marketing, research and development and customer support functionsoccupy approximately 201,000 square feet of space that we lease in Burlington, Massachusetts. We also lease additional properties in theUnited States and a number of foreign countries. The following table summarizes our significant properties as of September 30, 2010:Location Sq. Ft. Lease Term Primary Use (approx.) Burlington, Massachusetts 201,000 March 2018 Corporate headquarters and administrative,sales, marketing, research and development andcustomer support functions.Redwood City, California(1) 141,000 July 2012 Twelve percent of this facility is unoccupied,the remainder has been sublet to third partytenants.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.Seattle Washington 46,000 January 2021 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 2012 Administrative and research and development.Aachen, Germany 22,000 March 2016 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, 2010, 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 any17Table of Contentsoffered licenses will be acceptable to us or that in all cases the dispute will be resolved without litigation, which may be time consumingand expensive, and may result in injunctive relief or the payment of damages by us.Item 4. [Removed and Reserved]18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 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 Fiscal 2010: First quarter $13.11 $16.31 Second quarter 14.12 17.41 Third quarter 14.85 18.55 Fourth quarter 14.45 17.68 HoldersAs of October 31, 2010, there were 856 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.19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 (as adjusted for the retrospective applicationof FASB ASC 470-20 in 2009, 2008 and 2007). Fiscal Year Ended September 30, 2010 2009 2008 2007 2006Operations: Total revenues $1,118.9 $950.4 $868.5 $602.0 $388.5 Gross profit 709.6 590.8 552.8 404.1 267.5 Income from operations 32.9 57.6 32.6 39.0 8.4 Provision for income taxes 18.0 40.4 14.6 22.5 15.1 Net loss $(19.1) $(19.4) $(37.0) $(14.9) $(22.9)Basic and Diluted Earnings Per Share Data: Net loss $(0.07) $(0.08) $(0.18) $(0.08) $(0.14)Weighted average common sharesoutstanding: Basic and diluted 287.4 253.6 209.8 176.4 163.9 Financial Position: Cash, cash equivalents and short and long-termmarketable securities $550.0 $527.0 $261.6 $187.0 $112.3 Total assets 3,769.7 3,499.5 2,846.0 2,172.6 1,235.1 Long-term debt, net of current portion 851.0 848.9 847.3 846.1 350.0 Total stockholders’ equity 2,297.2 2,043.0 1,471.7 931.9 576.6 Selected Data and Ratios: Working capital $459.2 $376.6 $133.5 $164.9 $51.3 Depreciation of property and equipment 21.6 18.7 16.4 12.1 8.4 Amortization of intangible assets 135.6 115.4 82.6 37.7 30.1 Gross margin percentage 63.4% 62.2% 63.7% 67.1% 68.8%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;20Table of Contents • future acquisitions, and anticipated benefits from 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 voice and language solutions for businesses and consumers around theworld. Our technologies, applications and services make the user experience more compelling by transforming the way people interactwith devices and systems. Our solutions are used every day by millions of people and thousands of businesses for tasks and servicessuch as requesting information from a phone-based self-service solution, dictating medical records, searching the mobile Web by voice,entering a destination into a navigation system, or working with PDF documents. Our solutions help make these interactions, tasks andexperiences more productive, compelling and efficient.Our technologies address our four core markets: • Healthcare. We provide comprehensive dictation and transcription solutions and services that automate the input andmanagement of medical information. Our hosted and on-premise solutions provide platforms to generate and distribute clinicaldocumentation through the use of advanced dictation and transcription features, and allow us to deliver scalable, highlyproductive medical transcription solutions. Our solutions also enable us to accelerate future innovation to transform the wayhealthcare providers document patient care, through improved interface with electronic medical records and extraction of clinicalinformation to support the billing and insurance reimbursement processes. We also offer speech recognition solutions forradiology, cardiology, pathology and related specialties, that help healthcare providers dictate, edit and sign reports withoutmanual transcription. • Mobile and Consumer. Our portfolio of mobile and consumer solutions and services includes an integrated suite of voicecontrol and text-to-speech solutions, dictation applications, predictive text technologies, mobile messaging services and emergingservices such as dictation, Web search and voicemail-to-text. Our suite of Dragon general purpose desktop and portable computerdictation applications increases productivity by using speech to create documents, streamline repetitive and complex tasks, inputdata, complete forms and automate manual transcription processes. In particular, we have focused in recent quarters onintegrating our Dragon technology and brand initiatives across mobile and consumer markets. • Enterprise. We deliver a portfolio of customer service business intelligence and authentication solutions that are designed to helpcompanies better support, understand and communicate with their customers. Our hosted and on-premise solutions include theuse of technologies such as speech recognition, natural language understanding, text-to-speech, biometric voice recognition andanalytics to automate caller identification and authorization, call steering, completion of tasks such as updates, purchases andinformation retrieval, and automated outbound notifications. In addition, we offer solutions that can meet customer care needsthrough direct interaction with thin-client applications on cell phones, enabling customers to very quickly retrieve relevantinformation. Our solutions improve the customer experience, increase the use of self-service and enable new revenue opportunities.21Table of Contents • Imaging. Our imaging solutions offer comprehensive PDF applications designed specifically for business users, opticalcharacter recognition technology to deliver highly accurate document and PDF conversion, and applications that combine PDFcreation with network scanning to quickly enable distribution of documents to users’ desktops or to enterprise applications, aswell as software development toolkits for independent software vendors.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 sell our products directly through a dedicated sales force andthrough our e-commerce website, and also through a global network of resellers, including system integrators, independent softwarevendors, value-added resellers, hardware vendors, telecommunications carriers and distributors.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, 2010, as compared to the fiscal year ended September 30, 2009, is as follows: • Total revenue increased by $168.5 million to $1,118.9 million; • Net loss decreased by $0.3 million to $19.1 million; • Gross margins increased by 1.2 percentage points to 63.4%; • Operating margins declined by 3.2 percentage points to 2.9%; and • Cash provided by operating activities for the year ended September 30, 2010 was $296.3 million, an increase of $37.6 millionfrom the same period in the prior fiscal year.StrategyIn fiscal 2011, 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 based22Table of Contents solutions will enable us to deliver applications that our customers use on a repeat basis, and pay for on a per use basis,providing us with the opportunity to enjoy the 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 voice and language based solutionsand services. • Pursue Strategic Acquisitions and Partnerships. We have selectively pursued strategic acquisitions to expand our technology,solutions and resources to complement our organic growth. We have also formed key partnerships with other importantcompanies in our markets of interest, and intend to continue to do so in the future where it will enhance the value of our business.We have proven experience in integrating businesses and technologies and in delivering enhanced value to our customers,partners, employees and shareholders. We intend to continue to pursue acquisitions that enhance our solutions, serve specificvertical markets and strengthen our technology portfolio.RESULTS OF OPERATIONSThe following table presents, as a percentage of total revenue, certain selected financial data for fiscal 2010, 2009 and 2008 (asadjusted for the retrospective application of FASB ASC 470-20 in 2009 and 2008). 2010 2009 2008 Revenues: Product and licensing 42.3% 39.3% 47.7%Professional services and hosting 41.4 43.3 35.2 Maintenance and support 16.3 17.4 17.1 Total revenues 100.0 100.0 100.0 Cost of revenues: Cost of product and licensing 4.4 3.9 5.3 Cost of professional services and hosting 25.1 26.8 24.6 Cost of maintenance and support 2.8 3.1 3.6 Cost of revenue from amortization of intangible assets 4.3 4.0 2.8 Gross margin 63.4 62.2 63.7 Operating expenses: Research and development 13.6 12.3 13.0 Sales and marketing 23.8 22.9 26.2 General and administrative 10.9 10.6 11.3 Amortization of intangible assets 7.9 8.1 6.8 In-process research and development — — 0.3 Acquisition-related costs, net 2.7 1.7 1.5 Restructuring and other charges (credits), net 1.6 0.5 0.8 Total operating expenses 60.5 56.1 59.9 Income from operations 2.9 6.1 3.8 Other income (expense), net (3.0) (3.8) (6.4)Income (loss) before income taxes (0.1) 2.3 (2.6)Provision for income taxes 1.6 4.3 1.7 Net loss (1.7)% (2.0)% (4.3)%23Table of ContentsTotal RevenuesThe following tables show total revenues from our four core market groups and revenue by geographic location, based on thelocation of our customers, in dollars and percentage change (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 Healthcare $444.6 $369.4 $289.3 20.4% 27.7%Mobile and Consumer 297.3 209.1 243.6 42.2% (14.2)%Enterprise 293.9 302.2 255.7 (2.7)% 18.2%Imaging 83.1 69.7 79.9 19.2% (12.8)%Total Revenues $1,118.9 $950.4 $868.5 17.7% 9.4%United States $802.0 $706.9 $669.3 13.5% 5.6%International 316.9 243.5 199.2 30.1% 22.2%Total revenues $1,118.9 $950.4 $868.5 17.7% 9.4%Fiscal 2010 Compared to Fiscal 2009The increase in total revenue for fiscal 2010, as compared to fiscal 2009, was driven by a combination of organic growth andcontributions from acquisitions. The Healthcare revenue increase is primarily made up of organic growth in sales of our Dragon Medicalproducts, on-demand solutions as well as SpeechMagic solutions. Mobile and Consumer revenue increased primarily driven by thegrowth in sales of our predictive text solutions, automotive solutions, connected mobile services and our fourth quarter launch of DragonNaturally Speaking 11. Enterprise revenue decreased as the trend toward customer preference for on-demand solutions continues whichimpacts the timing of revenue recognition. Imaging revenue increased primarily as a result of contributions from our acquisitions ofeCopy, Inc. and X-Solutions Group B.V. and growth in our core imaging solutions.Based on the location of our customers, the geographic split for fiscal 2010 was 72% of total revenue in the United States and 28%internationally, as compared to 74% of total revenue in the United States and 26% internationally for the same period last year. Theincrease in the proportion of revenue generated internationally during fiscal 2010 as compared to fiscal 2009 was primarily due tocontributions from our acquisition of SpinVox in fiscal 2010, as well as the increase in revenue contributions from our predictive textproducts and SpeechMagic solutions, which are sold predominantly outside the United States.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. Healthcare revenue increased primarily driven by contributions from our acquisitions of eScription andPSRS, and organic growth of our on-demand solution. Enterprise revenue increased primarily driven by contributions from ouracquisition of SNAPin, as well as growth in our hosted, on-demand solutions. Mobile and Consumer revenue decreased primarily due toa general decline in consumer spending due to economic conditions resulting in a decline in sales of our automotive solutions and DragonNaturally Speaking consumer products. Imaging revenue decreased primarily due to a decline in Windows-based software sales and ageneral decline in corporate spending due to 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 fiscal 2008. The increase in theproportion of revenue generated internationally was primarily due to contributions from our acquisition of PSRS near the end of fiscal2008.24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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Product and licensing revenue $473.5 $373.4 $414.4 26.8% (9.9)%As a percentage of total revenues 42.3% 39.3% 47.7% Fiscal 2010 Compared to Fiscal 2009The increase in product and licensing revenue for fiscal 2010, as compared to fiscal 2009, consisted of a $57.8 million increase inMobile and Consumer revenue primarily driven by the growth in sales of our predictive text products, automotive solutions as well as ourfourth quarter launch of Dragon Naturally Speaking 11. Healthcare revenue increased $37.7 million primarily driven by increased salesof our Dragon Medical products and SpeechMagic solutions. Imaging revenue increased $9.9 million primarily as a result of ouracquisitions of eCopy and X-Solutions in fiscal 2009. Enterprise revenue decreased $5.4 million primarily due to the continued migrationof customers to our on-demand solutions. The growth in our product and licensing revenue streams outpaced the relative growth of ourother revenue types, resulting in the 3.0 percentage point increase as a percent of total revenue.Fiscal 2009 Compared to Fiscal 2008The decrease in product and licensing revenue for fiscal 2009, as compared to fiscal 2008, consisted of a $40.9 million decrease inMobile and Consumer revenue primarily due to a general decline in consumer spending due to economic conditions resulting in a declinein sales of our automotive solutions together with an $11.3 million decrease in Imaging revenue primarily due to a decline in Windows-based software sales and a general decline in corporate spending due to economic conditions. Healthcare product and licensing revenueincreased $10.4 million driven primarily by our acquisition of PSRS in September 2008. As a percentage of total revenue, product andlicensing revenue decreased 8.4 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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Professional services and hosting revenue $463.5 $411.4 $305.5 12.7% 34.7%As a percentage of total revenues 41.4% 43.3% 35.2% Fiscal 2010 Compared to Fiscal 2009The increase in professional services and hosting revenue for fiscal 2010, as compared to fiscal 2009, consisted of a $31.8 millionincrease in Healthcare revenue resulting largely from the growth of our on-demand solutions. In the fourth quarter of fiscal 2010, theannualized line run-rate in our healthcare on-demand business was25Table of Contentsapproximately 3.334 billion lines per year, up 14% from 2.917 billion lines per year during the fourth quarter of fiscal 2009. Theannualized line run-rate is determined by the number of lines actually billed in a given quarter, multiplied by four. Mobile and Consumerrevenue increased $28.5 million primarily due to contributions from our connected mobile services. Additionally, Enterprise professionaland hosting revenue decreased $9.4 million. Our backlog hours in enterprise professional services were 328,000 hours as ofSeptember 30, 2010, compared to 248,000 hours as of September 30, 2009. Enterprise professional services backlog hours reflect theaccumulated estimated hours necessary to fulfill all of our existing, executed professional services contracts within the enterprisebusiness, including those that are cancelable by customers, based on the original estimate of hours sold. As a percentage of total revenue,professional services and hosting revenue decreased 1.9 percentage points as compared to the corresponding period in the prior year,primarily due to the strong growth in the product and licensing revenue relative to professional services and hosting revenue.Fiscal 2009 Compared to Fiscal 2008The increase in professional services and hosting revenue for fiscal 2009, as compared to fiscal 2008, consisted of a $62.2 millionincrease in Healthcare revenue primarily as a result of our acquisition of eScription as well as organic growth of our on-demand solutions.Additionally, Enterprise revenue increased $41.4 million primarily due to contributions from our acquisition of SNAPin, and growth inour hosted, on-demand solutions. The organic growth together with the acquired revenue streams outpaced the relative growth of our otherrevenue types, resulting in an 8.1 percentage point increase in professional services and hosting revenue as a percentage 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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Maintenance and support revenue $181.9 $165.6 $148.6 9.8% 11.4%As a percentage of total revenues 16.3% 17.4% 17.1% Fiscal 2010 Compared to Fiscal 2009The increase in maintenance and support revenue for fiscal 2010, as compared to fiscal 2009, consisted primarily of a $6.5 millionincrease in Enterprise revenue, driven by continued organic growth, a $5.6 million increase in Healthcare revenue as a result of theexpansion of our current installed base and a $2.3 million increase in Imaging revenue primarily due to contributions from growth in salesof our core imaging products and our acquisition of X-Solutions.Fiscal 2009 Compared to Fiscal 2008The increase in maintenance and support revenue for fiscal 2009, as compared to fiscal 2008, consisted primarily of a $7.7 millionincrease related to the expansion of our current installed base of Healthcare solutions, and a $4.2 million increase in Enterprise and a$4.0 million increase in Mobile and Consumer maintenance and support revenue, driven by organic growth.26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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Cost of product and licensing revenue $49.6 $37.3 $45.7 33.0% (18.4)%As a percentage of product and licensing revenue 10.5% 10.0% 11.0% Fiscal 2010 Compared to Fiscal 2009The increase in cost of product and licensing revenue for fiscal 2010, as compared to fiscal 2009, was primarily due to a$3.1 million increase in Mobile and Consumer costs related to our predictive text, automotive solutions and our fourth quarter launch ofDragon Naturally Speaking 11, as well a $4.6 million increase in Healthcare costs related to increased sales of Dragon Medical andincreased costs in our transcription business. The cost of product and licensing revenue also increased as a result of a $2.3 millionincrease in Imaging costs related to our eCopy acquisition and a $2.4 million increase in Enterprise costs. Gross margin relative to ourproduct and licensing revenue remained relatively constant during the period.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$4.6 million decrease in Healthcare costs, a $2.7 million decrease in Imaging costs due to a decline in Windows-based software sales,and a $1.6 million decrease in Mobile and Consumer costs as a result of a general decline in consumer spending and a decline in sales ofour automotive solutions. The cost of product and licensing revenue decreased as a percentage of revenue due to a change in the revenuemix towards products 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 hosted, on-demand solutions. The following tableshows cost of professional services and hosting revenue, in dollars and as a percentage of professional services and hosting revenue(dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 Cost of professional services and hosting revenue $280.7 $254.8 $214.0 10.6% 19.1%As a percentage of professional services and hosting revenue 60.6% 61.9% 70.0% Fiscal 2010 Compared to Fiscal 2009The increase in cost of professional services and hosting revenue for fiscal 2010, as compared to fiscal 2009, was primarily due to a$35.9 million increase in Mobile and Consumer costs driven by growth in our connected mobile services, a $1.5 million increase inHealthcare and a $1.4 million increase in Imaging costs driven by our eCopy acquisition. These increases are partially offset by a$12.8 million decrease in Enterprise costs. Gross margin27Table of Contentsrelative to our professional services and hosting revenue increased 1.3 percentage points primarily due to growth in our higher marginhealthcare on-demand business and improved professional services utilization rates.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$24.7 million increase in Enterprise costs as a result of our acquisition of SNAPin and growth in our on-demand solutions. Additionaldrivers include a $13.8 million increase in Healthcare costs related to our eScription and PSRS acquisitions and a $2.2 million increasein Mobile and Consumer costs. Gross margin relative to our professional services and hosting revenue increased 8.1 percentage points asa result of growth in our higher margin hosted, on-demand business.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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Cost of maintenance and support revenue $31.3 $29.1 $31.5 7.6% (7.6)%As a percentage of maintenance and support revenue 17.2% 17.6% 21.2% Fiscal 2010 Compared to Fiscal 2009The increase in cost of maintenance and support revenue for fiscal 2010, as compared to fiscal 2009, was primarily due to a$1.8 million increase in Imaging costs as a result of our eCopy and X-solutions acquisitions and a $0.4 million increase in Mobile andConsumer costs. Gross margin relative to our maintenance and support revenue remained relatively constant during the period.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$2.6 million decrease in Healthcare costs as a result of effective cost containment actions. As a percentage of revenue, cost of maintenanceand support revenue decreased due to effective cost controls in our core business and changes in the overall revenue mix.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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Research and development expense $152.1 $116.8 $112.8 30.2% 3.5%As a percentage of total revenues 13.6% 12.3% 13.0% Fiscal 2010 Compared to Fiscal 2009The increase in research and development expense for fiscal 2010, as compared to fiscal 2009, primarily consisted of a$16.7 million increase in services from a third party related to the research collaboration agreements28Table of Contentsdiscussed in Note 2 to the audited consolidated financial statements, a $16.5 million increase in compensation and temporary employeeexpenses attributable to the additional headcount and other resources from our acquisitions during the period, and a $2.9 million increasein infrastructure investment to support ongoing research and development projects. To date, we have not capitalized any softwaredevelopment costs.Fiscal 2009 Compared to Fiscal 2008The increase in research and development expense for fiscal 2009, as compared to fiscal 2008, primarily consisted of a$10.8 million increase in infrastructure investment to support ongoing research and development projects, which was partially offset by a$6.4 million decrease in compensation expense primarily driven by decrease in stock-based compensation expense.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 2010 vs 2009 vs 2010 2009 2008 2009 2008 Sales and marketing expense $266.2 $217.8 $227.7 22.2% (4.3)%As a percentage of total revenues 23.8% 22.9% 26.2% Fiscal 2010 Compared to Fiscal 2009The increase in sales and marketing expenses for fiscal 2010, as compared to fiscal 2009, was primarily attributable to a$35.4 million increase in compensation, including an $11.1 million increase in stock based compensation expense driven primarily bythe increase in grant values resulting from increase in our stock price, and other variable costs such as commissions and travel expenses.An $8.0 million increase in marketing program spending, including marketing communications and channel programs, related to newproducts launched during the fourth quarter of fiscal 2010. Sales and marketing expense as a percentage of total revenue increased by0.9 percentage points, as a result of increased investment in sales and marketing programs to drive revenue growth.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$2.3 million decrease in compensation and other variable costs, such as commissions and travel expenses and a $4.0 million decrease inmarketing program spending. Sales and marketing expense as a percentage of total revenue decreased by 3.3 percentage points, as a resultof increased cost efficiencies of our sales and marketing expenditures.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 advisors29Table of Contentsincluding accountants and attorneys, insurance, and provisions for doubtful accounts. The following table shows general andadministrative expense, in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 General and administrative expense $122.1 $100.5 $98.4 21.5% 5.9%As a percentage of total revenues 10.9% 10.6% 11.3% Fiscal 2010 Compared to Fiscal 2009The increase in general and administrative expense for fiscal 2010, as compared to fiscal 2009, was primarily attributable to$16.9 million increase in compensation driven primarily by increase in stock-based compensation grant values resulting from theincrease in our stock price, $2.3 million increase in other compensation expense and a $2.8 million increase in legal costs associated withon-going litigation and intellectual property maintenance. This increase is partially offset by a reduction of $3.0 million in temporaryemployees and professional services as a result of cost containment efforts and acquisition related synergies.Fiscal 2009 Compared to Fiscal 2008The increase in general and administrative expense for fiscal 2009, as compared to fiscal 2008, was primarily attributable to a$6.5 million increase in compensation associated with our acquisitions including increase in stock-based compensation as a result ofincreases in new grants during the year. This increase was partially offset by a decrease in bad debt expense of $2.4 million in fiscal 2009compared to fiscal 2008 as a result of a significant receivable written off as bad debt expense in fiscal 2008.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 benefits of the customer relationships are being realized. Other identifiable intangible assets are amortized on a straight-line basisover their estimated useful lives. Amortization expense was recorded as follows (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 Cost of revenue $47.8 $38.4 $24.4 24.5% 57.4%Operating expense 87.8 77.0 58.2 14.0% 32.3%Total amortization expense $135.6 $115.4 $82.6 17.5% 39.7%As a percentage of total revenues 12.1% 12.1% 9.5% Fiscal 2010 Compared to Fiscal 2009The increase in amortization of intangible assets for fiscal 2010, compared to fiscal 2009, was primarily attributable to theamortization of acquired customer relationship and core technology intangible assets from our acquisitions of eCopy in September 2009and SpinVox in December 2009. Fiscal 2010 amortization expense also increased over fiscal 2009 due to our acquisition and licensing ofcertain technology from third-parties during fiscal 2009 and 2010.30Table of ContentsFiscal 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.Based on our balance of amortizable intangible assets as of September 30, 2010, and assuming no impairment or reduction inexpected lives, we expect amortization of intangible assets for fiscal 2011 to be $135.3 million.In-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 2010, 2009 or2008.Acquisition-Related Costs, NetAcquisition-related costs include those costs related to business and other acquisitions, including potential acquisitions. These costsconsist of transition and integration costs, including retention payments, transitional employee costs and earn-out payments treated ascompensation expense, as well as the costs of integration-related services provided by third-parties; professional service fees, includingdirect third-party costs of the transaction and post-acquisition legal and other professional service fees associated with disputes andregulatory matters related to acquired entities; and adjustments to acquisition-related items that are required to be marked to fair value eachreporting period, such as contingent consideration, and other items related to acquisitions for which the measurement period has ended.Acquisition-related costs were recorded as follows (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 Transition and integration costs $13.6 $4.7 $8.3 189.4% (43.4)%Professional service fees 17.1 15.0 5.0 14.0% 200.0%Acquisition-related adjustments (0.1) (4.0) — (97.5)% — Total Acquisition-related costs, net $30.6 $15.7 $13.3 94.9% 39.7%As a percentage of total revenue 2.7% 1.7% 1.5% Fiscal 2010 Compared to Fiscal 2009The increase in acquisition-related costs, net for fiscal year 2010, as compared to fiscal 2009, was largely a result of our adoption ofASC 805, Business Combinations, on October 1, 2009, which requires that transaction costs related to acquisitions be expensed asincurred. We recognized approximately $9.4 million in transaction costs, included within professional service fees above, during fiscal2010 that would have been included as part of the consideration transferred and capitalized in periods prior to our adoption of ASC 805.This includes $2.2 million that had been capitalized as of September 30, 2009 related to costs incurred in prior periods that was requiredto be expensed upon our adoption of ASC 805. The remainder of the increase was primarily attributable to an $8.9 million increase intransition and integration costs primarily driven by our acquisitions of eCopy and SpinVox.Fiscal 2009 Compared to Fiscal 2008The increase in acquisition-related costs, net for fiscal year 2009, as compared to fiscal 2008, was attributable to an increase in postacquisition legal fees associated with regulatory matters relating to a fiscal 2008 acquisition and the Phonetic earn-out arbitration. Theincrease was offset by a $3.4 million gain as a result of a final settlement of a pre-acquisition contingency after the measurement periodhad ended.31Table of ContentsRestructuring and Other Charges (Credits), NetThe following table sets forth the activity relating to the restructuring accruals included in Restructuring and Other Charges(Credits), net, in fiscal 2010, 2009 and 2008 (dollars in millions): Personnel Facilities Related Costs Other Total Balance at October 1, 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 Restructuring and other charges (credits), net 9.6 0.2 8.9 18.7 Non-cash adjustments — — (6.8) (6.8)Cash payments (8.4) (0.2) (2.1) (10.7)Balance at September 30, 2010 $1.8 $0.3 $— $2.1 For fiscal 2010, we recorded net restructuring and other charges of $18.7 million, which consisted primarily of $9.6 million relatedto the elimination of approximately 175 personnel across multiple functions within our company, including acquired entities, a$6.8 million write-off of previously capitalized patent defense costs as a result of unsuccessful litigation and $2.1 million of contracttermination costs. Excluding the $6.8 million write-off of previously capitalized patent defense costs, restructuring charges increased forfiscal 2010, as compared to fiscal 2009, as a result of current year adoption of the business combinations guidance in ASC 805. Underthe previous accounting guidance, restructuring costs related to certain post-acquisition activities to integrate acquired companies weregenerally recorded at the date of acquisition, while the guidance in ASC 805 generally requires that these costs be recorded to the acquiringcompany’s statement of operations as the activities are undertaken.For 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.Other Income (Expense), NetThe following table shows other income (expense), net in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 Interest income $1.2 $3.6 $8.0 (66.6)% (55.0)%Interest expense (41.0) (47.3) (62.1) 13.3% 23.8%Other income (expense), net 5.8 7.2 (1.0) (19.4)% 820%Total other income (expense), net $(34.0) $(36.5) $(55.1) As a percentage of total revenue (3.0)% (3.8)% (6.3)% Fiscal 2010 Compared to Fiscal 2009The change in other income (expense), net for fiscal 2010, as compared to fiscal 2009, was primarily driven by changes in foreignexchange as a result of the U.S. dollar and British Pound strengthening against the Euro primarily in the first three quarters of fiscal2010, offset by a one time gain taken in 2009 relating to the foreign currency32Table of Contentscontracts that were not designated as hedges in fiscal 2009. Interest income and interest expense were lower due to lower prevailing marketrates.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.Provision for Income TaxesThe following table shows the provision for income taxes and the effective income tax rate (dollars in thousands): % % Change Change Fiscal Fiscal Fiscal 2010 vs 2009 vs 2010 2009 2008 2009 2008 Income tax provision $18.0 $40.4 $14.6 (55.4)% 176.7%Effective income tax rate (1,693.3)% 192.3% (65.0)% Fiscal 2010 Compared to Fiscal 2009Our effective income tax rate was (1,693.3)% and 192.3% for fiscal 2010 and 2009, respectively. The decrease in the rate was duepartially to the adoption of ASC 805, which no longer requires the release of the valuation allowance on acquired tax assets to be includedas a component of goodwill. Under the new standard, such benefits are included in the statements of operations as a reduction to theprovision for income taxes. Also contributing to the decrease was an $8.0 million tax provision recorded during fiscal 2009 upon ourelection to treat the eScription acquisition as an asset purchase, as well as a $3.2 million tax provision recorded during fiscal 2009 as aresult of a Massachusetts state tax law enactment relating to the utilization of net operating losses. The decreases were partially offset byan increase in the fiscal 2010 foreign tax provision resulting from increased foreign profits in certain jurisdictions.Fiscal 2009 Compared to Fiscal 2008Our effective income tax rate was 192.3% and (65.0)% 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 purchase.Our tax provision also includes state and foreign tax expense, which is determined on either a legal entity or separate tax jurisdictionbasis.33Table of ContentsLIQUIDITY AND CAPITAL RESOURCESCash and cash equivalents totaled $516.6 million as of September 30, 2010, a decrease of $10.4 million as compared to$527.0 million as of September 30, 2009. Our working capital, which at September 30, 2010 included short-term marketable securitiesof $5.0 million, was $459.2 million compared to $376.6 million of working capital at September 30, 2009. In addition, we have$28.3 million of non-current marketable securities where we have invested excess cash balances at the end of fiscal 2010. As ofSeptember 30, 2010, our total accumulated deficit was $281.4 million. We do not expect our accumulated deficit to impact our futureability to operate the business given our strong cash and operating cash flow positions, and believe our current cash and cash equivalentsand marketable securities on-hand are sufficient to meet our operating needs for at least the next twelve months.Cash provided by operating activitiesFiscal 2010 Compared to Fiscal 2009Cash provided by operating activities for fiscal 2010 was $296.3 million, an increase of $37.6 million, or 15%, as compared tocash provided by operating activities of $258.7 million for fiscal 2009. The increase was primarily driven by the following factors: • An increase in cash resulting from a decrease in net loss, after excluding non-cash adjustment items, of approximately$45.1 million; • An increase in cash of $40.2 million from deferred revenue primarily attributable to billings of our eCopy imaging solutions; • A decrease in cash of $34.3 million from accounts receivable primarily attributable to improved collection efforts and continuousDSO improvements in 2009, while maintaining consistent receivables balances in 2010; and • A decrease in cash from accounts payable and accrued expenses of $23.6 million primarily attributable to the timing of cashpayments under our normal operating cycles.Fiscal 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 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; • 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; • 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; and • 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.34Table of ContentsCash used in investing activitiesFiscal 2010 compared to Fiscal 2009Cash used in investing activities for fiscal 2010 was $315.6 million, an increase of $131.0 million, or 71%, as compared to cashused in investing activities of $184.6 million for fiscal 2009. The net increase was primarily driven by the following factors: • An increase in cash payments related to acquisitions of $104.6 million, primarily driven by the cash paid for the acquisition ofSpinVox and other fiscal 2010 business acquisitions, the PSRS deferred acquisitions payments, and the Phonetic earn-outpayment; • Cash payments of $33.5 million related to our purchase of marketable securities in fiscal 2010; • A decrease of $50.6 million in cash used for acquisitions of technology; and • The use of $22.1 million in restricted cash related to cash placed in an irrevocable standby letter of credit account for a fixedobligation in connection with our acquisition of SpinVox.Fiscal 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 millionto acquire 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.Cash provided by financing activitiesFiscal 2010 compared to Fiscal 2009Cash provided by financing activities for fiscal 2010 was $9.9 million, a decrease of $179.5 million, or 95%, as compared tocash provided by financing activities of $189.4 million for fiscal 2009. The change was primarily driven by the following factors: • A decrease of $183.2 million in cash proceeds from the sale of our common stock. During fiscal 2009, we sold 17.4 millionshares of our common stock, together with warrants to purchase an additional 3.9 million shares of our common stock, for netproceeds of $175.1 million; • An increase of $11.0 million in cash payments to net share settle employee equity awards, due to an increase in the number ofshares vested and an increase in the intrinsic value of the shares vested as a result of the overall increase in our stock price infiscal 2010 as compared to fiscal 2009; and • An increase of $9.7 million in cash proceeds from the issuance of common stock upon exercise of employee stock options andpursuant to our employee stock purchase plan.Fiscal 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 together with 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 stock together with warrants to purchase 3.7 millionshares of our common stock, for net proceeds of $330.6 million during fiscal 2008;35Table of Contents • 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.Credit Facilities and Debt2.75% Convertible DebenturesWe have $250 million of 2.75% convertible senior debentures due in 2027 (“the 2027 Debentures”) that were issued on August 13,2007 in a private placement to Citigroup Global Markets Inc. and Goldman, Sachs & Co. The 2027 Debentures bear an interest rate of2.75% per annum, payable semi-annually in arrears beginning on February 15, 2008, and mature on August 15, 2027 subject to theright of the holders of the 2027 Debentures to require us to redeem the 2027 Debentures on August 15, 2014, 2017 and 2022. The relateddebt discount and debt issuance costs are being amortized to interest expense using the effective interest rate method through August 2014.As of September 30, 2010 and 2009, the ending unamortized discount was $36.3 million and $44.9 million, respectively, and the endingunamortized deferred debt issuance costs were $0.4 million and $0.5 million, respectively. The 2027 Debentures are general seniorunsecured obligations, ranking equally in right of payment to all of our existing and future unsecured, unsubordinated indebtedness andsenior in right of payment to any indebtedness that is contractually subordinated to the 2027 Debentures. The 2027 Debentures areeffectively subordinated to our secured indebtedness to the extent of the value of the collateral securing such indebtedness and arestructurally subordinated to indebtedness and other liabilities of our subsidiaries. If converted, the principal amount of the 2027Debentures is payable in cash and any amounts payable in excess of the $250 million principal amount, will (based on an initialconversion rate, which represents an initial conversion price of $19.47 per share, subject to adjustment as defined therein) be paid incash or shares of our common stock, at our election, only in the following circumstances and to the following extent: (i) on any dateduring any fiscal quarter beginning after September 30, 2007 (and only during such fiscal quarter) if the closing sale price of ourcommon stock was more than 120% of the then current conversion price for at least 20 trading days in the period of the 30 consecutivetrading days ending on the last trading day of the previous fiscal quarter; (ii) during the five consecutive business-day period followingany five consecutive trading-day period in which the trading price for $1,000 principal amount of the Debentures for each day duringsuch five trading-day period was less than 98% of the closing sale price of our common stock multiplied by the then current conversionrate; (iii) upon the occurrence of specified corporate transactions, as described in the indenture for the 2027 Debentures; and (iv) at theoption of the holder at any time on or after February 15, 2027. Additionally, we may redeem the 2027 Debentures, in whole or in part, onor after August 20, 2014 at par plus accrued and unpaid interest; each holder shall have the right, at such holder’s option, to require us torepurchase all or any portion of the 2027 Debentures held by such holder on August 15, 2014, August 15, 2017 and August 15, 2022.Upon conversion, we will pay cash and shares of our common stock (or, at our election, cash in lieu of some or all of such commonstock), if any. If we undergo a fundamental change (as described in the indenture for the 2027 Debentures) prior to maturity, holders willhave the option to require us to repurchase all or any portion of their debentures for cash at a price equal to 100% of the principal amountof the debentures to be purchased plus any accrued and unpaid interest, including any additional interest to, but excluding, therepurchase date. As of September 30, 2010, no conversion triggers were met. If the conversion triggers were met, we could be required torepay 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, 2010, $643.6 million remained outstanding under the term loans, there were $21.2 million of letters of credit issued underthe revolving credit line and there were no other outstanding borrowings under the revolving credit line.36Table of ContentsThe 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, 2010, 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, 2010, our applicable margin for the term loan was 1.00% for baserate borrowings and 1.75% 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, 2010, thecommitment fee rate was 0.375% and the effective interest rate was 2.02%.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, 2010 and 2009, the ending unamortized deferred financing fees were $5.8 million and$7.7 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. We have not generated excess cash flow in either fiscal 2009 or 2010 and thus no payments have been required. We willcontinue to evaluate the extent to which a payment is due in the first quarter of future fiscal years based on excess cash flow generation. Atthe current time, we are unable to predict the amount of the outstanding principal, if any, that we may be required to repay in future yearspursuant to the excess cash flow sweep provisions. Any term loan borrowings not paid through the baseline repayment, the excess cashflow sweep, or any other mandatory or optional payments that we may make, will be repaid upon maturity. If only the baselinerepayments are made, the annual aggregate principal amount of the term loans repaid would be as follows (in thousands):Year Ending September 30, Amount 2011 $6,700 2012 6,700 2013 630,163 Total $643,563 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, and37Table of Contents100% of extraordinary receipts. We may voluntarily prepay borrowings under the Credit Facility without premium or penalty other thanbreakage costs, as defined with respect to LIBOR-based loans.We believe that cash flows from future operations in addition to cash and cash equivalents and marketable securities on-hand will besufficient to meet our working capital, investing, financing and contractual obligations and the contingent payments for acquisitions, ifany are realized, as they become due for at least the next twelve months. We also believe that in the event future operating results are not asplanned, that we could take actions, including restructuring actions and other cost reduction initiatives, to reduce operating expenses tolevels which, in combination with expected future revenue, will continue to generate sufficient operating cash flow. In the event that theseactions are not effective in generating operating cash flows we may be required to issue equity or debt securities on terms that may be lessfavorable.Off-Balance Sheet Arrangements, Contractual Obligations, Contingent Liabilities and CommitmentsContractual ObligationsThe following table outlines our contractual payment obligations as of September 30, 2010 (dollars in millions): Payments Due by Fiscal Year Ended September 30, 2012 2014 Contractual Obligations Total 2011 and 2013 and 2015 Thereafter Credit Facility(2) $643.6 $6.7 $636.9 $— $— 2.75% Convertible Senior Debentures(1) 250.0 — — 250.0 — Interest payable under Credit Facility(2) 32.1 12.9 19.2 — — Interest payable under 2.75% Convertible Senior Debentures(3) 27.6 6.9 13.8 6.9 — Letter of Credit(4) 24.5 24.5 — — — Lease obligations and other liabilities: Operating leases 119.6 21.0 36.8 28.8 33.0 Other lease obligations associated with the closing of duplicatefacilities related to restructurings and acquisitions(5) 6.0 3.1 2.9 — — Pension, minimum funding requirement(6) 5.5 1.4 2.7 1.4 — Collaboration agreements(7) 65.2 20.9 41.8 2.5 — Other long-term liabilities assumed(8) 34.2 13.9 14.6 4.7 1.0 Total contractual cash obligations $1,208.3 $111.3 $768.7 $294.3 $34.0 (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, 2010 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)We have placed EUR 18.0 million ($24.5 million based on the September 30, 2010 exchange rates) in an irrevocable standby letter ofcredit account for payment of a fixed obligation assumed in connection with our acquisition of SpinVox.(5)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, 2010, total gross lease obligations are $2.2 million and are included in the contractualobligations herein. This includes $3.8 million in contractual lease commitments associated with the implemented plans to eliminateduplicate facilities in conjunction with38Table of Contentsour acquisitions. As of September 30, 2010, we have subleased certain of the facilities to unrelated third parties with total subleaseincome of $2.2 million through fiscal 2013.6)Our U.K. pension plan has a minimum funding requirement of £859,900 ($1.4 million based on the exchange rate at September 30,2010) for each of the next 4 years, through fiscal 2014.(7)Payments under the research collaboration agreements are payable in cash or common stock at our option.(8)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 $34.2 million. As of September 30, 2010, 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$11.6 million, which ranges from $1.3 million to $3.2 million on an annualized basis through 2016.As a result of our adoption of ASC 740-10 (formerly referred to as FIN 48, Accounting for Uncertainty in Income Taxes — anInterpretation of FASB Statement No. 109) on October 1, 2007, our gross liability for unrecognized tax benefits was approximately$2.5 million. The gross liability as of September 30, 2010 was $12.8 million. We do not expect a significant change in the amount ofunrecognized tax benefits within the next 12 months. We estimate that none of this amount will be paid within the next year and we arecurrently unable to reasonably estimate the timing of payments for the remainder of the liability.Contingent Liabilities and CommitmentsIn connection with certain of our acquisitions, we have agreed to make contingent cash payments to the former shareholders ofcertain of the acquired companies. The following represents the contingent cash payments that we may be required to make.In connection with our acquisition of SNAPin Software, Inc. (“SNAPin”), we agreed to make a contingent earn-out payment of up to$45.0 million in cash to be paid, if at all, based on the business achieving certain performance targets that are measurable from theacquisition date to December 31, 2009. In April 2010, the Company and the former shareholders of SNAPin agreed on a final earn-outpayment of $21.2 million and we issued 593,676 shares of our common stock, valued at $10.2 million, as our first payment under theearn-out agreement. The remaining balance is payable in cash or stock, solely at our option, on or before October 1, 2011 and is includedin long-term liabilities as of September 30, 2010.In connection with our acquisition of Multi-Vision Communications, Inc. (“Multi-Vision”), we agreed to make contingent earn-outpayments of up to $15.0 million, payable in stock, or cash, solely at our discretion, relating to earn-out provisions described in the sharepurchase agreement. We have notified the former shareholders of Multi-Vision that the performance targets were not achieved. ThroughSeptember 30, 2010, we have not recorded any obligation or related compensation expense relative to these measures.In connection with our acquisition of Vocada, Inc. (“Vocada”), we agreed to make contingent earn-out payments of up to$21.0 million, payable in stock, or cash, solely at our discretion, upon the achievement of certain financial targets measured over definedperiods through December 31, 2010. Earn-out payments, if any, will be recorded as incremental purchase price and allocated to goodwill.We have notified the former shareholders of Vocada that the financial targets for certain periods were not achieved and they have requestedadditional information regarding this determination. We are currently in discussions with the former shareholders of Vocada regarding thismatter. Through September 30, 2010, we have not recorded any earn-out obligation relative to the Vocada acquisition.In connection with the acquisition of Commissure, Inc. (“Commissure”), we agreed to make contingent earn-out payments of up to$8.0 million, payable in stock, or cash, solely at our discretion, upon the achievement of certain financial targets for the fiscal years2008, 2009 and 2010. Earn-out payments, if any, will be recorded as incremental purchase price and allocated to goodwill. We havenotified the former shareholders of Commissure that the financial targets for the fiscal years 2008 and 2009 were not achieved and therelated contingent earn-out39Table of Contentspayment was not earned. Through September 30, 2010, we have not recorded any earn-out obligation relative to the CommissureacquisitionFinancial InstrumentsWe use financial instruments to manage our interest rate and foreign exchange risk. We follow Statement of Financial AccountingStandards No. 133, Accounting for Derivative Instruments and Hedging Activities, amended by SFAS No. 138, Accounting forCertain Derivative Instruments and Certain Hedging Activities, now referred to as Financial Accounting Standards Board AccountingStandards Codification 815 (“ASC 815”), for certain designated forward contracts and interest rate 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, 2010, 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, 2010, and 2009, the aggregatecumulative unrealized gains (losses) related to these swaps, and a previous swap that matured on March 31, 2009, were $3.5 million and$(4.0) million, respectively and were included in accumulated other comprehensive income in the accompanying balance sheets.During fiscal 2009 and 2010, we entered into foreign currency contracts to hedge exposure on the variability of cash flows inCanadian dollars which are designated as cash flow hedges. At September 30, 2010 the unsettled contracts had an aggregate remainingnotional value of CAD$13.7 million ($13.3 million based on the September 30, 2010 exchange rate). These contracts settle monthlythrough October 2011. As of September 30, 2010, the aggregate cumulative unrealized gains related to these contracts were immaterial.During fiscal 2010, we entered into foreign currency contracts to hedge exposure on the variability of cash flows in HungarianForints (“HUF”) which are designated as cash flow hedges. At September 30, 2010, the unsettled contracts had an aggregate remainingnotional value of HUF 1,017.0 million ($5.0 million based on the September 30, 2010 exchange rate). These contracts settle monthlythrough October 2011. As of September 30, 2010, the aggregate cumulative unrealized gains related to these contracts were immaterial.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 currencyexposure on the deferred acquisition payment of €44.3 million related to our acquisition of PSRS, resulting in a net gain during that periodof $8.0 million included in other income (expense). The foreign currency contracts matured and were settled on October 22, 2009. Thegain for the period from September 30, 2009 to settlement on October 22, 2009 was $1.6 million, but was offset in other income(expense), net by the loss resulting from the corresponding change in the associated deferred acquisition payment liability.During fiscal 2010, we entered into a foreign currency forward contract to offset foreign currency exposure on a fixed obligationassumed in connection with our acquisition of SpinVox. The notional value of the contract is Euro 18.0 million. The contract matures inDecember 2010.From time to time we will enter into agreements that allow us to issue shares of our common stock as part or all of the considerationrelated to partnering and technology acquisition activities. Generally these shares are issued subject to security price guarantees which areaccounted for as derivatives. We have determined that these instruments would not be considered equity instruments if they werefreestanding. The security price guarantees require payment from either us to the third party, or from the third party to us, based upon thedifference between the price of our common stock on the issue date and an average price of our common stock approximately six monthsfollowing the issue date. Changes in the fair value of these security price guarantees are reported in earnings in each period as non-operating income (expense) with other income (expense), net. During the year ended September 30, 2010, we received cash paymentstotaling $7.3 million to settle agreements that closed during the year.40Table of ContentsPension PlansWe assumed the assets and obligations related to certain defined benefit pension plans in connection with our acquisition ofDictaphone, 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 2011, without additional funding. In fiscal 2010, total cash funding forthe 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, 2010) for each of the next four years, through fiscal 2014.Off-Balance Sheet ArrangementsThrough September 30, 2010, 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 valuation of goodwill, intangible assets and tangible long-lived assets; accounting for business combinations; accounting for stock-based compensation; accounting for derivative instruments;accounting for income taxes and related valuation allowances; and loss contingencies. Our management bases its estimates on historicalexperience, market participant fair value considerations and various other factors that are believed to be reasonable under thecircumstances. 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 access to take immediate possession of the software or technology. In select situations, we sellor license intellectual property in conjunction with, or in place of, embedding our intellectual property in software. We recognize revenuefrom the sale or license of software products and licensing of technology 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 exists when a company can support what the fair value of its softwareand/or software-related services is based on evidence of the prices charged by the company when the same elements are sold separately.VSOE of fair value is required, generally, in order to separate the accounting for various elements in a software and related servicesarrangement. 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 five years. Revenue from PCS is recognized ratably on astraight-line basis over the term that the maintenance service is provided.41Table of ContentsNon-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.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 allocating VSOE of fair value of the professional services asprofessional service revenue and the residual portion as license revenue. We generally determine the percentage-of-completion by comparingthe labor hours incurred to-date to the estimated total labor hours required to complete the project. We consider labor hours to be the mostreliable, available measure of progress on these projects. Adjustments to estimates to complete are made in the periods in which factsresulting in a change become known. When the estimate indicates that a loss will be incurred, such loss is recorded in the periodidentified. Significant judgments and estimates are involved in determining the percent complete of each contract. Different assumptionscould yield materially different results.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 retailers or end-users, we make an estimate of sales returns based on historical experience. Theprovision for these estimated returns is recorded as a reduction of revenue and accounts receivable at the time that the related revenue isrecorded. If actual returns differ significantly from our estimates, such differences could have a material impact on our results ofoperations for the period 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.42Table of ContentsWe 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 as of the business combination date. The purchaseprice allocation process requires us to use significant estimates and assumptions, including fair value estimates 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; • 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. Subsequent to the purchaseprice allocation period any adjustment to assets acquired or liabilities assumed is included in operating results in the period in which theadjustment is determined. For changes in the valuation of intangible assets between preliminary and final purchase price allocation, therelated 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.43Table of ContentsFor 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 we areunable to determine the fair value of a pre-acquisition contingency at the end of the purchase price allocation period, 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. After the end of the purchase price allocation period, any adjustment to amounts recorded for a pre-acquisition contingency will be included in our operating results in the period in which 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 finite-lived tangible and intangible assets are customer relationships,licensed technology, patents and core technology, completed technology, 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 annually in the fourth quarter, and between annual tests ifindicators 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 three reporting unitsbased on the level of information provided to, and review thereof, by our core market management. In certain instances we have aggregatedcomponents of an operating segment into a single reporting unit based on similar economic characteristics. 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. Intangible assets with indefinite lives are not amortized, but are required to be evaluated periodically toensure that their current fair value exceeds the stated book value. Based on our assessments, we have not had any impairment chargesduring our history as a result of our impairment evaluation of goodwill and other indefinite-lived intangible assets. Significant adversechanges in our future revenues and/or adjusted EBITDA results, or significant degradation in the enterprise values of comparablecompanies within our core markets, could result in the determination that all or44Table of Contentsa portion of our goodwill is impaired. However, as of our fiscal 2010 annual impairment assessment date, our estimated fair values of ourreporting 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 the reportingunits and assessing when events or circumstances would require an interim impairment analysis of goodwill or other long-lived assets tobe performed. Changes in our organization or management reporting structure, as well as other events and circumstances, including butnot limited to technological advances, increased competition and changing economic or market conditions, could result in (a) shorterestimated useful lives, (b) changes to 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 Stock-Based Compensation. 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, net of estimated forfeitures. We will recognize a benefit from stock-based compensation in equity usingthe with-and-without approach for the utilization of tax attributes. The Restricted Stock and Restricted Units are collectively referred to as“Restricted Awards.” Determining the fair value of share-based awards at the grant date requires judgment, including estimating expecteddividends, share price volatility and the amount of share-based awards that are expected to be forfeited. If actual results differsignificantly 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 created as a result of share-based payments or other equitytransactions where prevailing guidance requires the change in valuation allowance to be traced forward. The recognition of the portion ofthe valuation allowance which relates to net deferred tax assets resulting from share-based payments or other qualifying equitytransactions will be recorded as additional paid-in-capital.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, when the minimum threshold for45Table of Contentsrecognition is not met, a tax position is recorded as the largest amount that is more than fifty percent likely of being realized upon ultimatesettlement.Loss Contingencies. We are subject to legal proceedings, lawsuits and other claims relating to labor, service and other mattersarising in the ordinary course of business, as discussed in Note 18 of Notes to our Consolidated Financial Statements. Quarterly, wereview the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legalproceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significantjudgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable.Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additionalinformation becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates.Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTSIn April 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-17, Revenue Recognition — Milestone Method(Topic 605): Milestone Method of Revenue Recognition. The ASU codifies the consensus reached in Emerging Issues Task Force(“EITF”) Issue No. 08-9, Milestone Method of Revenue Recognition. The amendments to the FASB Accounting Standards Codificationprovide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenuerecognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may berecognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to beconsidered substantive. The amendments in the ASU are effective on a prospective basis for milestones achieved in fiscal years, andinterim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. If an entity elects early adoption andthe period of adoption is not the beginning of the entity’s fiscal year, the entity must apply the amendments retrospectively from thebeginning of the year of adoption. Entities may also elect to adopt the amendments in the ASU retrospectively for all prior periods. We donot expect the implementation of ASU No 2010-17 to have a material impact on our financial statements.In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair ValueMeasurements (Topic 820) — Fair Value Measurements and Disclosures (“ASU 2010-06”) which requires additional disclosuresabout the different classes of assets and liabilities measured at fair value, the valuation techniques and inputs used, the activity in Level 3fair value measurements, and transfers between Levels 1, 2, and 3. Levels 1, 2 and 3 of fair value measurements are defined in Note 12of Notes to our consolidated Financial Statements. ASU 2010-06 was effective for us for the interim reporting period beginning January 1,2010, except for the provisions related to activity in Level 3 fair value measurements. Those provisions are effective for fiscal yearsbeginning after December 15, 2010, and for interim periods within those fiscal years. ASU 2010-06 impacts disclosure only andtherefore, did not, and is not expected to, have a material impact on our financial statements.In September 2009, the Financial Accounting Standards Board amended the Accounting Standards Codification as summarized inASU 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, RevenueRecognition (Topic 605): Multiple-Deliverable Revenue Arrangements. As summarized in ASU 2009-14, ASC Topic 985 has beenamended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions,tangible products containing software components and non-software components that function together to deliver the product’s essentialfunctionality. As summarized in ASU 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multipledeliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity toallocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objectiveevidence (“or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocaterevenue using the relative selling price method. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are botheffective for fiscal years beginning on or after June 15, 2010. We are continuing to evaluate the potential impact of these changes.46Table of ContentsItem 7A. Quantitative and Qualitative Disclosures about Market RiskWe are exposed to market risk from changes in foreign currency exchange rates, interest rates and equity prices which could affectoperating results, financial position and cash flows. We manage our exposure to these market risks through our regular operating andfinancing activities and, when appropriate, through the use of derivative financial instruments.Exchange Rate SensitivityWe are exposed to changes in foreign currency exchange rates. Any foreign currency transaction, defined as a transactiondenominated in a currency other than the U.S. dollar, will be reported in U.S. dollars at the applicable exchange rate. Assets and liabilitiesare translated into U.S. dollars at exchange rates in effect at the balance sheet date and income and expense items are translated at averagerates for the period. The primary foreign currency denominated transactions include revenue and expenses and the resulting accountsreceivable and accounts payable balances reflected on our balance sheet. Therefore, the change in the value of the U.S. dollar compared toforeign currencies will have either a positive or negative effect on our financial position and results of operations. Historically, our primaryexposure has related to transactions denominated in the Euro, British Pound, Canadian Dollar, Japanese Yen, Indian Rupee andHungarian Forint.A hypothetical change of 10% in appreciation or depreciation in foreign currency exchange rates from the quoted foreign currencyexchange rates at September 30, 2010 would not have a material impact on our revenue, operating results or cash flows in the coming year.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. At September 30, 2010, we have foreign currency contracts with a totalnotional value of approximately $18.3 million designated as cash flow hedges. These contracts all mature within the next twelve months.The notional contract amount of outstanding foreign currency exchange contracts not designated as cash flow hedges wasEuro 18.0 million at September 30, 2010. During fiscal 2010 and 2009, we recorded foreign exchange gains of $3.5 million and$7.0 million, respectively. Based on the nature of the transaction for which the contracts were purchased, a hypothetical change of 10% inexchange rates would not have a material impact on our financial results.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, 2010, we held approximately $516.6 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, 2010, our total outstanding debt balance exposed to variable interest rates was $643.6 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 30,2010, 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, 2010 and 2009, the aggregate cumulative unrealized gains (losses) related to thesederivatives were $3.5 million and $(4.0) million, respectively. A hypothetical change in market rates would have a significant impact oninterest expense and amounts payable. Assuming a one percentage point increase in interest rates, our interest expense relative to ouroutstanding debt would increase $6.2 million per annum.Equity Price RiskWe are exposed to equity price risk as a result of security price guarantees that we enter in to from time to time. Generally, these priceguarantees are for a period of six months or less, and require payment from either us to a third party, or from the third party to us, basedupon changes in our stock price during the contract term. As of September 30, 2010, we have security price guarantees outstanding forapproximately 3.7 million shares of our47Table of Contentscommon stock. A 10% change in our stock price during the next six months would result in additional cash outflows of up to$5.7 million for a decrease in the stock price or additional cash inflows of up to $5.7 million for an increase in the stock price duringfiscal 2011.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, 2010 and2009, 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, 2010. 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, 2010 and 2009, and the results of its operations and its cash flows for each of the threeyears in the period ended September 30, 2010, in conformity with accounting principles generally accepted in the United States ofAmerica. As discussed in Note 2 to the consolidated financial statements, effective October 1, 2009 the Company retrospectively adoptedASC Topic 470-20, “Debt with Conversion and other features” as it related to the convertible debt. The Company also prospectivelyadopted ASC Topic 805 as it relates to business combinations.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, 2010, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations (COSO), and our report datedNovember 29, 2010 expressed an unqualified opinion thereon./s/ BDO USA, LLPBDO USA, LLPBoston, MassachusettsNovember 29, 201050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, 2010, based on criteriaestablished in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (the COSO criteria). Nuance Communications, Inc.’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in theaccompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinionon the Company’s internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control overfinancial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for our opinion.A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordancewith generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financialstatements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies or procedures may deteriorate.As indicated in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting, management’sassessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls ofSpinvox Limited, which was acquired on December 30, 2009, and which is included in the consolidated balance sheets of NuanceCommunications, Inc. as of September 30, 2010, and the related consolidated statements of operations, stockholders’ equity andcomprehensive loss, and cash flows for the year then ended. Spinvox Limited constituted 0.6% of consolidated assets as of September 30,2010, and 2.2% of revenues for the year then ended. Management did not assess the effectiveness of internal control over financialreporting of Spinvox Limited because of the timing of the acquisition which was completed on December 30, 2009. Our audit of internalcontrol over financial reporting of Nuance Communications, Inc. also did not include an evaluation of the internal control over financialreporting of Spinvox.In our opinion, Nuance Communications, Inc. maintained, in all material respects, effective internal control over financial reportingas of September 30, 2010, 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, 2010 and 2009, 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 30,2010 and our report dated November 29, 2010 expressed an unqualified opinion thereon./s/ BDO USA, LLPBDO USA, LLPBoston, MassachusettsNovember 29, 201051Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended September 30, 2010 2009 2008 (In thousands, except per share amounts) Revenues: Product and licensing $473,460 $373,367 $414,360 Professional services and hosting 463,567 411,363 305,540 Maintenance and support 181,921 165,622 148,562 Total revenues 1,118,948 950,352 868,462 Cost of revenues: Product and licensing 49,618 37,255 45,746 Professional services and hosting 280,725 254,777 214,031 Maintenance and support 31,269 29,129 31,477 Amortization of intangible assets 47,758 38,390 24,389 Total cost of revenues 409,370 359,551 315,643 Gross profit 709,578 590,801 552,819 Operating expenses: Research and development 152,071 116,774 112,788 Sales and marketing 266,208 217,773 227,661 General and administrative 122,061 100,478 98,356 Amortization of intangible assets 87,819 76,978 58,245 In-process research and development — — 2,601 Acquisition-related costs, net 30,611 15,703 13,335 Restructuring and other charges (credits), net 17,891 5,520 7,219 Total operating expenses 676,661 533,226 520,205 Income from operations 32,917 57,575 32,614 Other income (expense): Interest income 1,238 3,562 8,032 Interest expense (40,993) (47,288) (62,088)Other income (expense), net 5,773 7,155 (964)(Loss) income before income taxes (1,065) 21,004 (22,406)Provision for income taxes 18,034 40,391 14,554 Net loss $(19,099) $(19,387) $(36,960)Net loss per share: Basic $(0.07) $(0.08) $(0.18)Diluted $(0.07) $(0.08) $(0.18)Weighted average common shares outstanding: Basic 287,412 253,644 209,801 Diluted 287,412 253,644 209,801 See accompanying notes. Financial statements as of September 30, 2009 and for the years ended September 30, 2009 and 2008 have beenadjusted for the retrospective application of FASB ASC 470-20 (see Note 2).52Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED BALANCE SHEETS September 30, September 30, 2010 2009 (In thousands, except per share amounts) ASSETSCurrent assets: Cash and cash equivalents $516,630 $527,038 Restricted cash (Note 9) 24,503 — Marketable securities 5,044 — Accounts receivable, less allowances for doubtful accounts of $6,301 and $6,833 217,587 199,548 Acquired unbilled accounts receivable 7,412 9,171 Prepaid expenses and other current assets 70,466 60,070 Total current assets 841,642 795,827 Land, building and equipment, net 62,083 53,468 Marketable securities 28,322 — Goodwill 2,077,943 1,891,003 Intangible assets, net 685,865 706,805 Other assets 73,844 52,361 Total assets $3,769,699 $3,499,464 LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities: Current portion of long-term debt and capital leases $7,764 $6,862 Contingent and deferred acquisition payments 2,131 91,431 Accounts payable 78,616 59,574 Accrued expenses and other current liabilities 151,621 116,963 Deferred maintenance revenue 90,969 84,607 Unearned revenue and customer deposits 51,371 59,788 Total current liabilities 382,472 419,225 Long-term portion of debt and capital leases 851,014 848,898 Deferred revenue, net of current portion 76,598 33,904 Deferred tax liability 63,731 56,346 Other liabilities 98,688 98,090 Total liabilities 1,472,503 1,456,463 Commitments and contingencies (Notes 3, 5, and 18) 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; 301,623 and 280,647 shares issued and297,950 and 276,935 shares outstanding 302 281 Additional paid-in capital 2,581,901 2,308,992 Treasury stock, at cost (3,673 and 3,712 shares) (16,788) (16,214)Accumulated other comprehensive income 8,505 7,567 Accumulated deficit (281,355) (262,256)Total stockholders’ equity 2,297,196 2,043,001 Total liabilities and stockholders’ equity $3,769,699 $3,499,464 See accompanying notes. Financial statements as of September 30, 2009 and for the years ended September 30, 2009 and 2008 have beenadjusted for the retrospective application of FASB ASC 470-20 (see Note 2).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 (In thousands) Balance at October 1, 2007 3,562 $4,631 196,368 $196 $1,132,501 3,190 $(15,418) $14,979 $(204,982) $931,907 Issuance of common stock under employee stock-based compensationplans 6,513 7 28,424 28,431 Issuance of restricted stock 3,316 3 (3) — Cancellation of restricted stock, and repurchase of common stock atcost for employee tax withholding (911) (1) (17,007) 32 (652) (17,660) Stock-based compensation 68,631 68,631 Excess tax benefit from share-based payment plans 5,200 5,200 Issuance of common stock in connection with equity offerings, net ofexpenses 19,158 19 330,398 330,417 Issuance of common stock in connection with business and assetacquisitions 6,383 6 132,245 132,251 Issuance of common stock to escrow agent in connection withacquisitions 1,765 2 (2) — Vested options for the purchase of common stock, assumed inconnection with acquisitions Repurchase of shares 32,606 32,606 Cumulative effect of adoption of FIN 48 Issuance of common stock inconnection with exercise of warrants (927) (927) Comprehensive loss: Net loss (36,960) (36,960) $(36,960) Unrealized losses on cash flow hedge derivatives 50 50 50 Foreign currency translation adjustment 3,291 3,291 3,291 Unrealized losses on pensions Adjustment to initially apply SFAS 158,net of tax (5,581) (5,581) (5,581) Comprehensive loss $(39,200) Balance at September 30, 2008 3,562 4,631 232,592 232 1,712,993 3,222 (16,070) 12,739 (242,869) 1,471,656 Issuance of common stock under employee stock-based compensationplans 3,722 5 19,832 19,837 Issuance of restricted stock 2,945 3 (3) — Cancellation of restricted stock, and repurchase of common stock atcost for employee tax withholding (886) (1) (10,401) 15 (143) (10,545) Stock-based compensation 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 17,396 17 175,029 175,046 Issuance of common stock in connection with warrant exercises, net ofissuance costs 4,575 5 20,520 20,525 Issuance of common stock in connection with business and assetacquisitions 19,196 19 268,669 475 (1) 268,687 Issuance of common stock to escrow agent in connection withacquisitions 1,107 1 (1) — Vested options for the purchase of common stock, assumed inconnection with acquisitions 11,523 11,523 Payments for escrow, make-whole and earn-out settlements 38,691 38,691 Comprehensive loss: Net loss (19,387) (19,387) $(19,387) Unrealized gains on cash flow hedge derivatives (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 $(24,559) Balance at September 30, 2009 3,562 4,631 280,647 281 2,308,992 3,712 (16,214) 7,567 (262,256) 2,043,001 Issuance of common stock under employee stock-based compensationplans 4,402 4 29,506 29,510 Issuance of restricted stock 5,737 6 (6) — Cancellation of restricted stock, and repurchase of common stock atcost for employee tax withholding (1,635) (2) (25,973) (39) (574) (26,549) Stock-based compensation 100,139 100,139 Excess tax benefit from share-based payment plans 1,060 1,060 Issuance of common stock in connection with warrant exercises, net ofissuance costs 2,509 3 12,347 12,350 Issuance of common stock in connection with business and assetacquisitions 9,369 9 145,627 145,636 Payments for escrow, make-whole and earn-out settlements 594 1 10,209 10,210 Comprehensive loss: Net loss (19,099) (19,099) $(19,099) Unrealized gains on cash flow hedge derivatives and investments 4,208 4,208 4,208 Unrealized gain on marketable securities 30 30 30 Foreign currency translation adjustment (2,807) (2,807) (2,807) Unrealized losses on pensions (493) (493) (493) Comprehensive loss $(18,161) Balance at September 30, 2010 3,562 $4,631 301,623 $302 $2,581,901 3,673 $(16,788) $8,505 $(281,355) $2,297,196 See accompanying notes. Financial statements as of September 30, 2009 and for the years ended September 30, 2009 and 2008 have beenadjusted for the retrospective application of FASB ASC 470-20 (see Note 2).54Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended September 30, 2010 2009 2008 (In thousands) Cash flows from operating activities Net loss $(19,099) $(19,387) $(36,960)Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation of property and equipment 21,579 18,691 16,366 Amortization of intangible assets 135,577 115,368 82,634 Non-cash interest expense 12,955 12,492 12,100 Non-cash restructuring expense 6,833 — — In-process research and development — — 2,601 Bad debt provision 873 1,823 4,173 Stock-based compensation 100,139 71,407 68,631 Gain on foreign currency forward contracts — (8,049) — Deferred tax provision 3,742 25,718 491 Other 703 143 1,799 Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable (773) 33,481 62,034 Prepaid expenses and other assets (3,840) (14,027) (1,421)Accounts payable 4,710 26,582 (11,946)Accrued expenses and other liabilities (6,760) (5,007) (14,251)Deferred revenue 39,643 (546) 9,948 Net cash provided by operating activities 296,282 258,689 196,199 Cash flows from investing activities Capital expenditures (25,974) (19,512) (17,716)Payments for acquisitions, net of cash acquired (203,729) (99,120) (392,527)Payment for equity investments (14,970) (159) (2,172)Purchases of marketable securities (33,529) — — Proceeds from maturities of marketable securities — 56 2,577 Payments for acquired technology and capitalized patent costs (15,300) (65,875) (36,479)Change in restricted cash balances (22,070) — 238 Net cash used in investing activities (315,572) (184,610) (446,079)Cash flows from financing activities Payments of debt and capital leases (8,460) (6,999) (7,771)Proceeds from issuance of common stock, net of issuance costs 12,350 195,571 330,603 Purchase of treasury stock (574) (144) (652)Payments on other long-term liabilities (9,870) (9,180) (11,379)Proceeds from settlement of share-based derivatives 7,306 — — Excess tax benefits from share-based awards 1,060 733 5,200 Proceeds from issuance of common stock from employee stock options and purchase plan 29,510 19,837 28,140 Cash used to net share settle employee equity awards (21,442) (10,402) (17,002)Net cash provided by financing activities 9,880 189,416 327,139 Effects of exchange rate changes on cash and cash equivalents (998) 2,003 (54)Net (decrease) increase in cash and cash equivalents (10,408) 265,498 77,205 Cash and cash equivalents at beginning of year 527,038 261,540 184,335 Cash and cash equivalents at end of year $516,630 $527,038 $261,540 See accompanying notes. Financial statements as of September 30, 2009 and for the years ended September 30, 2009 and 2008 have beenadjusted for the retrospective application of FASB ASC 470-20 (see Note 2).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 voice and language solutions forbusinesses and consumers around the world. Our technologies, applications and services make the user experience more compelling bytransforming the way people interact with devices and systems. Our solutions are used for tasks and services such as requestinginformation from a phone-based self-service solution, dictating medical records, searching the mobile Web by voice, entering a destinationinto a navigation system, or working with PDF documents. Our solutions help make these interactions, tasks and experiences moreproductive, 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 sell our products directly through a dedicated sales force andthrough our e-commerce website and also through a global network of resellers, including system integrators, independent softwarevendors, value-added resellers, hardware vendors, telecommunications carriers and distributors.We have built a portfolio of intellectual property, technologies, applications and solutions through both internal development andacquisitions. We expect to continue to pursue opportunities to expand our assets, geographic presence, distribution network and customerbase through acquisitions of other businesses and technologies. Significant business acquisitions during fiscal 2010, 2009 and 2008 wereas follows: • December 30, 2009 — SpinVox, Limited (“SpinVox”) • 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”);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; theallowances for doubtful accounts and sales returns; accounting for patent legal defense costs; the valuation of goodwill, intangible assetsand tangible long-lived assets; accounting for business combinations; accounting for stock-based compensation; accounting for long-termfacility obligations; the accounting for derivative instruments; accounting for income taxes and related valuation allowances; and losscontingencies. We base our estimates on historical experience, market participant fair value considerations and various other factors thatare believed to be reasonable under the circumstances. Actual amounts could differ significantly from these estimates.56Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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.ReclassificationWe reclassified certain acquisition-related costs included within operating expenses for the years ended September 30, 2009 and 2008to conform to our revised statement of operations presentation for such costs as disclosed below. The current and long-term portions of ouraccrued business combination costs have been included in the accrued expenses and other current liabilities and other liabilities line itemswhere as previously they were presented as separate line items. Inventory has been included in the prepaid expenses and other currentassets line item where as previously it was presented as a separate line item. Such reclassifications have no impact on earnings or cashflows provided by operations.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 access to take immediate possession of the software or technology. In select situations, we sellor license intellectual property in conjunction with, or in place of, embedding our intellectual property in software. We recognize revenuefrom the sale or license of software products and licensing of technology 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 exists when a company can support what the fair value of its softwareand/or software-related services is based on evidence of the prices charged when the same elements are sold separately. VSOE of fair valueis required, generally, in order to separate the accounting for various elements in a software and related services arrangement. We haveestablished VSOE of fair value for the majority 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 five 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.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.57Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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 contract 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 allocating VSOE of fair value of the professional services asprofessional service revenue and the residual portion as license revenue. We generally determine the percentage-of-completion by comparingthe labor hours incurred to-date to the estimated total labor hours required to complete the project. We consider labor hours to be the mostreliable, available measure of progress on these projects. Adjustments to estimates to complete are made in the periods in which factsresulting in a change become known. When the estimate indicates that a loss will be incurred, such loss is recorded in the periodidentified. Significant judgments and estimates are involved in determining the percent complete of each contract. Different assumptionscould yield materially different results.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 use historical returns from these distributors and resellersas a basis upon which to estimate future sales returns. As a result, we recognize revenue from sales to these distributors and resellerswhen the products are sold through to retailers and end-users.When products are sold directly to retailers or end-users, we make an estimate of sales returns based on historical experience. Theprovision for these estimated returns is recorded as a reduction of revenue and accounts receivable at the time that the related revenue isrecorded. If actual returns differ significantly from our estimates, such differences could have a material impact on our results ofoperations for the period 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.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 in our operating results from the date58Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of acquisition. The purchase price allocation process requires us to use significant estimates and assumptions, including fair valueestimates, 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 fair market value 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. Subsequent to the purchaseprice allocation period any adjustment to assets acquired or liabilities assumed is included in operating results in the period in which theadjustment is determined.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 a comparison of the fair value of our reporting units to their recorded carrying values.We have three reporting units based on the level of information provided to, and review thereof, by our core market management. Incertain instances, we have aggregated components of an operating segment into a single reporting unit based on similar economiccharacteristics. The fair values of the reporting units for the annual impairment assessment were determined based on estimates of thosereporting units’ enterprise values as a function of trailing-twelve-month (“TTM”) revenues and EBITDA as compared to companiescomparable to each of the reporting units on a standalone basis. The carrying values of the reporting units were determined based on anallocation of the Company’s assets and liabilities through specific allocation of certain assets and liabilities to the reporting units and anapportionment method based on relative size of the reporting units’ revenues and operating expenses compared to the Company as a whole.Certain corporate assets that are not instrumental to the reporting units’ operations and would not be transferred to hypotheticalpurchasers of the reporting units were excluded from the reporting units’ carrying values. Indefinite-lived intangibles are evaluated forimpairment through comparison of the fair value of the assets to their net book value. No impairments of goodwill or indefinite-livedintangibles have been recorded in fiscal 2010, 2009, or 2008.59Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Long-Lived AssetsOur long-lived assets consist principally of acquired intangible assets and land, building and equipment. Land, building andequipment are stated at cost. Building 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 significant improvements on existing software forinternal use are capitalized and amortized over the useful life of the upgraded software. Depreciation is computed using the straight-linemethod. Repair and maintenance costs are expensed as incurred. The cost and related accumulated depreciation of sold or retired assets areremoved from the 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 2010 and 2009 and concludedthat our long-lived assets were not impaired. In fiscal 2008, we recorded impairment charges of $3.9 million resulting from theidentification of certain specific acquired intangible assets that were no longer being utilized or providing economic benefit, of which$0.3 million was included in cost of revenue from amortization of intangible assets, and $3.6 million was included in amortization ofintangible assets within operating expenses.Cash and Cash EquivalentsCash and cash equivalents consists of cash on hand, including money market funds and commercial paper with original maturitiesof 90 days or less.Marketable Securities and Minority 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. Marketable securitiesconsist primarily of high-quality corporate debt instruments and have maturity dates ranging from September 22, 2011 to March 15,2012. As of September 30, 2010 the total cost basis was $33.3 million.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 our investments for impairment whenever declines in estimated fair value are deemed to be other-than-temporary.60Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Accounts Receivable AllowancesAllowances 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.Allowances for Sales Returns: We maintain an allowance for sales returns from customers for which we have the ability toestimate returns based on historical experience. The returns allowance is recorded as a reduction in revenue and accounts receivable at thetime the related revenue is recorded. Receivables are written off against the allowance in the period the return is received.For the years ended September 30, 2010, 2009 and 2008, the activity related to accounts receivable allowances was as follows (inthousands): Allowance for Allowance for Doubtful Accounts Sales Returns Balance at October 1, 2007 $6,155 $7,323 Bad debt provision 4,173 — Write-offs, net of recoveries (3,403) — Revenue adjustments, net — (960)Balance at September 30, 2008 6,925 6,363 Bad debt provision 1,823 — Write-offs, net of recoveries (1,915) — Revenue adjustments, net — (257)Balance at September 30, 2009 6,833 6,106 Bad debt provisions 873 — Write-offs, net of recoveries (1,405) — Revenue adjustments, net — 723 Balance at September 30, 2010 $6,301 $6,829 InventoriesInventories are stated at the lower of cost, computed using the first-in, first-out method, or market value and are included in othercurrent assets. We regularly review inventory quantities on hand and record a provision for excess and/or obsolete inventory primarilybased on future purchase commitments with our suppliers, and the estimated utility of our inventory as well as other factors includingtechnological changes and new product development.Inventories, net of allowances, consisted of the following (dollars in thousands): September 30, September 30, 2010 2009 Components and parts $5,357 $6,479 Inventory at customers 936 967 Finished products 2,308 1,079 $8,601 $8,525 61Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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.Research and Development CostsInternal costs relating to research and development costs incurred for new software products and enhancements to existing productsare expensed as incurred.Accounting for Collaboration AgreementsOn October 9, 2009, we entered into a five-year collaboration agreement with a third party to accelerate the development of newspeech technologies. All intellectual property derived from the collaboration will be jointly-owned by the two parties and Nuance will havethe sole rights to commercialize the intellectual property during the term of the agreement. In consideration for the services from the thirdparty in the collaboration efforts, as well as the joint ownership rights over intellectual property developed under the arrangement and theexclusive right to commercialize such developed intellectual property for the term of the arrangement, we will pay $80.0 million in fiveequal payments of $16.0 million on August 15th of each year, payable in cash or our common stock, at our option. These upfrontpayments will be recorded as a prepaid asset and expensed ratably over each annual period, commensurate with the pattern in which weexpect the third party to perform its services and convey our rights under the arrangement. On October 14, 2009, we made our firstpayment under the arrangement consisting of 1,047,120 shares of our common stock valued at $16.0 million. We issued 1,024,984additional shares of our common stock on September 28, 2010 for payment of the second $16.0 installment under this agreement. For theyear ended September 30, 2010, $16.0 million has been recorded as research and development expense in our consolidated statements ofoperations.On January 13, 2010, we amended the collaboration agreement discussed above to extend certain provisions for eighteen monthsfollowing the termination of the agreement. In consideration for the extension, we agreed to pay an additional $12.0 million to the third-party in five equal payments of $2.4 million on August 15th of each year over the five-year agreement term, payable in cash or ourcommon stock, at our option, with the exception of the first payment, which was made during the second quarter of fiscal 2010 throughthe issuance of 145,897 shares of our common stock. We issued 153,747 additional shares of our common stock on September 28,2010 for payment of the second $2.4 million installment under this agreement. These upfront payments are recorded as a prepaid assetwhen made and will be expensed ratably to sales and marketing expense during the eighteen-month extension period.On June 15, 2010, we entered into a five-year research collaboration agreement with the same third party noted above to enhance thetechnologies related to data analysis and fact extraction for electronic health records. All intellectual property resulting from the agreementwill be jointly-owned by the two parties and Nuance will have the sole rights to commercialize the resultant intellectual property during theterm of the agreement. In consideration for the agreement, we agreed to pay $12.5 million in five equal installments of $2.5 million inJune of each year, payable in cash or our common stock, at our option. These periodic payments will initially be recorded as a prepaidasset and expensed as research and development expense ratably over each annual period. On June 25, 2010, we made our first paymentunder the arrangement consisting of 152,440 shares of our common stock valued at $2.5 million. For the year ended September 30, 2010,$0.8 million has been recorded as research and development in our consolidated statements of operations.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 and62Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)amortized to cost of revenue over the estimated useful life of the related products. We have determined that technological feasibility isreached shortly before the general release of our software products. Costs incurred after technological feasibility is established have notbeen material, and accordingly, we have expensed the internal costs relating to research and 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, we had capitalized patent defense costs of$6.8 million included in other assets. During fiscal 2010, these deferred costs were expensed and included in restructuring and othercharges (credits), net as a result of unsuccessful litigation.Acquisition-Related Costs, netDuring the first quarter of fiscal 2010, we adopted the guidance in Financial Accounting Standards Board (“FASB”) AccountingStandards Codification (“ASC” 805, Business Combinations (formerly referred to as Statement of Financial Accounting Standard(“SFAS”) No. 141 (revised), Business Combinations and related Staff Positions effective October 1, 2009. ASC 805 supersedes theprevious accounting guidance related to business combinations, including the measurement of acquirer shares issued in consideration fora business combination, the recognition of and subsequent accounting for contingent consideration, the recognition of acquired in-processresearch and development, the accounting for acquisition-related restructurings, the treatment of acquisition-related transaction costs andthe recognition of changes in the acquirer’s income tax valuation allowance. The guidance is applied prospectively from the date ofacquisition with minor exception related to income tax contingencies from companies acquired prior to the adoption date. As a result of ouradoption of the new guidance, we expensed $2.2 million in acquisition-related transaction costs which were capitalized as ofSeptember 30, 2009. These costs were recorded as expense within the “acquisition-related costs, net” line in the consolidated statement ofoperations.Acquisition-related costs include those costs related to business and other acquisitions, including potential acquisitions. These costsconsist of transition and integration costs, including retention payments, transitional employee costs and earn-out payments treated ascompensation expense, as well as the costs of integration-related services provided by third-parties; professional service fees, includingdirect third-party costs of the transaction and post-acquisition legal and other professional service fees associated with disputes andregulatory matters related to acquired entities; and adjustments to acquisition-related items that are required to be marked to fair value eachreporting period, such as contingent consideration, and other items related to acquisitions for which the measurement period has ended.Previous to our adoption of ASC 805, certain acquisition-related costs and adjustments now recorded as operating expenses in ourconsolidated statements of operations were included as a part of the consideration transferred and capitalized as a part of the accountingfor our business acquisitions pursuant to previous accounting rules, primarily direct transaction costs. In addition, there were no itemsunder the legacy business combination accounting guidance that were required to be re-measured to fair value on a recurring basis. 2010 2009 2008 Transition and integration costs $13,562 $4,698 $8,295 Professional service fees 17,156 15,048 5,040 Acquisition-related adjustments (107) (4,043) — Total $30,611 $15,703 $13,335 63Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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 $21.1 million, $15.8 million and $20.9 million for fiscal 2010, 2009 and2008, respectively.Accounting for Convertible DebtEffective October 1, 2009, we adopted the provisions in FASB ASC 470-20 as they relate to our convertible debt instruments thatmay be settled in cash upon conversion (formerly referred to as FASB Staff Position APB 14-1, Accounting for Convertible DebtInstruments that May be Settled in Cash upon Conversion (Including Partial Cash Settlement)) effective October 1, 2009. Theguidance requires us to separately account for the liability (debt) and equity (conversion option) components of our convertible debtinstruments that require or permit settlement in cash upon conversion in a manner that reflects our nonconvertible debt borrowing rate atthe time of issuance. The equity components of our convertible debt instruments are recorded to stockholders’ equity with an offsettingdebt discount. The debt discount created is amortized to interest expense in our consolidated statement of operations using the effectiveinterest method over the expected term of the convertible debt. The provisions herein discussed have been applied retrospectively to allfinancial information presented. Refer to information below and in Note 10 for further information.The following table illustrates the retrospective effect of adopting ASC 470-20 to the consolidated statements of operations for theyears ended September 30, 2009 and 2008 (dollars in thousands): Year Ended Year Ended September 30, 2009 September 30, 2008 As Adjusted for As Adjusted for As Originally Retrospective As Originally Retrospective Reported Application Reported Application Interest expense $(40,103) $(47,288) $(55,196) $(62,088)Income (loss) before income taxes 28,189 21,004 (15,514) (22,406)Net loss (12,202) (19,387) (30,068) (36,960)Net loss per share — Basic and Diluted $(0.05) $(0.08) $(0.14) $(0.18)The following table illustrates the retrospective effect of adopting ASC 470-20 to the consolidated balance sheet as of September 30,2009 (dollars in thousands): As Adjusted for As Originally Retrospective Reported Application Other assets(a) $52,511 $52,361 Long-term portion of debt and capital leases(b) 888,611 848,898 Additional paid-in-capital(c) 2,254,511 2,308,992 Accumulated deficit $(247,338) $(262,256)(a)Other assets have been adjusted for the portion of the debt issuance costs attributable to the 2.75% Convertible Debentures that mustbe retrospectively allocated to the equity component of the debt instrument through additional paid-in-capital as of the date of thenotes issuance.64Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)(b)Long-term portion of debt and capital leases has been adjusted to reflect retrospective recognition of the debt discount created bybifurcating the equity component of the convertible notes from the liability component.(c)Additional paid-in-capital has been adjusted to reflect recording, retrospectively, the equity component of the convertible notes, aswell as the equity component allocation of the debt issuance costs attributable to the 2.75% Convertible Debentures.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. and foreign deferred tax assets, which we believe do not meet the “more likelythan not” criteria for recognition. If we are subsequently able to utilize all or a portion of the deferred tax assets for which a valuationallowance has been established, then we may be required to recognize these deferred tax assets through the reduction of the valuationallowance which could result in a material benefit to our results of operations in the period in which the benefit is determined. This benefitwill exclude the recognition of the portion of the valuation allowance which relates to net deferred tax assets created as a result of stock-based compensation or other equity transactions where prevailing guidance requires the change in valuation allowance to be traced forwardthrough stockholders’ equity and recorded as additional paid-in-capital.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, when the minimum threshold for recognition is not met, a tax position isrecorded as the largest amount that is more than fifty percent likely of being realized upon ultimate settlement.Comprehensive LossTotal comprehensive loss, net of taxes, was approximately $18.2 million, $24.6 million and $39.2 million for fiscal 2010, 2009and 2008, respectively. For the purposes of comprehensive loss disclosures, we do not record tax provisions or benefits for the netchanges in the foreign currency translation adjustment, as we intend to reinvest undistributed earnings in our foreign subsidiariespermanently.The components of accumulated other comprehensive income, reflected in the Consolidated Statements of Stockholders’ Equity andComprehensive Loss, consisted of the following (dollars in thousands): 2010 2009 2008 Foreign currency translation adjustment $13,067 $15,874 $15,145 Unrealized gains on marketable securities 30 — — Net unrealized gains (losses) on cash flow hedge derivatives 230 (3,982) (879)Net unrealized losses on pensions (net of tax of $33, $0 & $0, respectively) (4,822) (4,325) (1,527) $8,505 $7,567 $12,739 65Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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, 2010 and 2009, no customer accounted for greater than 10% of our net accounts receivable balance. No customeraccounted for more than 10% of our revenue for fiscal 2010, 2009 or 2008.Fair Value of Financial InstrumentsFinancial instruments including cash equivalents, marketable securities, accounts receivable, and derivative instruments, arecarried in the financial statements at amounts that approximate their fair value based on the short maturities of those instruments. Refer toNote 10 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 2010, 2009, and 2008 were $3.5 million, $7.0 million, and $(0.3) million, respectively.Financial Instruments and Hedging ActivitiesWe utilize derivative instruments to hedge specific financial risks such as interest rate and foreign exchange risk. We do not engagein speculative hedging activity. In order for us to account for a derivative instrument as a hedge, specific criteria must be met, including:(i) ensuring at the inception of the hedge that formal documentation exists for both the hedging relationship and the entity’s riskmanagement objective and strategy for undertaking the hedge and (ii) at the inception of the hedge and on an ongoing basis, the hedgingrelationship is expected to be highly effective in achieving offsetting changes in fair value attributed to the hedged risk during the periodthat the hedge is designated. Further, an assessment of effectiveness is required whenever financial statements or earnings are reported.Absent meeting these criteria, changes in fair value are recognized in other income (expense), net, in the consolidated statements ofoperations. Once the underlying forecasted transaction is realized, the gain or loss from the derivative designated as a hedge of thetransaction is reclassified from accumulated other comprehensive income (loss) to the statement of operations, in the appropriate revenueor expense caption. Any ineffective portion of the derivatives designated as cash flow hedges is recognized in current earnings.Accounting for Stock-Based CompensationWe account for stock-based compensation 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 stock-based compensation as a charge against earnings.We recognize stock-based compensation expense over the requisite service period, net of estimated forfeitures. We will recognize a benefitfrom stock-based66Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)compensation in equity using the with-and-without approach for the utilization of tax attributes. The Restricted Stock and RestrictedUnits are collectively referred 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 the preferred shares are excluded from basic earnings per share.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 our 2.75% Convertible Debentures. Theconvertible debentures are considered Instrument C securities due to the fact that only the excess of the conversion value on the date ofconversion can be paid in our common shares; the principal portion of the conversion must be paid in cash. Therefore, only the shares ofcommon stock potentially issuable with respect to the excess of the conversion value over its principal amount, if any, is considered asdilutive potential common shares for purposes of calculating diluted net income per share. The conversion value for the convertibledebentures was less than the principal amount since its issuance date and no shares were assumed to be issued for purposes of computingthe 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 20.7 million shares, 31.6 million shares and 33.1 million shares for theyears ended September 30, 2010, 2009 and 2008, respectively, have been excluded from the computation of diluted net loss per sharebecause their inclusion would be anti-dilutive.Recently Issued Accounting StandardsIn April 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-17, Revenue Recognition — Milestone Method(Topic 605): Milestone Method of Revenue Recognition. The ASU codifies the consensus reached in Emerging Issues Task Force(“EITF”) Issue No. 08-9, Milestone Method of Revenue Recognition. The amendments to the FASB Accounting Standards Codificationprovide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenuerecognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may berecognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to beconsidered substantive. The amendments in the ASU are effective on a prospective basis for milestones achieved in fiscal years, andinterim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. If an entity elects early adoption andthe period of adoption is not the beginning of the entity’s fiscal year, the entity must apply the amendments retrospectively from thebeginning of the year of adoption. Entities may also elect to adopt the amendments in the ASU retrospectively for all prior periods. We donot expect the implementation of ASU No 2010-17 to have a material impact on our financial statements.In September 2009, the Financial Accounting Standards Board amended the Accounting Standards Codification as summarized inASU 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, RevenueRecognition (Topic 605): Multiple-Deliverable Revenue Arrangements. As summarized in ASU 2009-14, ASC Topic 985 has beenamended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions,tangible products containing software components and non-software components that function together to deliver the product’s essential67Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)functionality. As summarized in ASU 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multipledeliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity toallocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objectiveevidence or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenueusing the relative selling price method. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are both effective forfiscal years beginning on or after June 15, 2010. We are continuing to evaluate the potential impact of these changes.3. Business Acquisitions2010 AcquisitionsAcquisition of SpinVoxOn December 30, 2009, we acquired all of the outstanding capital stock of SpinVox Limited (“SpinVox”), a UK-based privately-held company engaged in the business of providing voicemail-to-text services. The acquisition was a stock purchase and the goodwillresulting from this acquisition is not expected to be deductible for tax purposes. The results of operations of SpinVox have been includedin our results of operations from January 1, 2010. The results of operations of SpinVox for the one day, December 31, 2009, of the fiscalfirst quarter during which SpinVox was a part of Nuance were excluded from our consolidated results for the year ended September 30,2010 as such amounts for that one day were immaterial.A summary of the preliminary allocation of the purchase consideration is as follows (dollars in thousands):Total purchase consideration: Cash $67,500 Common Stock(a) 36,352 Total purchase consideration $103,852 Allocation of the purchase consideration: Cash $4,061 Accounts receivable(b) 11,140 Other assets 5,856 Property and equipment 1,585 Identifiable intangible assets 32,400 Goodwill 111,063 Total assets acquired 166,105 Current liabilities(c) (61,201)Deferred revenue (1,052)Total liabilities assumed (62,253)Net assets acquired $103,852 (a)Approximately 2.3 million shares of our common stock, valued at $15.81 per share based on the closing price of our commonstock on the acquisition date, were issued at closing.(b)Accounts receivable have been recorded at their estimated fair value, which consists of the gross accounts receivable assumed of$16.6 million, reduced by a fair value reserve of $5.5 million representing the portion of contractually owed accounts receivablewhich we do not expect to be collected.68Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)(c)Current liabilities include a commitment of EUR 25.0 million ($36.0 million based on the December 31, 2009 exchange rate) fixedobligation, payable in cash.The following are the identifiable intangible assets acquired and their respective weighted average useful lives, as determined basedon a preliminary valuation (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $23,400 12.0 Core and completed technology 8,400 4.7 Non-compete agreements 600 2.0 Total $32,400 Other Fiscal 2010 AcquisitionsDuring fiscal 2010, we acquired an additional seven businesses primarily to expand our product offerings and enhance ourtechnology base. The results of operations of these companies have been included in our consolidated results from their respectiveacquisition dates. The total consideration for these acquisitions was $86.2 million, including the issuance of 1.2 million shares of ourcommon stock valued at $21.8 million. In allocating the total purchase consideration for these acquisitions based on estimated fairvalues, we preliminarily recorded $44.0 million of goodwill and $33.9 million of identifiable intangible assets. The allocations of thepurchase consideration were based upon preliminary valuations and our estimates and assumptions are subject to change. Intangibleassets acquired included primarily core and completed technology and customer relationships with weighted average useful lives of6.7 years. The acquisitions were primarily stock acquisitions and the goodwill resulting from these acquisitions is expected to bedeductible for tax purposes.2009 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 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 to be paid, ifat all, based on the business achieving certain performance targets that are measurable from the acquisition date to December 31, 2009. InApril 2010, a final earn out amount of $21.2 million was agreed upon; we issued 593,676 shares of our common stock, valued at$10.2 million, as our first payment under the earn-out agreement. The remaining balance is payable in cash or stock, solely at our option,on or before October 1, 2011 and is included in long-term liabilities as of September 30, 2010.69Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)A summary of the purchase price allocation for the acquisition of SNAPin is as follows (dollars in thousands):Total purchase consideration: Common stock(a) $166,253 Stock options and restricted stock units assumed 11,523 Contingent earn-out consideration 21,200 Transaction costs 2,825 Total purchase consideration $201,801 Allocation of the purchase consideration: Current assets $6,084 Other assets 2,972 Deferred tax asset(b) 2,327 Identifiable intangible assets 60,900 Goodwill 161,558 Total assets acquired 233,841 Current liabilities (2,191)Deferred tax liability(b) (2,327)Deferred revenue(c) (27,522)Total liabilities assumed (32,040)Net assets acquired $201,801 (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 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.(c)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.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 17.70Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following are the identifiable intangible assets acquired and their respective weighted average useful lives (dollars 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 Other Fiscal 2009 AcquisitionsDuring fiscal 2009, we acquired an additional six businesses primarily to expand our product offerings and enhance our technologybase. The results of operations of these acquisitions are included in our fiscal 2009 financial statements from their respective acquisitiondates. The total consideration for these acquisitions was approximately $161.3 million,. The gross purchase price consisted of theissuance of 6.4 million shares of our common stock valued at $80.8 million, $71.7 million in cash and $8.8 million for transactioncosts. Cash totaling $5.2 million has been placed in escrow related to two of the acquisitions and has been excluded from the totalpurchase consideration until the escrow contingencies have been satisfied. In allocating the total purchase consideration for theseacquisitions based on estimated fair values, we have recorded $63.1 million of goodwill, $71.9 million of identifiable intangible assets,and $26.3 million in net assets (resulting primarily from cash assumed; acquired unbilled receivables, net of liabilities assumedincluding contingencies; deferred income taxes; and restructuring). We have assumed a $5.0 million tax contingency established foruncertain foreign tax positions relating to one of the acquisitions. Intangible assets acquired included primarily core and completedtechnology and customer relationships with weighted average useful lives of 9.5 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 $101.2 million, consisting of: net cash consideration of€66.3 million, which equated to $97.1 million based on the exchange rate as of the acquisition date, and transaction costs of$4.2 million. The acquisition was a taxable event. Payment of $34.4 million was made at the acquisition date and the remaining deferredacquisition payment was paid in the first quarter of fiscal 2010.71Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)A summary of the purchase price allocation for the acquisition of PSRS is as follows (dollars in thousands):Total purchase consideration: Cash $97,066 Transaction costs 4,167 Total purchase consideration $101,233 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 53,833 Total assets acquired 125,771 Accounts payable and accrued expenses (5,757)Other liabilities (18,781)Total liabilities assumed (24,538)Net assets acquired $101,233 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 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 agreed to make contingent earn-out payments of up to $15.0 million, payable in stock, or cash, solely at our discretion, relatingto earn-out provisions described in the share purchase agreement. We have notified the former shareholders of Multi-Vision that theperformance targets were not achieved and at September 30, 2010, we have not recorded any obligation relative to these measures.72Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The purchase price allocation for the acquisition of Multi-Vision is as follows (dollars 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 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 per share issued in fiscal 2009 upon release of shares held in escrow. During the second quarter of fiscal 2009, weelected to treat this acquisition as an asset purchase under provisions contained in the Internal Revenue Code. See Note 20 for furtherdiscussion of this election.73Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)A summary of the purchase price allocation for the acquisition of eScription is as follows (dollars 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 in to 806,044 shares of Nuance common stock, in connection with our acquisition of eScription. Thesestock options 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 17.74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 $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 (dollars 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 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 $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, 2010, 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 (dollars 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 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 $3,800 10.0 Core and completed technology 2,000 5.0 Trademark 90 5.0 Non-compete 40 3.0 Total $5,930 4. Pro Forma Results (Unaudited)The following table shows unaudited pro forma results of operations as if we had acquired SpinVox on October 1, 2008 (dollars inthousands): 2010 2009 Revenue $1,130,924 $967,868 Net loss $(50,663) $(122,030)Net loss per share $(0.18) $(0.48)We have not furnished pro forma financial information relating to our other fiscal 2010 and 2009 acquisitions because suchinformation is not material, individually or in the aggregate, to our financial results. The unaudited pro forma results of operations are notnecessarily indicative of the actual results that would have occurred had the transactions actually taken place at the beginning of theperiods indicated.5. Contingent Acquisition PaymentsContingent acquisition payment arrangements related to acquisitions completed during fiscal 2009 and 2008 are discussed above inNote 3. In addition to those transactions, we remain a party to certain contingent consideration arrangements relative to acquisitionscompleted in other fiscal years. Those arrangements are discussed below.Earn-out PaymentsIn accordance with our adoption of ASC 805 in fiscal 2010, for business combinations occurring subsequent to October 1, 2009,the fair value of any contingent consideration has been established at the acquisition date and included as purchase price with subsequentchanges to the estimated fair value recorded as an adjustment in current earnings in each reporting period. Contingent consideration relatedto acquisitions prior to our adoption of ASC 805 have been and will continue to be recorded as additional purchase price when thecontingency is resolved and additional consideration is due.In connection with an immaterial acquisition during fiscal 2010, we agreed to make contingent earn-out payments of up to$2.5 million, payable in stock, upon the achievement of certain financial targets. At the acquisition date, we recorded $1.0 million as thefair value of the contingent consideration. For the year ended September 30, 2010, we have recorded income of $0.3 million as fair valueadjustments included in acquisition-related costs, net in our consolidated statement of operations.In connection with our acquisition of Commissure, Inc. (“Commissure”) in September 2007, we agreed to make contingent earn-outpayments of up to $8.0 million, payable in stock, or cash, solely at our discretion, upon77Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)the achievement of certain financial targets for the fiscal years 2008, 2009 and 2010. Earn-out payments, if any, will be recorded asincremental purchase price and allocated to goodwill. We have notified the former shareholders of Commissure that the financial targetsfor the fiscal years 2008 and 2009 were not achieved and the related contingent earn-out payment was not earned. Through September 30,2010, we have not recorded any earn-out obligation relative to the Commissure acquisition.In November 2008, we amended the earn-out provisions set forth in the merger agreement related to the acquisition of Mobile VoiceControl, Inc. (“MVC”) such that the former shareholders of MVC were eligible to earn 377,964 and 755,929 shares of common stockbased on the achievement of calendar 2008 and 2009 financial targets, respectively. We notified the former shareholders of MVC that thefinancial targets for calendar 2008 and 2009 were not achieved and therefore we have not recorded any obligation relative to these measuresIn 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. In December 2009, we paid $11.3 million to the former shareholders of Phonetic in final settlement of the contingent earn-outprovisions and recorded the amount paid as additional purchase price related to the Phonetic acquisition.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 anyindemnification claims we may have. If no claims are made, the escrowed amounts will be released to the former shareholders of theacquired companies. Historically, under the previous accounting guidance SFAS No. 141, Business Combinations (“SFAS 141”), wecould not make a determination, beyond a reasonable doubt, whether the escrow would become payable to the former shareholders of thesecompanies until the escrow period had expired. Accordingly these amounts were treated as contingent purchase price until it wasdetermined that the escrow was payable, at which time the escrowed amounts would be recorded as additional purchase price andallocated to goodwill. Under the revised accounting guidance of ASC 805, escrow payments are generally considered part of the initialpurchase consideration and accounted for as goodwill.The following table summarizes the terms of the escrow arrangements that were entered into under the guidance of SFAS 141 thathave not been released as of September 30, 2010 (dollars in thousands): Initially Scheduled Escrow Release Date Cash Payment X-Solutions Group B.V December 10, 2010 $1,050 eCopy December 30, 2010 4,100 Total $5,150 78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 2010 and 2009, are as follows (dollars in thousands):Balance as of October 1, 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 Goodwill acquired 155,076 Escrow amounts released 3,700 Purchase accounting adjustments 30,111 Effect of foreign currency translation (1,947)Balance as of September 30, 2010 $2,077,943 Purchase accounting adjustments recorded in fiscal 2010 consisted primarily of a $13.1 million increase due to a change in the fairvalue estimate of acquired intangible assets from our fourth quarter fiscal 2009 acquisition of eCopy, a $11.3 million increase related tothe Phonetic earn-out payment, an $8.3 million increase to the SNAPin earn-out liability based on the final settlement discussed in Note 3above. These increases were partially offset by a $1.9 million reduction to the PSRS purchase price based on a final working capitaladjustment that was agreed to with the former shareholder of PSRS in November 2009.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 final determination of the fair value estimate of contingent liabilitiesassumed; partially offset by the following decreases: a $9.7 million reversal of assumed deferred tax liabilities as a result of our electionto treat eScription as an asset purchase, $5.8 million related to the utilization of acquired net operating losses from acquisitions, a$6.3 million adjustment to deferred taxes, and a $4.7 million decrease in accrued transaction costs.Intangible assets consist of the following as of September 30, 2010 and 2009, which includes $151.0 million and $112.7 million oflicensed technology, respectively (dollars in thousands): September 30, 2010 Weighted Average Gross Carrying Accumulated Net Carrying Remaining Amount Amortization Amount Life (Years) Customer relationships $597,672 $(231,079) $366,593 7.0 Technology and patents 389,508 (124,607) 264,901 8.6 Tradenames, trademarks, and other 38,798 (14,047) 24,751 4.4 Non-competition agreements 5,068 (3,248) 1,820 2.0 Subtotal 1,031,046 (372,981) 658,065 7.5 Tradename, indefinite life 27,800 — 27,800 n/a Total $1,058,846 $(372,981) $685,865 79Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued) 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 Included with the technology and patents grouping above are assets totaling $45 million relating to purchases of patents and licensesin fiscal 2010. We made payments to third parties of both cash and shares of our common stock in connection with these acquisitions, atotal of 2,180,600 shares of our common stock were issued subject to price guarantees as described further in Note 11. The weightedaverage useful life related to these acquired assets is 10 years.In June 2009, we entered into a joint marketing and selling agreement with a third party and paid $7.0 million in consideration of thearrangement. We have capitalized the 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 2009, we issued 879,567 shares of our common stock valued at $13.0 million in December 2009 upon the third partymeeting certain performance criteria under the agreement. The additional $13.0 million was capitalized in fiscal 2010 and classified in thesame manner as the initial $7.0 million payment.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 targetswere met 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.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 $47.8 million, $38.4 million and $24.4 million in fiscal 2010, 2009 and2008, respectively. Amortization expense for customer relationships; tradenames, trademarks, and other; and non-competition agreementsis included in operating expenses and was80Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)$87.8 million, $77.0 million and $58.2 million in fiscal 2010, 2009 and 2008, respectively. Estimated amortization expense for each ofthe five succeeding years as of September 30, 2010, is as follows (in thousands): Other Cost of Operating Year Ending September 30, Revenue Expenses Total 2011 $51,268 $84,055 $135,323 2012 47,024 73,846 120,870 2013 41,250 59,107 100,357 2014 32,710 52,006 84,716 2015 28,997 42,783 71,780 Thereafter 63,652 81,367 145,019 Total $264,901 $393,164 $658,065 7. Accounts ReceivableAccounts receivable, excluding acquired unbilled accounts receivable, consisted of the following (dollars in thousands): September 30, September 30, 2010 2009 Trade accounts receivable $214,861 $197,176 Unbilled accounts receivable under long-term contracts 15,856 15,311 Gross accounts receivable 230,717 212,487 Less — allowance for doubtful accounts (6,301) (6,833)Less — allowance for sales returns (6,829) (6,106)Accounts receivable, net $217,587 $199,548 8. Land, Building and Equipment, NetLand, building and equipment, net at September 30, 2010 and 2009 were as follows (dollars in thousands): September 30, September 30, Useful Life 2010 2009 (In years) Land — $2,400 $2,400 Building 30 5,363 5,117 Machinery and equipment 3-5 5,786 5,558 Computers, software and equipment 3-5 108,278 75,586 Leasehold improvements 2-7 15,659 15,073 Furniture and fixtures 5 10,759 10,366 Construction in progress n/a 662 4,266 Subtotal 148,907 118,366 Less: accumulated depreciation (86,824) (64,898)Land, building and equipment, net $62,083 $53,468 81Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)At September 30, 2009, construction in progress related to the build-out of hosted data centers. Depreciation expense, associated withbuilding and equipment, for fiscal 2010, 2009 and 2008 was $21.6 million, $18.7 million and $16.4 million, respectively.9. Accrued Expenses and Other Current LiabilitiesAccrued expenses consisted of the following (dollars in thousands): September 30, September 30, 2010 2009 Compensation $56,047 $52,600 Sales and marketing incentives(a) 40,780 4,413 Cost of revenue related liabilities 10,028 7,585 Accrued business combination costs 10,197 12,144 Professional fees 9,908 8,945 Sales and other taxes payable 5,211 5,913 Acquisition costs and liabilities 4,970 8,522 Income taxes payable 4,357 7,185 Deferred tax liability — 1,614 Security price guarantee 1,034 — Other 9,089 8,042 Total $151,621 $116,963 (a)Accrued sales and marketing incentives include a EUR 25.0 million ($34.0 million based on the September 30, 2010 exchange rate)fixed obligation assumed in connection with our acquisition of SpinVox as disclosed in Note 3. During the third quarter of fiscal2010, we placed EUR 18.0 million ($24.5 million based on the September 30, 2010 exchange rate) in an irrevocable standby letter ofcredit account. These funds are restricted for the payment of the portion of the fixed obligation due in December 2010 and has beenreported as restricted cash in the accompanying balance sheets.10. Credit Facilities and DebtAt September 30, 2010 and 2009, we had the following borrowing obligations (dollars in thousands): September 30, September 30, 2010 2009 2.75% Convertible Debentures, net of unamortized discount of $36.3 million and $44.9 million,respectively $213,654 $205,064 Credit Facility 643,563 650,263 Obligations under capital leases and other 1,561 433 Total long-term debt 858,778 855,760 Less: current portion 7,764 6,862 Non-current portion of long-term debt $851,014 $848,898 The estimated fair value of our long-term debt approximated $902.2 million and $893.2 million at September 30, 2010 and 2009,respectively. These fair value amounts represent the value at which our lenders could trade our debt within the financial markets, and donot represent the settlement value of these long-term debt liabilities to us at each reporting date. The fair value of the long-term debt issueswill continue to vary each period82Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)based on fluctuations in market interest rates, as well as changes to our credit ratings. These fluctuations may have little to no correlationto our reported debt balances. The term loan portion of our Credit Facility is traded and the fair values are based upon traded prices as ofthe reporting dates. The fair values of the 2.75% Convertible Debentures at each respective reporting date were estimated using theaverages of the September 30, 2010 and September 30, 2009 bid and ask trading quotes. We had no outstanding balance on the revolvingcredit line portion of our Credit Facility. Our capital lease obligations and other debt are not traded and the fair values of these instrumentsare assumed to approximate their carrying values as of September 30, 2010 and September 30, 2009.2.75% 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. Upon the adoption ofASC 470-20, the difference of $54.7 million between the fair value of the liability component of the 2027 Debentures and the net proceedson the date of issuance was retrospectively recorded as additional paid-in-capital and additional debt discount. The aggregate debtdiscount, consisting of both the discount related to the adoption of ASC 470-20 and the date of issuance difference between the principalamount of the 2027 Debentures and the net proceeds received, and debt issuance costs are being amortized to interest expense using theeffective interest rate method through August 2014. As of September 30, 2010 and 2009, the ending unamortized discount was$36.3 million and $44.9 million, respectively, and the ending unamortized deferred debt issuance costs were $0.4 million and$0.5 million, respectively. The 2027 Debentures are general senior unsecured obligations, ranking equally in right of payment to all ofour existing and future unsecured, unsubordinated indebtedness and senior in right of payment to any indebtedness that is contractuallysubordinated to the 2027 Debentures. The 2027 Debentures are effectively subordinated to our secured indebtedness to the extent of thevalue of the collateral securing such indebtedness and are structurally subordinated to indebtedness and other liabilities of oursubsidiaries. If converted, the principal amount of the 2027 Debentures is payable in cash and any amounts payable in excess of the$250 million principal amount, will (based on an initial conversion rate, which represents an initial conversion price of $19.47 pershare, subject to adjustment) be paid in cash or shares of our common stock, at our election, only in the following circumstances and tothe following extent: (i) on any date during any fiscal quarter beginning after September 30, 2007 (and only during such fiscal quarter) ifthe closing sale price of our common stock was more than 120% of the then current conversion price for at least 20 trading days in theperiod of the 30 consecutive trading days ending on the last trading day of the previous fiscal quarter; (ii) during the five consecutivebusiness-day period following any five consecutive trading-day period in which the trading price for $1,000 principal amount of theDebentures for each day during such five trading-day period was less than 98% of the closing sale price of our common stock multipliedby 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, 2010, 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.83Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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, 2010, $643.6 million remained outstanding under the term loans, there were $21.2 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, 2010, 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, 2010, the applicable margin for the term loan was 1.00% for base rateborrowings and 1.75% 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, 2010, thecommitment fee rate was 0.375% and the effective interest rate was 2.02%.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, 2010 and 2009, the ending unamortized deferred financing fees were $5.8 million and$7.7 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. We have not generated excess cash flows in any period and no additional payments are required. We will continue to evaluatethe extent to which a payment is due in the first quarter of future fiscal years based on excess cash flow generation. At the current time, weare unable to predict the amount of the outstanding principal, if any, that may be required to be repaid in future fiscal years pursuant tothe excess cash flow sweep provisions. Any term loan borrowings not paid through the baseline repayment, the excess cash flow sweep,or any other mandatory or optional payments that we may make, will be84Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)repaid upon maturity. If only the baseline repayments are made, the annual aggregate principal amount of the term loans repaid would beas follows (dollars in thousands):Year Ending September 30, Amount 2011 $6,700 2012 6,700 2013 630,163 Total $643,563 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.11. 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, 2010, 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, 2010 and 2009, the aggregate cumulativeunrealized gains (losses) related to these swaps, and a previous swap that matured on March 31, 2009, were $3.5 million and$(4.0) million, respectively and were included in accumulated other comprehensive income in the accompanying balance sheets.Forward Currency Contracts Designated as Cash Flow HedgesDuring fiscal 2009 and 2010, we entered into foreign currency contracts to hedge exposure on the variability of cash flows inCanadian dollars which are designated as cash flow hedges. At September 30, 2010 the unsettled contracts had an aggregate remainingnotional value of CAD$13.7 million ($13.3 million based on the September 30, 2010 exchange rate). These contracts settle monthlythrough October 2011. As of September 30, 2010, the aggregate cumulative unrealized gains related to these contracts were immaterial.During fiscal 2010, we entered into foreign currency contracts to hedge exposure on the variability of cash flows in HungarianForints (“HUF”) which are designated as cash flow hedges. At September 30, 2010, the unsettled contracts had an aggregate remainingnotional value of HUF 1,017.0 million ($5.0 million based on the September 30, 2010 exchange rate). These contracts settle monthlythrough October 2011. As of September 30, 2010, the aggregate cumulative unrealized gains related to these contracts were immaterial.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.85Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)During the three months ended December 31, 2008, we entered into foreign currency forward contracts to offset foreign currencyexposure on the deferred acquisition payment of €44.3 million related to our acquisition of PSRS, resulting in a net gain during that periodof $8.0 million included in other income (expense). The foreign currency contracts matured and were settled on October 22, 2009. Thegain for the period from September 30, 2009 to settlement on October 22, 2009 was $1.6 million, but was offset in other income(expense), net by the loss resulting from the corresponding change in the associated deferred acquisition payment liability.During fiscal 2010, we entered into a foreign currency forward contract to offset foreign currency exposure on a fixed obligationassumed in connection with our acquisition of SpinVox as disclosed in Note 3. The notional value of the contract is Euro 18.0 million.The contract matures in December 2010.From time to time we will enter into agreements that allow us to issue shares of our common stock as part or all of the considerationrelated to partnering and technology acquisition activities. These transactions are described in Notes 2 and 6. Generally these shares areissued subject to security price guarantees which are accounted for as derivatives. We have determined that these instruments would notbe considered equity instruments if they were freestanding. The security price guarantees require payment from either us to a third party,or from a 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. Changes in the fair value of these security price guarantees are reportedin earnings in each period as non-operating income (expense) with other income (expense), net. During the year ended September 30, 2010,we received cash payments totaling $7.3 million upon the settlement of the arrangements that closed during the year.The following is a summary of the outstanding shares subject to security price guarantees at September 30, 2010 (dollars inthousands): Number of Shares Total Value of SharesIssue Date Issued Settlement Date on Issue DateMarch 31, 2010 753,800 October 1, 2010 $12,400 June 24, 2010 152,440 December 24, 2010 $2,500 September 28, 2010 1,178,732 March 28, 2011 $18,400 September 30, 2010 1,572,607 March 30, 2011 $24,800 86Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following table provides a quantitative summary of the fair value of our hedged and non-hedged derivative instruments as ofSeptember 30, 2010 and 2009 (dollars in thousands): Fair Value September 30, September 30, Description Balance Sheet Classification 2010 2009 Derivatives Not Designated as Hedges: Foreign currency contracts Prepaid expenses and other current assets $767 $8,682 Security Price Guarantees Prepaid expenses and other current assets — 2,299 Security Price Guarantees Accrued expenses and other current liabilities (982) — Net asset (liability) value of non-hedged derivative instruments $(215) $10,981 Derivatives Designated as Hedges: Foreign currency contracts Prepaid expenses and other current assets $729 $— Interest rate swaps Accrued expenses and other current liabilities (503) — Interest rate swaps Other long-term liabilities — (3,982)Net asset (liability) value of hedged derivative instruments $226 $(3,982)The following tables summarize the activity of derivative instruments for fiscal 2010 and 2009 (dollars 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) 2010 2009 2010 2009Foreign currency contracts $734 $— Other income (expense),net $(5) $— Interest rate swaps $3,479 $(3,103) N/A $— $— Derivatives Not Designated as Hedges for the Fiscal Year Ended September 30 Amount of Gain Location of Gain Recognized in Income Recognized in Income 2010 2009Foreign currency contracts Other income (expense), net $767 $8,682 Security price guarantees Other income (expense), net $4,026 $2,299 12. Fair Value MeasuresWe adopted the provisions of ASC 820 Fair Value Measurement, relative to financial instruments on October 1, 2008. ASC 820defines fair value, establishes a framework for measuring fair value, and enhances disclosures about fair value measurements. Fair valueis defined as the price that would be received for an asset, or paid to transfer a liability, in an orderly transaction between marketparticipants at the measurement date. Valuation techniques must maximize the use of observable inputs and minimize the use ofunobservable inputs.87Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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.Assets and liabilities measured at fair value on a recurring basis at September 30, 2010 and 2009 consisted of (dollars inthousands): September 30, 2010 Level 1 Level 2 Level 3 Total Assets: Money market funds(a) $470,845 $— $— $470,845 US government agency securities(a) 1,000 — — 1,000 Marketable securities(b) — 33,366 — 33,366 Foreign currency exchange contracts(b) — 1,496 — 1,496 Total assets at fair value $471,845 $34,862 $— $506,707 Liabilities: Security price guarantees(c) $— $982 $— $982 Interest rate swaps(d) — 503 — 503 Contingent earn-out(e) — — 724 724 Total liabilities at fair value $— $1,485 $724 $2,209 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(c) — 2,299 — 2,299 Total assets at fair value $413,263 $10,981 $— $424,244 Liabilities: Interest rate swaps(d) $— $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 marketable securities and foreign currency exchange contracts is based on the most recent observable inputsfor similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or aredirectly or indirectly observable.(c)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 common88Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)stock. The valuation model values both the put and call components of the guarantees simultaneously, with the net value of thosecomponents representing the fair value of each instrument.(d)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.(e)The fair value of the contingent earn-out is estimated using the probability of achieving certain financial targets established in thepurchase agreement together with the changes in our common stock price.The following table provides a summary of changes in fair value of our Level 3 financial instruments for the year endedSeptember 30, 2010 (dollars in thousands):Balance as of October 1, 2009 $— Earn-out liability established at time of acquisition 1,034 Charges (credits) to acquisition-related costs, net (310)Balance as of September 30, 2010 $724 13. 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. In accordance with our adoption ofASC 805 in fiscal 2010, restructuring expenses are recognized at the date of acquisition if such restructuring costs meet the recognitioncriteria in ASC 420, Exit or Disposal Cost Obligations. Prior to our adoption of ASC 805, restructuring expenses were recognized basedupon plans that were committed to by management at the date of acquisition, but were generally subject to refinement during the purchaseprice allocation period (generally within one year of the acquisition date). In addition to plans resulting from the business combination,previous acquisitions have included companies who have established liabilities relating to lease exit costs as result of their previousrestructuring activities. Regardless of the origin of the lease exit costs, we are required to make assumptions relating to sublease terms,sublease rates and discount rates. We base our estimates and assumptions on the best information available at the time of the obligationhaving arisen. These estimates are reviewed and revised as facts and circumstances dictate, with any changes being recorded to goodwill(for acquisitions completed prior to October 2009) or restructuring and other charges (credits), net. Changes in these estimates could havea material effect on the amount accrued on the balance sheet. Discussed in detail below are two individually significant facilities whichwere abandoned by the acquired company prior to our acquisition of the company, and for which the obligations to the lessors, we haveassumed.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 a liabilityassumed by 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, prior to the adoption of ASC 805, we implemented restructuring plans to eliminate duplicate facilities, personnel orassets in connection with business combinations. These costs were recognized as liabilities assumed, and accordingly are included in theallocation of the purchase price, generally resulting in an increase to the recorded amount of the goodwill.89Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The activity for the years ended September 30, 2010, 2009 and 2008, relating to all facilities and personnel recorded in accruedbusiness combination costs, is as follows (dollars in thousands): Facilities Personnel Total Balance at October 1, 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 Charged to goodwill (15) (759) (774)Charged to restructuring and other charges, net (769) — (769)Charged to interest expense 1,241 — 1,241 Cash payments, net of sublease receipts (11,137) (1,579) (12,716)Balance at September 30, 20010 $23,871 $159 $24,030 September 30, September 30, 2010 2009 Reported as: Current $10,197 $12,144 Long-term 13,833 24,904 Total $24,030 $37,048 14. Restructuring and Other Charges, netFiscal 2010For fiscal 2010, we recorded net restructuring and other charges of $18.7 million, which consisted primarily of $9.6 million relatedto the elimination of approximately 175 personnel across multiple functions within our company, including acquired entities, a $6.8million write-off of previously capitalized patent defense costs as a result of unsuccessful litigation and $2.1 million of contracttermination costs.Fiscal 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,90Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)adverse ruling arising from a vendor’s claims of underpayment of historical royalties for technology discontinued in 2005 and$1.4 million related to the consolidation or elimination of excess facilities.The following table sets forth the fiscal 2010, 2009 and 2008 accrual activity relating to restructuring and other charges (inthousands): Personnel Facilities Other Total Balance at October 1, 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 Cash payments (5,042) (544) (1,396) (6,982)Balance at September 30, 2009 607 310 28 945 Restructuring and other charges (credits), net 9,634 155 8,871 18,660 Non-cash adjustment — — (6,833) (6,833)Cash payments (8,403) (182) (2,066) (10,651)Balance at September 30, 2010 $1,838 $283 $— $2,121 15. Supplemental Cash Flow InformationCash paid for Interest and Income Taxes: Year Ended September 30, 2010 2009 2008 (In thousands) Interest Paid $27,899 $33,857 $49,988 Income taxes paid $14,215 $18,227 $5,599 Non Cash Investing and Financing Activities:During fiscal 2010, 2009 and 2008, 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 2010, 2009, and 2008 to complete business acquisitions during those years. Note 6 details the same information withregard to our fiscal 2010 and 2009 intangible asset acquisitions. We did not complete any significant asset acquisitions in fiscal 2008.16. 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 and has a liquidation preference of $1.30 per share plus all declared butunpaid dividends. The holders of Series B Preferred Stock are entitled to non-cumulative dividends at91Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)the rate of $0.05 per annum per share, payable when, and if, declared by the Board of Directors. To date, no dividends have beendeclared by the Board of Directors. Holders of Series B Preferred Stock have no voting rights, except those rights provided underDelaware law. The undesignated shares of preferred stock will have rights, preferences, privileges and restrictions, including votingrights, dividend rights, conversion rights, redemption privileges and liquidation preferences, as shall be determined by the Board ofDirectors upon issuance of the preferred stock. We have reserved 3,562,238 shares of our common stock for issuance upon conversionof the Series B Preferred Stock. Other than the 3,562,238 shares of Series B Preferred Stock that are issued and outstanding, there are noother shares of preferred stock issued or outstanding in fiscal 2010 or fiscal 2009.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 SecuritiesWe have, from time to time, entered into stock and warrant agreements with Warburg Pincus. In connection with these agreements,we granted Warburg Pincus the right to request that we use commercially reasonable efforts to register some or all of the shares of commonstock issued to them under each of their purchase transactions, including shares of common stock underlying the warrants. Thefollowing table summarizes the warrant and stock activities with Warburg Pincus during the three year period ended September 30, 2010:Warrants Exercised Exercise Price Date per Share Total Shares Proceeds Received (Dollars in thousands)April 7, 2010 $4.94 2,500,000 $12,350 September 15, 2009 5.00 3,177,570 15,888 July 29, 2009 5.00 863,236 4,316 July 29, 2009 0.61 525,732 321 Common Stock IssuedDate Price per Share Total Shares Proceeds Received (Dollars in thousands)January 29, 2009 $10.06 17,395,626 $175,046 May 20, 2008 17.36 5,760,369 100,110 At September 30, 2010, Warburg Pincus holds the following warrants to purchase shares of our common stock:Issuance Date Price per Share Total Shares Expiration DateJanuary 29, 2009 $11.57 3,862,422 January 29, 2013 May 20, 2008 20.00 3,700,000 May 20, 2012 92Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Other Common Stock Warrant ActivityOn November 15, 2004, in connection with our acquisition of Phonetic, we issued warrants to purchase 750,000 shares of ourcommon stock at an exercise price of $4.46 per share that were to vest, if at all, upon the achievement of certain performance targets. InDecember 2009, we paid $11.3 million in cash to the former shareholders of Phonetic in final settlement of the earn-out provisions of theagreement. The 750,000 warrants did not vest and were cancelled in connection with the final settlement.In 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. In May 2010, the remaining 12,190 shares were exercised in a cashless exercise resulting in theissuance of 9,350 shares of common stock.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.17. 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): 2010 2009 2008Cost of product and licensing $28 $11 $18 Cost of professional services, subscription and hosting 11,043 9,889 7,991 Cost of maintenance and support 756 743 1,278 Research and development 9,381 9,840 14,325 Selling and marketing 38,152 27,057 24,394 General and administrative 40,779 23,867 20,625 $100,139 $71,407 $68,631 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 2009 and 2010, 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.93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, 2010, 2009 and 2008: Weighted Weighted Average Average Remaining Aggregate Number of Exercise Contractual Intrinsic Shares Price Term Value(1) Outstanding at October 1, 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 Granted 1,200,000 $13.81 Exercised (3,433,701) $5.39 Forfeited (350,884) $13.65 Expired (266,044) $16.26 Outstanding at September 30, 2010 10,703,237 $8.44 3.5 years $78.4 million Exercisable at September 30, 2010 9,137,554 $7.62 3.1 years $74.2 million Exercisable at September 30, 2009 10,575,346 Exercisable at September 30, 2008 10,473,073 (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, 2010 ($15.64) and the exercise price of the underlying options.As of September 30, 2010, the total unamortized fair value of stock options was $7.0 million with a weighted average remainingrecognition period of 1.1 years. A summary of weighted-average grant-date (including assumed options) fair value and intrinsic value ofstock options exercised is as follows: 2010 2009 2008Weighted-average grant-date fair value per share $5.90 $8.00 $14.78 Total intrinsic value of stock options exercised (in millions) $36.1 $21.0 $89.6 94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: 2010 2009 2008Dividend yield 0.0% 0.0% 0.0%Expected volatility 50.9% 55.1% 53.9%Average risk-free interest rate 2.4% 2.7% 3.3%Expected term (in years) 4.2 5.8 5.5 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.95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, 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 Granted 1,698,743 4,693,440 Earned/released (950,253) (4,800,175)Forfeited (721,323) (853,481)Outstanding at September 30, 2010 2,867,840 7,795,114 Weighted average remaining contractual term of outstanding Restricted Units 0.8 years 1.3 years Aggregate intrinsic value of outstanding Restricted Units(1) $44.9 million $121.9 million Restricted Units vested and expected to vest 2,660,986 7,152,809 Weighted average remaining contractual term of Restricted Units vested and expectedto vest 0.8 years 1.3 years Aggregate intrinsic value of Restricted Units vested and expected to vest(1) $41.6 million $111.9 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, 2010 ($15.64) 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, 2010, unearned stock-based compensationexpense related to all unvested Restricted Units is $117.2 million, which will, based on expectations of future performance vestingcriteria, where applicable, be recognized over a weighted-average period of 1.7 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: 2010 2009 2008Weighted-average grant-date fair value per share $13.15 $11.39 $18.01 Total intrinsic value of shares vested (in millions) $91.3 $33.3 $55.5 96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. There wereno new grants of restricted stock in fiscal 2010 or 2009 and all shares were fully vested at September 30, 2009. The table belowsummarizes activity relating to Restricted Stock for fiscal 2008 and 2009: Number of Shares Weighted Underlying Average Grant Restricted Date Fair Stock Value Outstanding at October 1, 2007 1,195,902 $6.17 Granted 250,000 $15.89 Vested (820,832) $5.53 Outstanding at September 30, 2008 625,070 $10.90 Vested (625,070) $10.90 Outstanding at September 30, 2009 — $— The purchase price for vested Restricted Stock is $0.001 per share. A summary of weighted-average grant-date fair value andintrinsic value of Restricted Stock vested are as follows: 2010 2009 2008Weighted-average grant-date fair value per share N/A N/A $15.89 Total intrinsic value of shares vested (in millions) N/A $8.65 $16.85 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, including units released related to acquisitions, we have historically cancelled a portion of thecommon stock upon the release. In fiscal 2010, we withheld payroll taxes totaling $26.5 million ($22.0 million of cash paid) relating to1.7 million shares of common stock that were repurchased or cancelled. Based on our estimate of the Restricted Awards that will vest orbe released in fiscal 2011, and further assuming that one-third of these Restricted Awards would be repurchased or cancelled to satisfy theemployee’s withholding tax liability (such amount approximating the tax rate of our employees), we would have an obligation to pay cashrelating to approximately 1.9 million shares during fiscal 2011.1995 Employee Stock Purchase PlanOur 1995 Employee Stock Purchase Plan (“the Plan”), as amended and restated on January 29, 2010, authorizes the issuance of amaximum of 10,000,000 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, 2010, 4,596,836 shares were reserved for future issuance. A summary of the weighted-average grant-date fair value,shares issued and total stock-based compensation expense recognized related to the Plan are as follows: 2010 2009 2008Weighted-average grant-date fair value per share $3.80 $3.49 $5.09 Total shares issued (in millions) 1.0 1.2 0.7 Total stock-based compensation expense (in millions) $3.5 $3.7 $3.4 97Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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: 2010 2009 2008Dividend yield 0.0% 0.0% 0.0%Expected volatility 38.7% 62.1% 53.1%Average risk-free interest rate 0.2% 0.3% 2.1%Expected term (in years) 0.5 0.5 0.5 18. 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 office locations that were vacated by certain of theacquired companies prior to the acquisition date (Note 13). Additionally, certain of our lease obligations have been included in variousrestructuring charges (Note 14). The following table outlines our gross future minimum payments under all non-cancelable operatingleases as of September 30, 2010 (dollars in thousands): Operating Leases Under Other Contractual Year Ending September 30, Leases Restructuring Obligations Assumed Total 2011 $21,020 $3,126 $13,947 $38,093 2012 19,403 1,942 12,299 33,644 2013 17,401 932 2,323 20,656 2014 14,667 — 2,326 16,993 2015 14,094 — 2,329 16,423 Thereafter 33,013 — 965 33,978 Total $119,598 $6,000 $34,189 $159,787 At September 30, 2010, we have subleased certain office space that is included in the above table to third parties. Total subleaseincome under contractual terms is $13.7 million and ranges from approximately $1.3 million to $4.3 million on an annual basis throughFebruary 2016.Total rent expense charged to operations was approximately $20.5 million, $19.6 million and $15.2 million for the years endedSeptember 30, 2010, 2009 and 2008, 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.Vianix LLC has filed three legal actions against us, consisting of two breach of contract actions and a copyright infringement claim.We believe that our maximum potential exposure, specifically related to one of the breach of contract actions and the copyrightinfringement claim, is immaterial. It is too early for us to reach a conclusion as to98Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)the ultimate outcome or proposed settlement of these actions, or to estimate the potential loss that could result from a settlement or adversejudgment against us in the second breach of contact action. We have not accrued any settlement liability for these actions.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, agreed upon amount. In some cases our total liability under such provisions is unlimited. In many, but notall, cases, the term of the indemnity provision is perpetual. While the maximum potential amount of future payments we could berequired to make under all the indemnification provisions is unlimited, we believe the estimated fair value of these provisions is minimaldue to the low frequency with which 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.19. 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 on or after April 1, 2004, vest one-third of thecontribution annually over a three-year period. Our contributions to the 401(k) Plan totaled $3.3 million, $3.2 million and $2.9 millionfor fiscal 2010, 2009 and 2008, 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. These amounts in accumulated other comprehensive losswill be subsequently recognized as net periodic pension expense.99Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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.The following table shows the changes in fiscal 2010 and 2009 in the projected benefit obligation, plan assets and funded status ofthe defined benefit pension plans (dollars in thousands): Pension Benefits 2010 2009 Change in Benefit Obligations: Benefit obligation at beginning of period $22,850 $22,408 Service cost 5 — Interest cost 1,222 1,179 Actuarial loss 1,933 2,752 Currency exchange rate changes 48 (2,456)Benefits paid (991) (1,033)Benefit obligation at end of period 25,067 22,850 Change in Plan Assets: Fair value of plan assets, beginning of period 17,549 18,397 Actual return on plan assets 2,194 1,121 Employer contribution 843 958 Currency exchange rate changes 155 (1,894)Benefits paid (991) (1,033)Fair value of plan assets, end of period 19,750 17,549 Funded status at end of period $(5,317) $(5,301)The amounts recognized in our consolidated balance sheets consisted of the following (dollars in thousands): Pension Benefits 2010 2009 Other assets $506 $1,124 Other liabilities (5,823) (6,425)Net liability recognized $(5,317) $(5,301)The amounts recognized in accumulated other comprehensive loss as of September 30, 2010 consisted of the following (dollars inthousands): Pension BenefitsActuarial loss recognized in accumulated other comprehensive loss $(4,855)The following represents the amounts included in accumulated other comprehensive loss on the consolidated balance sheet as ofSeptember 30, 2010 that we expect to recognize in earnings during fiscal 2011 (dollars in thousands): Pension ExpenseActuarial loss $(255)100Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The projected benefit obligations for the two defined benefit pension plans was $25.1 million at September 30, 2010.Included in the table below are the amounts relating to our UK pension plan, which has accumulated benefit obligations andprojected benefit obligations in excess of plan assets (in thousands): Pension Benefits 2010 2009 Aggregate projected benefit obligations $21,939 $19,967 Aggregate accumulated benefit obligations 21,939 19,967 Aggregate fair value of plan assets 16,117 13,542 The components of net periodic benefit cost of the pension plans were as follows (dollars in thousands): Pension Benefits 2010 2009 Service cost $5 $— Interest cost 1,222 1,179 Expected return on plan assets (1,038) (1,058)Amortization of unrecognized loss 251 47 Net periodic pension cost $440 $168 Plan Assumptions:Weighted-average assumptions used in developing the net periodic benefit cost for the pension plans were as follows: Pension Benefits 2010 2009Discount rate 5.5% 6.1%Average compensation increase N/A(1) N/A(1)Expected rate of return on plan assets 6.2% 6.7%(1)Rate of compensation increase is not applicable as there are no active members in the plan.The weighted average discount rate used in developing the benefit obligations was 5.0% and 6.1% at September 30 2010 and 2009,respectively.Asset 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, 2010 and September 30, 2009, were as follows: Actual Target Asset Category 2010 2009 2010 2009 Equity securities 54% 62% 40% 58%Debt securities 46% 38% 60% 42%Total 100% 100% 100% 100%The plan administrators recently updated the asset allocation targets to reflect changes in the participant population and the expectedperiod that future benefits will become payable. The investments held by the plans will101Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)be rebalanced during the next fiscal year to reflect this updated target allocation. The weighted average expected long-term rate of return forthe plan assets is 6.2%. The expected long-term rate of return on plan assets is determined based on a variety of considerations, includingestablished asset allocation targets and expectations for those asset classes, historical returns of the plans’ assets and other marketconsiderations. We invest our pension assets with the objective of achieving a total rate of return, over the long term, sufficient to fundfuture pension obligations and to minimize future pension contribution requirements. All of the assets are invested in funds offered toinstitutional investors that are similar to mutual funds in that they provide diversification by holding various debt and equity securities.The fair value of total pension plan assets by major category at September 30, 2010 is as follows: September 30, 2010 Equity securities $10,728 Debt Securities 9,022 Total pension assets 19,750 The assets are all invested in funds which are not quoted on any active market and are valued based on the underlying debt andequity investments and their individual prices at any given time, and thus are classified as Level 2 within the fair value hierarchy asdefined in ASC 20 and described in Note 12.Employer Contributions:We expect to contribute $1.4 million to our pension plans in fiscal 2011. 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, 2010) 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 (dollars in thousands):Year Ending September 30, Pension Benefits 2011 $1,154 2012 1,175 2013 1,221 2014 1,242 2015 1,262 Thereafter 6,605 Total $12,659 102Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)20. Income TaxesThe components of income (loss) before income taxes are as follows (dollars in thousands): Year Ended September 30, 2010 2009 2008 Domestic $(15,543) $(1,549) $(30,434)Foreign 14,478 22,553 8,028 Income (loss) before income taxes $(1,065) $21,004 $(22,406)The components of the income tax provision (benefit) are as follows (dollars in thousands): Year Ended September 30, 2010 2009 2008 Current: Federal $(1,634) $1,119 $1,048 State 2,484 5,439 10,782 Foreign 13,442 8,115 2,233 14,292 14,673 14,063 Deferred: Federal 7,052 14,952 20,177 State 942 12,740 (20,796)Foreign (4,252) (1,974) 1,110 3,742 25,718 491 Provision for income taxes $18,034 $40,391 $14,554 A reconciliation of our effective tax rate to the statutory federal rate is as follows: 2010 2009 2008 Federal statutory tax rate 35.0% 35.0% 35.0%Stock-based compensation (298.9) 17.5 (30.1)Foreign taxes (228.4) (6.2) (13.8)Foreign benefit — refundable credits — — 24.9 State tax, net of federal benefit (287.1) 25.3 (48.2)State tax law enactment, net of federal benefit — 39.9 131.6 Nondeductible expenditures (47.8) 8.8 (9.3)Change in valuation allowance (958.8) 62.5 (163.4)Executive compensation (381.4) 7.6 (1.1)Federal credits, net — — 6.3 Other 474.1 1.9 3.1 Effective income tax rate (1,693.3)% 192.3% (65.0)%During fiscal 2010, tax benefits were recorded for the favorable settlements of a $1.1 million U.S. federal tax audit contingencyrelated to our acquisition of eCopy and a $1.0 million state tax penalty contingency related to our acquisition of escription. Additionally,we recorded a $1.1 million U.S. federal tax benefit related to certain tax loss103Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)carrybacks resulting from a tax law change and a $1.1 million tax benefit resulting from certain international research and developmentcredits.During fiscal 2009, the tax provision includes a charge of $8.0 million related to our election to treat the eScription acquisition as anasset purchase. Also included in the fiscal 2009 tax provision is a charge of $3.2 million as a result of the Massachusetts state tax lawenactment relating to the utilization of net operating losses.The cumulative amount of undistributed earnings of our foreign subsidiaries amounted to $77.0 million at September 30, 2010. 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.Deferred tax assets (liabilities) consist of the following at September 30, 2010 and 2009 (dollars in thousands): 2010 2009 Deferred tax assets: Net operating loss carryforwards $268,882 $225,660 Federal and state credit carryforwards 22,768 19,241 Capitalized research and development costs 23,673 26,351 Accrued expenses and other reserves 55,385 51,315 Deferred revenue 25,090 14,490 Deferred compensation 18,952 18,335 Depreciation — 2,955 Other 6,205 8,712 Total deferred tax assets 420,955 367,059 Valuation allowance for deferred tax assets (297,513) (224,597)Net deferred tax assets 123,442 142,462 Deferred tax liabilities: Depreciation (1,900) — Convertible debt (12,120) (15,131)Acquired intangibles (170,022) (180,148)Net deferred tax liabilities $(60,600) $(52,817)Reported as: Current deferred tax assets(a) $— $1,394 Long-term deferred tax assets(b) 3,131 3,749 Current deferred tax liabilities(c) — (1,614)Long-term deferred tax liability(d) (63,731) (56,346)Net deferred tax liabilities $(60,600) $(52,817)(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.104Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)As of September 30, 2010, our valuation allowance for U.S. net deferred tax assets totaled $186.2 million, which consists of$192.5 million in beginning allowance, plus a $3.7 million increase to income tax provision due to increases in net deferred tax assets infiscal 2010, a $9.5 million increase in valuation allowance resulting from goodwill and acquisition related adjustments and a$19.5 million decrease for an adjustment to the underlying deferred tax carrying balances.. A portion of the deferred tax liabilities arecreated resulting from the different treatment of goodwill for book and tax purposes which cannot offset deferred tax assets in determiningthe valuation allowance. As of September 30, 2010, our valuation allowance for foreign deferred tax assets totaled $111.3 million, whichconsists of $32.0 million in beginning allowance, plus a $6.7 million increase to income tax provision due to increases in net deferred taxassets in fiscal 2010 and a $72.6 million increase in valuation allowance resulting from goodwill and acquisition related adjustments.As of September 30, 2010 and 2009, $240.1 million and $164.3 million, respectively, of our valuation allowance is associated withtax assets arising from business combinations. When and if any of this valuation allowance is released, it will be recorded as a benefit inthe statement of operations.At September 30, 2010 and 2009, we had U.S. federal net operating loss carryforwards of $579.1 million and $600.6 million,respectively, of which $210.0 million and $186.7 million, respectively, relate to tax deductions from stock-based compensation whichwill be recorded as additional paid-in-capital when realized. At September 30, 2010 and 2009, we had state net operating losscarryforwards of $203.5 million and $170.2 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. At September 30, 2010 and 2009, we had foreign net operating loss carryforwards of $427.0 million and $127.3 million,respectively. These carryforwards will expire at various dates beginning in 2010 and extending through 2029, if not utilized.At September 30, 2010 and 2009, we had federal research and development carryforwards of $15.2 million and $13.0 million,respectively. At September 30, 2010 and 2009, we had state research and development credit carryforwards of $5.9 million and$6.9 million, respectively.Uncertain Tax PositionsEffective October 1, 2007, we adopted the provisions of ASC 740-10 (formerly referred to as FASB Interpretation No. 48(“FIN 48”)), and we began establishing reserves for tax uncertainties that reflect the use of the comprehensive model for the recognitionand measurement of uncertain tax positions. Under the comprehensive model, reserves are established when we have determined that it ismore likely than not that 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 the adoption of ASC 740-10, during fiscal 2008, we recognized an adjustment of $0.9 million in our liability forunrecognized tax benefits. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes.The aggregate changes in the balance of our gross unrecognized tax benefits were as follows: September 30, 2010 2009 Balance, beginning of year $12.1 $2.7 Increases for tax positions taken during current period 0.4 3.1 Increases for interest charges 0.8 0.5 Increases for acquisitions 1.0 6.8 Decreases for tax settlements (1.5) (1.0)Balance, at end of year $12.8 $12.1 105Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)As of September 30, 2010, $12.8 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 $1.7 million of such interest and penalties as ofSeptember 30, 2010.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 2007 through 2010.21. Segment and Geographic Information and Significant CustomersWe follow the provisions of ASC 280 (formerly referred to as SFAS No. 131, Disclosures About Segments of an Enterprise andRelated Information), which establishes standards for reporting information about operating segments. ASC 280 also establishedstandards for disclosures about products, services and geographic areas. Operating segments are defined as components of an enterprisefor which separate financial information is available and evaluated regularly by the chief operating decision maker in deciding how toallocate resources and in assessing performance. Our chief operating decision maker (“CODM”) is the Chief Executive Officer of theCompany.We have several customer-facing market groups that oversee the core markets where we conduct business. These groups are referredto as Healthcare, Mobile and Consumer, Enterprise and Imaging. These groups do not directly manage centralized or shared resources orthe allocation decisions regarding the activities related to these functions, which include sales and sales operations, certain research anddevelopment initiatives, business development and all general and administrative activities. Our CODM oversees these groups as well aseach of the functions that provide the shared and centralized activities noted above. To manage the business, allocate resources and assessperformance, the CODM primarily reviews revenue data by market group, while reviewing gross margins, operating margins, and othermeasures of income or loss on a consolidated basis. Thus, we have determined that we operate in one segment.The following table presents revenue information for our four core markets (dollars in thousands): Fiscal Fiscal Fiscal 2010 2009 2008 Healthcare $444,593 $369,406 $289,194 Mobile and Consumer 297,335 209,128 243,601 Enterprise 293,940 302,155 255,734 Imaging 83,080 69,663 79,933 Total Revenue $1,118,948 $950,352 $868,462 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 (dollars in thousands): 2010 2009 2008 United States $802,049 $706,858 $669,239 International 316,899 243,494 199,223 Total $1,118,948 $950,352 $868,462 106Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)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 (dollars in thousands): September 30, September 30, 2010 2009 United States $2,479,952 $2,395,923 International 448,105 307,864 Total $2,928,057 $2,703,787 22. 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. We paid WilsonSonsini Goodrich & Rosati $3.4 million, $8.7 million and $13.1 million for fiscal 2010, 2009 and 2008, respectively for professionalservices. As of September 30, 2010 and 2009, we had $1.4 million and $1.7 million, respectively, included in accounts payable andaccrued expenses to Wilson Sonsini Goodrich & Rosati.23. Quarterly Data (Unaudited)The following information has been derived from unaudited consolidated financial statements that, in the opinion of management,include all recurring adjustments necessary for a fair statement of such information (in thousands, except per share amounts): First Second Third Fourth Quarter Quarter Quarter Quarter Year2010 Total revenue $262,977 $273,005 $273,203 $309,763 $1,118,948 Gross margin $169,382 $169,405 $171,425 $199,366 $709,578 Net income (loss) $(4,278) $(15,396) $(1,530) $2,105 $(19,099)Net income (loss) per share: Basic $(0.02) $(0.05) $(0.01) $0.01 $(0.07)Diluted $(0.02) $(0.05) $(0.01) $0.01 $(0.07)Weighted average common sharesoutstanding: Basic 279,068 284,994 291,610 293,971 287,412 Diluted 279,068 284,994 291,610 307,382 287,412 107Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued) 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) $(26,318) $5,280 $(2,815) $4,466 $(19,387)Net income (loss) per share: Basic $(0.11) $0.02 $(0.01) $0.02 $(0.08)Diluted $(0.11) $0.02 $(0.01) $0.02 $(0.08)Weighted average common shares outstanding: Basic 236,237 250,656 260,750 266,932 253,644 Diluted 236,237 269,187 260,750 285,948 253,644 108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, 2010, 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, 2010, utilizing thecriteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”). The internal controls over financial reporting for SpinVox Limited, which we acquired on December 30, 2009,were excluded from management’s assessment. SpinVox Limited constituted approximately 0.6% of our consolidated assets as ofSeptember 30, 2010 and approximately 2.2% of our consolidated revenue for the fiscal year ended September 30, 2010. Based on theresults of this assessment, management (including our Chief Executive Officer and our Chief Financial Officer) has concluded that, as ofSeptember 30, 2010, 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, 2010 issued byBDO USA, LLP, an independent registered public accounting firm, appears in Item 8 of this Annual Report on Form 10-K.109Table of ContentsChanges in Internal Controls Over Financial ReportingThere have been no changes in our internal controls over financial reporting during the fourth quarter of fiscal 2010 that havematerially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.Item 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 the110Table of Contentstransaction. 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.The 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.111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 29, 2010 /s/ Paul A. Ricci Paul A. Ricci, Chief Executive Officer andChairman of the Board(Principal Executive Officer) Date: November 29, 2010 /s/ Thomas L. BeaudoinThomas L. Beaudoin, Executive Vice President andChief Financial Officer(Principal Financial Officer) Date: November 29, 2010 /s/ Daniel D. TempestaDaniel D. Tempesta, Chief Accounting Officer andCorporate Controller(Principal Accounting Officer) Date: November 29, 2010 /s/ Robert J. FrankenbergRobert J. Frankenberg, Director Date: November 29, 2010 /s/ Patrick T. HackettPatrick T. Hackett, Director Date: November 29, 2010 /s/ William H. JanewayWilliam H. Janeway, Director Date: November 29, 2010 /s/ Mark R. LaretMark R. Laret, Director Date: November 29, 2010 /s/ Katharine A. MartinKatharine A. Martin, Director Date: November 29, 2010 /s/ Mark MyersMark Myers, Director Date: November 29, 2010 /s/ Philip QuigleyPhilip Quigley, Director Date: November 29, 2010 /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 Agreement for the acquisition of the entire issuedshare capital of SpinVox Limited, the substitutionof Foxtrot Acquisition Limited as the issuer of adebt instrument issued by SpinVox Limited, andthe release and cancellation of such debt instrumentin consideration of shares in Foxtrot AcquisitionLimited dated December 29, 2009 8-K 0-27038 2.1 1/5/2010 2.2 Agreement for the acquisition of shares in FoxtrotAcquisition Limited and the payment of certainsums to the Mezzanine Lenders and other partiesdated December 29, 2009 8-K 0-27038 2.2 1/5/2010 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 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 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 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 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 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 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 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 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 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 10.37 Letter, dated March 29, 2010, to Janet Dillioneregarding certain employment matters. 10-Q 0-27038 10.1 8/9/2010 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 USA, 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Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 101 The following materials from NuanceCommunications, Inc.’s Annual Report onForm 10-K for the fiscal year ended September 30,2010, formatted in XBRL (Extensible BusinessReporting Language): (i) the ConsolidatedStatements of Operations, (ii) the ConsolidatedBalance Sheets, (iii) the Consolidated Statementsof Stockholders’ Equity and ComprehensiveLoss, (iv) the Consolidated Statements of CashFlows, and (v) Notes to Consolidated FinancialStatements. X*Denotes management compensatory plan or arrangementExhibit 21.1Subsidiary Name Jurisdiction TypeART Advanced Recognition Technologies, Inc. Delaware Domestic Caere Corporation Delaware Domestic Dictaphone Corporation Delaware Domestic eScription, Inc. Delaware Domestic eCopy, LLC. Delaware Domestic Focus Infomatics, Inc. Delaware Domestic Keisense, Inc. Delaware Domestic Language and Computing Inc. Delaware Domestic Locus Dialogue Technologies USA, Inc. Delaware Domestic MacSpeech LLC Delaware Domestic Medford Acquisition LLC Delaware Domestic Nuance Communications International, Inc. Delaware Domestic Nuance Communications LLC Delaware Domestic Nuance Services, Inc. Delaware Domestic OSi LLC Delaware Domestic Phonetic Systems Inc. Delaware Domestic Rhetorical, Inc. Delaware Domestic SNAPin Software LLC Delaware Domestic SpeechWorks International, Inc. Delaware Domestic SpinVox Incorporated Delaware Domestic Viecore LLC Delaware Domestic Viecore Federal Systems Division, Inc. Delaware Domestic Voice Signal Technologies, Inc. Delaware Domestic X-Solutions North America Inc. Delaware Domestic Zi Holding Corporation Delaware Domestic Zi Corporation of America, Inc. Nevada Domestic Tegic Communications, Inc. Washington Domestic Encompass Medical Transcription, Inc. Wisconsin Domestic Nuance Communications Australia Pty. Ltd. Australia International ITA Services Pty Ltd. Australia International Information Technologies Australia Pty Ltd. Australia International OTE Pty Limited Australia International Nuance Communications Austria GmbH Austria International SpeechMagic Holdings GmbH Austria International Multi-Corp International Ltd. Barbados International Language and Computing N.V. Belgium International Nuance Communications International BVBA Belgium International Zi (Bermuda) Corporation Bermuda International Nuance Communications Ltd. Brazil International BlueStar Options Inc. British Virgin Islands International BlueStar Resources Limited British Virgin Islands International SpeechWorks BVI Ltd. British Virgin Islands International 845162 Alberta Ltd. Canada International 1448451 Ontario Inc. Canada International Nuance Acquisition ULC Canada International Nuance Communications Canada, Inc. Canada International Zi Corporation Canada International Zi Corporation of Canada, Inc. Canada International  Subsidiary Name Jurisdiction TypeFoxtrot Acquisition II Limited Cayman Islands International Foxtrot Acquisition Limited Cayman Islands International Huayu Zi Software Technology (Beijing) Co., Ltd. China International Nuance Software Technology (Beijing) Co., Ltd. China International Nuance Communications Finland OY Finland International Voice Signal Technologies Europe OY Finland International Nuance Communications France Sarl France International Dictaphone Deutschland GmbH Germany International Nuance Communications Aachen GmbH Germany International Nuance Communications Germany GmbH Germany International Nuance Communications Healthcare Germany GmbH Germany International Asia Translation & Telecommunications Limited Hong Kong SAR International Huayu Zi Software Technology Limited Hong Kong SAR International Telecom Technology Corporation Limited Hong Kong SAR International Zi Corporation (H.K.) Limited Hong Kong SAR International Zi Corporation of Hong Kong Limited Hong Kong SAR International Nuance Communications Hong Kong Limited Hong Kong SAR International Nuance Recognita Corp. Hungary International FocusMT India Private Limited India International Nuance India Pvt. Ltd. India International Nuance Communications Israel, Ltd. Israel International Phonetic Systems Ltd. Israel International Nuance Communications Italy Srl Italy International Nuance Communications Japan K.K. Japan International Voice Signal K.K. Japan International Nuance Communications Netherlands B.V. Netherlands International X-Solutions Group B.V. Netherlands International X-Solutions International B.V. Netherlands International Zeros Solutions B.V. Netherlands International Aangel Processing Limited New Zealand International Casseggers Holdings Limited New Zealand International Rhetorical Group plc. Scotland International Rhetorical Systems Limited Scotland International Nuance Communications Asia Pacific Pte. Ltd. Singapore International Nuance Communications Iberica SA Spain International Nuance Communications Korea Ltd. South Korea International Nuance Communications Sweden, A.B. Sweden International Zi Decuma AB Sweden International Nuance Communications Taiwan Taiwan International Dictaphone Company Limited United Kingdom International Dictaphone International Limited United Kingdom International eCopy Ltd. United Kingdom International Nuance Communications UK Limited United Kingdom International SpinVox Limited United Kingdom International EXHIBIT 23.1Consent of Independent Registered Public Accounting FirmNuance Communications, Inc.Burlington, MassachusettsWe 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, 333-04131, and 333-164955) of Nuance Communications, Inc. of our reportsdated November 29, 2010, relating to the consolidated financial statements and the effectiveness of Nuance Communications, Inc.’sinternal control over financial reporting, which appears in this Form 10-K./s/ BDO USA, LLPBoston, MassachusettsNovember 29, 2010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 factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleading withrespect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in allmaterial respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in thisreport;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange ActRules 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 underour supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made knownto us by others within those 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 bedesigned under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation offinancial statements for external 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 conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on suchevaluation; andd) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materiallyaffected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financialreporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalentfunctions):a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financialinformation; andb) any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal controls over financial reporting. By: /s/ Paul A. RicciPaul A. RicciChief Executive Officer and Chairman of the BoardNovember 29, 2010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 factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleading withrespect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in allmaterial respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in thisreport;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange ActRules 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 underour supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made knownto us by others within those 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 bedesigned under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation offinancial statements for external 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 conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on suchevaluation; andd) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materiallyaffected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financialreporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalentfunctions):a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financialinformation; andb) any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal controls over financial reporting. By: /s/ Thomas L. BeaudoinThomas L. BeaudoinExecutive Vice President and Chief Financial OfficerNovember 29, 2010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 of2002, that the Annual Report of Nuance Communications, Inc. on Form 10-K for the period ended September 30, 2010 fully complieswith the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such AnnualReport on Form 10-K fairly presents in all material respects the financial condition and results of operations of Nuance Communications,Inc. By: /s/ Paul A. RicciPaul A. RicciChief Executive Officer and Chairman of the BoardNovember 29, 2010I, Thomas L. Beaudoin, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002, that the Annual Report of Nuance Communications, Inc. on Form 10-K for the period ended September 30, 2010 fullycomplies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in suchAnnual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of NuanceCommunications, Inc. By: /s/ Thomas L. BeaudoinThomas L. BeaudoinExecutive Vice President and Chief Financial OfficerNovember 29, 2010

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