Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _____________________________________________
Form 10-Q
 _____________________________________________
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2017
Or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 000-27038
 _____________________________________________
NUANCE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
 _____________________________________________
Delaware
 
94-3156479
(State or Other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
1 Wayside Road
Burlington, Massachusetts
 
01803
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:
(781) 565-5000
 _____________________________________________
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 Act of 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 to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File 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 for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
Accelerated filer
¨

Emerging growth company
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
 
Smaller reporting company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.      ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

The number of shares of the Registrant’s Common Stock, outstanding as of January 31, 2018 was 293,699,330.

 




NUANCE COMMUNICATIONS, INC.
TABLE OF CONTENTS
 
 
 
 
 
Page
Item 1.
 
Condensed Consolidated Financial Statements (unaudited):
 
 
 
 
Consolidated Statements of Operations for the three months ended December 31, 2017 and 2016
 
 
 
Consolidated Statements of Comprehensive Income (Loss) for the three months ended December 31, 2017 and 2016

 
 
 
Consolidated Balance Sheets at December 31, 2017 and September 30, 2017
 
 
 
Consolidated Statements of Cash Flows for the three months ended December 31, 2017 and 2016
 
 
 
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
 
Item 1.
 
 
Item 1A.
 
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
Item 5.
 
 
Item 6.
 
 
 
 
Certifications
 
 



Table of Contents



NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

 
 
Three Months Ended December 31,
 
 
2017
 
2016
 
(Unaudited)
(In thousands, except per share amounts)
Revenues:
 
 
 
 
Professional services and hosting
 
$
259,027

 
$
253,417

Product and licensing
 
161,810

 
151,752

Maintenance and support
 
80,808

 
82,489

Total revenues
 
501,645

 
487,658

Cost of revenues:
 
 
 
 
Professional services and hosting
 
172,528

 
164,892

Product and licensing
 
19,069

 
18,378

Maintenance and support
 
14,241

 
13,598

Amortization of intangible assets
 
15,356

 
15,542

Total cost of revenues
 
221,194

 
212,410

Gross profit
 
280,451

 
275,248

Operating expenses:
 
 
 
 
Research and development
 
73,366

 
66,322

Sales and marketing
 
101,960

 
101,516

General and administrative
 
52,892

 
39,790

Amortization of intangible assets
 
23,064

 
27,859

Acquisition-related costs, net
 
5,561

 
9,026

Restructuring and other charges, net
 
14,801

 
6,703

Total operating expenses
 
271,644

 
251,216

Income from operations
 
8,807

 
24,032

Other (expense) income:
 
 
 
 
Interest income
 
2,192

 
1,023

Interest expense
 
(36,070
)
 
(38,021
)
Other expense, net
 
(222
)
 
(610
)
Loss before income taxes
 
(25,293
)
 
(13,576
)
(Benefit) provision for income taxes
 
(78,521
)
 
10,353

Net income (loss)
 
$
53,228

 
$
(23,929
)
Net income (loss) per share:
 
 
 
 
Basic
 
$
0.18

 
$
(0.08
)
Diluted
 
$
0.18

 
$
(0.08
)
Weighted average common shares outstanding:
 
 
 
 
Basic
 
291,367

 
288,953

Diluted
 
295,995

 
288,953









See accompanying notes.

1

Table of Contents


NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
Three Months Ended December 31,
 
2017
 
2016
 
(Unaudited)
 
(In thousands)
Net income (loss)
$
53,228

 
$
(23,929
)
Other comprehensive income (loss):
 
 
 
Foreign currency translation adjustment
1,515

 
(30,566
)
Pension adjustments
116

 
118

Unrealized loss on marketable securities
(277
)
 
(31
)
Total other comprehensive income (loss), net
1,354

 
(30,479
)
Comprehensive income (loss)
$
54,582

 
$
(54,408
)










































See accompanying notes.

2

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS 
 
December 31,
2017
 
September 30,
2017
 
(Unaudited)
 
(In thousands, except per
share amounts)
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
398,461

 
$
592,299

Marketable securities
112,044

 
251,981

Accounts receivable, less allowances for doubtful accounts of $13,013 and $14,333
432,552

 
395,392

Prepaid expenses and other current assets
105,411

 
88,269

Total current assets
1,048,468

 
1,327,941

Marketable securities
42,115

 
29,844

Land, building and equipment, net
172,748

 
176,548

Goodwill
3,600,768

 
3,590,608

Intangible assets, net
627,556

 
664,474

Other assets
145,902

 
142,508

Total assets
$
5,637,557

 
$
5,931,923

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
Current portion of long-term debt
$

 
$
376,121

Contingent and deferred acquisition payments
15,506

 
28,860

Accounts payable
82,674

 
94,604

Accrued expenses and other current liabilities
193,406

 
245,901

Deferred revenue
427,541

 
366,042

Total current liabilities
719,127

 
1,111,528

Long-term debt
2,299,594

 
2,241,283

Deferred revenue, net of current portion
453,106

 
423,929

Deferred tax liabilities
35,769

 
131,320

Other liabilities
104,830

 
92,481

Total liabilities
3,612,426

 
4,000,541

 
 
 
 
Commitments and contingencies (Note 15)

 

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock, $0.001 par value per share; 560,000 shares authorized; 297,243 and 293,938 shares issued and 293,492 and 290,187 shares outstanding, respectively
297

 
294

Additional paid-in capital
2,669,291

 
2,629,245

Treasury stock, at cost (3,751 shares)
(16,788
)
 
(16,788
)
Accumulated other comprehensive loss
(99,988
)
 
(101,342
)
Accumulated deficit
(527,681
)
 
(580,027
)
Total stockholders’ equity
2,025,131

 
1,931,382

Total liabilities and stockholders’ equity
$
5,637,557

 
$
5,931,923







See accompanying notes.

3

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Three Months Ended December 31,
 
2017
 
2016
 
(Unaudited)
(In thousands)
Cash flows from operating activities:
 
 
 
Net income (loss)
$
53,228

 
$
(23,929
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
54,315

 
58,006

Stock-based compensation
37,986

 
39,130

Non-cash interest expense
13,341

 
13,039

Deferred tax (benefit) provision
(97,226
)
 
2,006

Other
631

 
1,856

Changes in operating assets and liabilities, excluding effects of acquisitions:
 
 
 
Accounts receivable
(36,340
)
 
(9,713
)
Prepaid expenses and other assets
(18,972
)
 
(15,999
)
Accounts payable
(11,856
)
 
(21,244
)
Accrued expenses and other liabilities
3,099

 
5,841

Deferred revenue
87,899

 
75,907

Net cash provided by operating activities
86,105

 
124,900

Cash flows from investing activities:
 
 
 
Capital expenditures
(12,543
)
 
(11,399
)
Payments for business and asset acquisitions, net of cash acquired
(8,648
)
 
(22,949
)
Purchases of marketable securities and other investments
(32,447
)
 
(72,797
)
Proceeds from sales and maturities of marketable securities and other investments
159,805

 
10,105

Net cash provided by (used in) investing activities
106,167

 
(97,040
)
Cash flows from financing activities:
 
 
 
Payments and redemption of debt
(331,172
)
 

Proceeds from issuance of long-term debt, net of issuance costs

 
495,000

Acquisition payments with extended payment terms
(16,880
)
 

Net payments on other long-term liabilities
(65
)
 
(87
)
Proceeds from issuance of common stock from employee stock plans
6

 
45

Cash used to net share settle employee equity awards
(38,617
)
 
(40,360
)
Net cash (used in) provided by financing activities
(386,728
)
 
454,598

Effects of exchange rate changes on cash and cash equivalents
618

 
(2,471
)
Net (decrease) increase in cash and cash equivalents
(193,838
)
 
479,987

Cash and cash equivalents at beginning of period
592,299

 
481,620

Cash and cash equivalents at end of period
$
398,461

 
$
961,607
















See accompanying notes.

4

Table of Contents
NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1. Organization and Presentation
The condensed consolidated financial statements include the accounts of Nuance Communications, Inc. (“Nuance”, “we”, "our", or “the Company”) and our wholly-owned subsidiaries. We prepared the unaudited interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (the “U.S.” or the "United States") and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The condensed consolidated financial statements reflect all normal and recurring adjustments that, in our opinion, are necessary to present fairly our financial position, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts and classifications of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period.
Although we believe the disclosures included herein are adequate to ensure that the condensed consolidated financial statements are fairly presented, certain information and footnote disclosures to the financial statements have been condensed or omitted in accordance with the rules and regulations of the SEC. Accordingly, the condensed consolidated financial statements and the footnotes included herein should be read in conjunction with the audited financial statements and the footnotes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017. The results of operations for the three months ended December 31, 2017 and 2016, are not necessarily indicative of the results for the entire fiscal year or any future period.
2. Summary of Significant Accounting Policies
Recently Adopted Accounting Standards
In October 2016, the FASB issued ASU 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory" ("ASU 2016-16"), which requires income tax consequences of inter-company transfers of assets other than inventory to be recognized when the transfer occurs. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. We early adopted the guidance during the first quarter of fiscal year 2018. As a result, deferred tax liabilities of $0.9 million arising from inter-company transfers in prior years were recognized and recorded against the beginning balance of accumulated deficit in the first quarter of fiscal year 2018. The adoption of the guidance does not have a material impact on our consolidated financial statements for any period presented.
Recently Issued Accounting Standards
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" ("ASU 2016-15"), which is effective for fiscal years beginning after December 15, 2017 and the interim periods therein, with early adoption permitted. The guidance requires cash flows with multiple characteristics to be classified using a three-step process, including (i) determining whether explicit guidance is applicable, (ii) separating each identifiable source or use of cash flows, and (iii) determining the predominant source or use of cash flows when the source or use of cash flows cannot be separately identifiable. We are still evaluating the impact of the guidance on our consolidated financial statement.
In February 2016, the FASB issued ASU No. 2016-02, "Leases" ("ASU 2016-02"). ASU 2016-02 requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing, and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for us in the first quarter of fiscal year 2020, and early application is permitted. We are currently evaluating the impact of our pending adoption of ASU 2016-02 on our consolidated financial statements, and we currently expect that most of our operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon our adoption of ASU 2016-02, which will increase our total assets and total liabilities that we report relative to such amounts prior to adoption.
In January 2016, the FASB issued ASU No. 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities" ("ASU 2016-01"). ASU 2016-01 amends the guidance on the classification and measurement of financial instruments. Although ASU 2016-01 retains many current requirements, it significantly revises accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. ASU 2016-01 also amends certain disclosure requirements associated with the fair value of financial instruments and is effective for us in the first quarter of fiscal year 2019. Based on the composition of our investment portfolio, we do not believe the adoption of ASU 2016-01 will have a material impact on our consolidated financial statements.

5


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers: Topic 606" ("ASU 2014-09"), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 permits two methods of adoption: (i) retrospective to each prior reporting period presented; or (ii) retrospective with the cumulative effect of initially applying the guidance recognized at the date of initial application. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date of the new revenue standard for periods beginning after December 15, 2016 to December 15, 2017, with early adoption permitted but not earlier than the original effective date.  Accordingly, the updated standard is effective for us in the first quarter of fiscal 2019 and we do not plan to early adopt. In the first quarter of fiscal 2017, we commenced a project to assess the potential impact of the new standard on our consolidated financial statements and related disclosures. This project also includes the assessment and enhancement of our internal processes and systems to address the new standard. While we are continuing to assess all potential impacts of the new standard, we currently believe the most significant impact relates to our accounting for arrangements that include term-based software licenses bundled with maintenance and support. Under current GAAP, the revenue attributable to these software licenses is recognized ratably over the term of the arrangement because vendor-specific objective evidence ("VSOE") does not exist for the undelivered maintenance and support element as it is not sold separately. The requirement to have VSOE for undelivered elements to enable the separation of revenue for the delivered software licenses is eliminated under the new standard. Accordingly, under the new standard we will be required to recognize as revenue a portion of the arrangement fee upon delivery of the software license. While we currently expect revenue related to our professional services and cloud offerings to remain substantially unchanged, we are still in the process of evaluating the impact of the new standard on these arrangements. We plan to adopt this guidance beginning on October 1, 2018 and apply the cumulative catch-up transition method, with a cumulative adjustment to retained earnings as opposed to retrospectively adjusting prior periods.
3. Business Acquisitions
We continue to expand our solutions and integrate our technologies in new offerings through acquisitions. A summary of our acquisition activities for the three months ended December 31, 2017 and December 31, 2016 is as follows:
Fiscal Year 2018
In the first quarter of fiscal year 2018, we completed an acquisition in our Healthcare segment for a total cash consideration of $8.7 million and contingent payments at fair value of $0.5 million. As a result, we recognized goodwill of $6.8 million, and other intangible assets of $2.0 million, with a weighted average life of 2.0 years. The acquisition does not have a material impact on our condensed consolidated financial statements for the period.
Fiscal Year 2017
In the first quarter of fiscal year 2017, we completed several acquisitions in our Enterprise and Healthcare segments for a total cash consideration of $24.2 million and contingent payments at fair value of $1.7 million. As a result, we recognized goodwill of $15.7 million, and other intangible assets of $10.4 million, with a weighted average life of 6.0 years. Such acquisitions were not significant individually or in the aggregate.
Acquisition-Related Costs, net
Acquisition-related costs include costs related to business acquisitions. These costs consist of (i) transition and integration costs, including retention payments, transitional employee costs and earn-out payments, and other costs related to integration activities; (ii) professional service fees, including financial advisory, legal, accounting, and other outside services incurred in connection with acquisition activities, and disputes and regulatory matters related to acquired entities; and (iii) fair value adjustments to acquisition-related contingencies.

6


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of acquisition-related costs, net is as follows (dollars in thousands):
 
Three Months Ended December 31,
2017
 
2016
Transition and integration costs
$
4,062

 
$
3,710

Professional service fees
511

 
5,017

Acquisition-related adjustments
988

 
299

Total
$
5,561

 
$
9,026

4. Goodwill and Intangible Assets
The changes in the carrying amount of goodwill and intangible assets for the three months ended December 31, 2017 are as follows (dollars in thousands): 
 
Goodwill
 
Intangible
Assets
Balance at September 30, 2017
$
3,590,608

 
$
664,474

Acquisitions (Note 3)
6,790

 
2,000

Purchase accounting adjustments
(348
)
 

Amortization

 
(38,420
)
Effect of foreign currency translation
3,718

 
(498
)
Balance at December 31, 2017
$
3,600,768

 
$
627,556

5. Financial Instruments and Hedging Activities
Derivatives Not Designated as Hedges
Forward Currency Contracts
We utilize foreign currency forward contracts to mitigate the risks associated with changes in foreign currency exchange rates. Generally, we enter into such contracts for less than 90 days and have no cash requirements until maturity. At December 31, 2017 and September 30, 2017, we had outstanding contracts with a total notional value of $82.4 million and $69.0 million, respectively.
We did not designate any forward contracts as hedging instruments for the three months ended December 31, 2017 or 2016. Therefore, changes in fair value of foreign currency forward contracts were recognized within other expense, net in our condensed consolidated statements of operations. The cash flows related to the settlement of forward contracts not designated as hedging instruments are included in cash flows from investing activities within our consolidated statement of cash flows.
A summary of the derivative instruments as of December 31, 2017 and September 30, 2017 is as follows (dollars in thousands):
Derivatives Not Designated as Hedges:
 
Balance Sheet Classification
 
Fair Value
 
December 31,
2017
 
September 30,
2017
Foreign currency forward contracts
 
Prepaid expenses and other current assets
 
$
535

 
$
220

Foreign currency forward contracts
 
Accrued expenses and other current liabilities
 
(65
)
 
(373
)

A summary of loss related to the derivative instruments for the three months ended December 31, 2017 and 2016 is as follows (dollars in thousands):
 
 
 
 
Three Months Ended December 31,
Derivatives Not Designated as Hedges
 
Classification of Loss Recognized in Income
 
2017
 
2016
Foreign currency forward contracts
 
Other expense, net
 
$
(397
)
 
$
(11,615
)


7


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6. Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Valuation techniques must maximize the use of observable inputs and minimize the use of unobservable inputs. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance.
The determination of the applicable level within the hierarchy of a particular financial asset or liability depends on the lowest level of inputs that are significant to the fair value measurement as of the measurement date as follows:
Level 1: Quoted prices for identical assets or liabilities in active markets.
Level 2: Observable inputs other than those described as Level 1.
Level 3: Unobservable inputs that are supportable by little or no market activities and are based on significant assumptions and estimates.
Assets and liabilities measured at fair value on a recurring basis at December 31, 2017 and September 30, 2017 consisted of the following (dollars in thousands):
 
December 31, 2017
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds(a)
$
245,036

 
$

 
$

 
$
245,036

Time deposits(b)

 
99,774

 

 
99,774

Commercial paper, $38,069 at cost(b)

 
38,182

 

 
38,182

Corporate notes and bonds, $83,827 at cost(b)

 
83,532

 

 
83,532

Foreign currency exchange contracts(b)

 
535

 

 
535

Total assets at fair value
$
245,036

 
$
222,023

 
$

 
$
467,059

Liabilities:
 
 
 
 
 
 
 
Foreign currency exchange contracts(b)
$

 
$
(65
)
 
$

 
$
(65
)
Contingent acquisition payments(c)

 

 
(10,431
)
 
(10,431
)
Total liabilities at fair value
$

 
$
(65
)
 
$
(10,431
)
 
$
(10,496
)

 
September 30, 2017
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds(a)
$
381,899

 
$

 
$

 
$
381,899

Time deposits(b)

 
85,570

 

 
85,570

Commercial paper, $41,805 at cost(b)

 
41,968

 

 
41,968

Corporate notes and bonds, $74,150 at cost(b)

 
74,067

 

 
74,067

Foreign currency exchange contracts(b)

 
220

 

 
220

Total assets at fair value
$
381,899

 
$
201,825

 
$

 
$
583,724

Liabilities:
 
 
 
 
 
 
 
Foreign currency exchange contracts(b)
$

 
$
(373
)
 
$

 
$
(373
)
Contingent acquisition payments(c)

 

 
(8,648
)
 
(8,648
)
Total liabilities at fair value
$

 
$
(373
)
 
$
(8,648
)
 
$
(9,021
)
 
(a) 
Money market funds and time deposits with original maturity of 90 days or less are included within cash and cash equivalents in the consolidated balance sheets, are valued at quoted market prices in active markets.
(b) 
Time deposits, commercial paper, corporate notes and bonds, and foreign currency exchange contracts are recorded at fair market values, which are determined based on the most recent observable inputs for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable. Time deposits are generally for terms of one year

8


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

or less. Commercial paper and corporate notes and bonds generally mature within three years and have a weighted average maturity of 0.54 years as of December 31, 2017 and 0.72 years as of September 30, 2017.
(c) 
The fair values of our contingent consideration arrangements were determined using either the option pricing model with Monte Carlo simulation or probability-weighted discounted cash flow method.

As of September 30, 2017, $80.2 million of debt securities included within marketable securities were designated as held-to-maturity investments, which had a weighted average maturity of 0.27 years and an estimated fair value of $80.4 million based on Level 2 measurements. No debt securities were designated as held-to-maturity investments as of December 31, 2017.
The estimated fair value of our long-term debt approximated $2,627.2 million (face value $2,587.0 million) and $2,930.9 million (face value $2,918.1 million) as of December 31, 2017 and September 30, 2017, respectively, based on Level 2 measurements. The fair value of each borrowing was estimated using the averages of the bid and ask trading quotes at each respective reporting date. There was no balance outstanding under our revolving credit agreement as of December 31, 2017 or September 30, 2017.
Additionally, contingent acquisition payments are recorded at fair values upon the acquisition, and remeasured in subsequent reporting periods with the changes in fair values recorded within acquisition-related costs, net. Such payments are contingent upon the achievement of specified performance targets and are valued using the option pricing model with Monte Carlo simulation or the probability-weighted discounted cash flow model.
The following table provides a summary of changes in the aggregate fair value of the contingent acquisition payments for the three months ended December 31, 2017 and 2016 (dollars in thousands):
 
Three Months Ended December 31,
2017
 
2016
Balance at beginning of period
$
8,648

 
$
8,240

Earn-out liabilities established at time of acquisition
500

 
1,653

Payments and foreign currency translation
(17
)
 
(1,498
)
Adjustments to fair value included in acquisition-related costs, net
1,300

 
566

Balance at end of period
$
10,431

 
$
8,961

Contingent acquisition payments are to be made in periods through fiscal year 2019. As of December 31, 2017, the maximum amount payable based on the agreements was $25.1 million if the specified performance targets are achieved.
7. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following (dollars in thousands): 
 
December 31,
2017
 
September 30,
2017
Compensation
$
103,991

 
$
159,951

Cost of revenue related liabilities
22,066

 
20,124

Accrued interest payable
21,733

 
26,285

Consulting and professional fees
19,274

 
12,649

Facilities related liabilities
5,540

 
7,158

Sales and marketing incentives
4,190

 
3,655

Sales and other taxes payable
3,190

 
3,125

Other
13,422

 
12,954

Total
$
193,406

 
$
245,901

8. Deferred Revenue
Deferred maintenance revenue consists of prepaid fees received for post-contract customer support for our products, including telephone support and the right to receive unspecified upgrades/updates on a when-and-if-available basis. Unearned revenue includes fees for up-front setup of the service environment; fees charged for on-demand service; certain software arrangements for which we do not have fair value of post-contract customer support, resulting in ratable revenue recognition for the entire arrangement on a straight-line basis; and fees in excess of estimated earnings on percentage-of-completion service contracts.

9


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Deferred revenue consisted of the following (dollars in thousands): 
 
December 31,
2017
 
September 30,
2017
Current liabilities:
 
 
 
Deferred maintenance revenue
$
171,980

 
$
162,958

Unearned revenue
255,561

 
203,084

Total current deferred revenue
$
427,541

 
$
366,042

Long-term liabilities:
 
 
 
Deferred maintenance revenue
$
62,494

 
$
60,298

Unearned revenue
390,612

 
363,631

Total long-term deferred revenue
$
453,106

 
$
423,929

9. Restructuring and Other Charges, net
Restructuring and other charges, net include restructuring expenses together with other charges that are unusual in nature, are the result of unplanned events, or arise outside of the ordinary course of our business.
The following table sets forth accrual activity relating to restructuring reserves for the three months ended December 31, 2017 (dollars in thousands): 
 
Personnel
 
Facilities
 
Total
Balance at September 30, 2017
$
1,546

 
$
9,159

 
$
10,705

Restructuring charges, net
4,883

 
1,665

 
6,548

Non-cash adjustment

 
(298
)
 
(298
)
Cash payments
(5,392
)
 
(1,753
)
 
(7,145
)
Balance at December 31, 2017
$
1,037

 
$
8,773

 
$
9,810

While restructuring and other charges, net are excluded from our calculation of segment profit, the table below presents the restructuring and other charges, net associated with each segment (dollars in thousands):

 
Three Months Ended December 31,
 
2017
 
2016
 
Personnel
 
Facilities
 
Total Restructuring
 
Other Charges
 
Total
 
Personnel
 
Facilities
 
Total Restructuring
 
Other Charges
 
Total
Healthcare
$
2,513

 
$
25

 
$
2,538

 
$

 
$
2,538

 
$
1,984

 
$
277

 
$
2,261

 
$

 
$
2,261

Mobile
400

 
11

 
411

 

 
411

 
213

 

 
213

 

 
213

Enterprise
262

 
2,360

 
2,622

 

 
2,622

 
424

 
607

 
1,031

 

 
1,031

Imaging
1,223

 
9

 
1,232

 

 
1,232

 
361

 
351

 
712

 

 
712

Corporate
485

 
(740
)
 
(255
)
 
8,253

 
7,998

 
669

 
664

 
1,333

 
1,153

 
2,486

Total
$
4,883

 
$
1,665

 
$
6,548

 
$
8,253

 
$
14,801

 
$
3,651

 
$
1,899

 
$
5,550

 
$
1,153

 
$
6,703


Fiscal Year 2018
During the three months ended December 31, 2017, we recorded restructuring charges of $6.5 million, which included $4.9 million related to the termination of approximately 160 employees and $1.7 million related to certain excess facilities. These actions were part of our initiatives to reduce costs and optimize processes. We expect the remaining outstanding severance of $1.0 million to be substantially paid during fiscal year 2018, and the remaining balance of $8.8 million related to excess facilities to be paid through fiscal year 2025, in accordance with the terms of the applicable leases.
Additionally, during the three months ended December 31, 2017, we recorded $2.3 million related to the transition agreement of our CEO, and $6.0 million related to our remediation and restoration efforts after the malware incident that occurred in the third quarter of fiscal year 2017. The cash payments associated with the transition agreement are expected to be made during fiscal years 2018 and 2019.

10


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Fiscal Year 2017
During the three months ended December 31, 2016, we recorded restructuring charges of $5.6 million. The restructuring charges for the three months ended December 31, 2016 included $3.7 million related to the termination of approximately 90 employees and $1.9 million related to certain excess facilities. These actions were part of our initiatives to reduce costs and optimize processes. The restructuring charges also included $1.9 million related to excess facilities. In addition, during the three months ended December 31, 2016, we recorded $1.2 million related to the transition agreement of our CEO.
10. Debt
At December 31, 2017 and September 30, 2017, we had the following long-term borrowing obligations (dollars in thousands): 
 
December 31,
2017
 
September 30,
2017
5.625% Senior Notes due 2026, net of deferred issuance costs of $5.5 million and $5.7 million, respectively. Effective interest rate 5.625%.
$
494,453

 
$
494,298

5.375% Senior Notes due 2020, net of unamortized premium of $0.9 million and $1.0 million, respectively, and deferred issuance costs of $2.1 million and $2.3 million, respectively. Effective interest rate 5.375%.
448,748

 
448,630

6.000% Senior Notes due 2024, net of deferred issuance costs of $2.0 million and $2.1 million, respectively. Effective interest rate 6.000%.
297,988

 
297,910

1.00% Convertible Debentures due 2035, net of unamortized discount of $135.0 million and $140.9 million, respectively, and deferred issuance costs of $6.6 million and $6.9 million, respectively. Effective interest rate 5.622%.
534,885

 
528,690

2.75% Convertible Debentures due 2031, net of unamortized discount of $1.5 million and deferred issuance costs of $0.1 million as of September 30, 2017. Effective interest rate 7.432%.
46,568

 
376,121

1.25% Convertible Debentures due 2025, net of unamortized discount of $90.2 million and $92.7 million, respectively, and deferred issuance costs of $4.1 million and $4.3 million, respectively. Effective interest rate 5.578%.
255,703

 
253,054

1.50% Convertible Debentures due 2035, net of unamortized discount of $40.1 million and $42.5 million, respectively, and deferred issuance costs of $1.4 million and $1.5 million, respectively. Effective interest rate 5.394%.
222,340

 
219,875

Deferred issuance costs related to our Revolving Credit Facility
(1,091
)
 
(1,174
)
Total debt
2,299,594

 
2,617,404

    Less: current portion

 
376,121

Total long-term debt
$
2,299,594

 
$
2,241,283


The following table summarizes the maturities of our borrowing obligations as of December 31, 2017 (dollars in thousands):
Fiscal Year
 
Convertible Debentures(1)
 
Senior Notes
 
Total
2018
 
$

 
$

 
$

2019
 

 

 

2020
 

 
450,000

 
450,000

2021
 

 

 

2022
 
310,463

 

 
310,463

Thereafter
 
1,026,488

 
800,000

 
1,826,488

Total before unamortized discount
 
1,336,951

 
1,250,000

 
2,586,951

Less: unamortized discount and issuance costs
 
(277,455
)
 
(9,902
)
 
(287,357
)
Total long-term debt
 
$
1,059,496

 
$
1,240,098

 
$
2,299,594

                 
(1) 
Pursuant to the terms of each convertible instrument, holders have the right to redeem the debt on specific dates prior to maturity. The repayment schedule above assumes that payment is due on the next redemption date after December 31, 2017.

11


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5.625% Senior Notes due 2026
In December 2016, we issued $500.0 million aggregate principal amount of 5.625% Senior Notes due on December 15, 2026 (the "2026 Senior Notes") in a private placement. The proceeds from the 2026 Senior Notes were approximately $495.0 million, net of issuance costs, and we used the proceeds to repurchase a portion of our 2020 Senior Notes. The 2026 Senior Notes bear interest at 5.625% per year, payable in cash semi-annually in arrears, beginning on June 15, 2017.
The 2026 Senior Notes are unsecured senior obligations and are guaranteed on an unsecured senior basis by certain of our domestic subsidiaries ("Subsidiary Guarantors"). The 2026 Senior Notes and the guarantees rank equally in right of payment with all of our and the Subsidiary Guarantors’ existing and future unsecured senior debt and rank senior in right of payment to all of our and the Subsidiary Guarantors’ future unsecured subordinated debt. The 2026 Senior Notes and guarantees effectively rank junior to all our secured debt and that of the Subsidiary Guarantors to the extent of the value of the collateral securing such debt and to all liabilities, including trade payables, of our subsidiaries that have not guaranteed the 2026 Senior Notes.
At any time before December 15, 2021, we may redeem all or a portion of the 2026 Senior Notes at a redemption price equal to 100% of the aggregate principal amount of the 2026 Senior Notes to be redeemed, plus a “make-whole” premium and accrued and unpaid interest to, but excluding, the redemption date. At any time on or after December 15, 2021, we may redeem all or a portion of the 2026 Senior Notes at certain redemption prices expressed as percentages of the principal amount, plus accrued and unpaid interest to, but excluding, the redemption date. At any time and from time to time before December 15, 2021, we may redeem up to 35% of the aggregate outstanding principal amount of the 2026 Senior Notes with the net cash proceeds received by us from certain equity offerings at a price equal to 105.625% of the aggregate principal amount, plus accrued and unpaid interest to, but excluding, the redemption date, provided that the redemption occurs no later than 120 days after the closing of the related equity offering, and at least 50% of the original aggregate principal amount of the 2026 Senior Notes remains outstanding immediately thereafter.
Upon the occurrence of certain asset sales or a change in control, we must offer to repurchase the 2026 Senior Notes at a price equal to 100% in the case of an asset sale, or 101% in the case of a change of control, of the principal amount plus accrued and unpaid interest to, but excluding, the repurchase date.
5.375% Senior Notes due 2020
In August 2012, we issued $700.0 million aggregate principal amount of 5.375% Senior Notes due on August 15, 2020 in a private placement. In October 2012, we issued an additional $350.0 million aggregate principal amount of our 5.375% Senior Notes (collectively the “2020 Senior Notes”). The 2020 Senior Notes bear interest at 5.375% per year, payable in cash semi-annually in arrears. The 2020 Senior Notes are our unsecured senior obligations and are guaranteed on an unsecured senior basis by certain of our domestic subsidiaries, ("the Subsidiary Guarantors"). The 2020 Senior Notes and guarantees rank equally in right of payment with all of our and the Subsidiary Guarantors' existing and future unsecured senior debt and rank senior in right of payment to all of our and the Subsidiary Guarantors' future unsecured subordinated debt. The 2020 Senior Notes and guarantees effectively rank junior to all secured debt of our and the Subsidiary Guarantors to the extent of the value of the collateral securing such debt and to all liabilities, including trade payables, of our subsidiaries that have not guaranteed the 2020 Senior Notes.
In January 2017, we repurchased $600.0 million in aggregate principal amount of our 2020 Senior Notes using cash and cash equivalents and the net proceeds from our 2026 Senior Notes issued in December 2016. In January 2017, we recorded an extinguishment loss of $18.6 million. In accordance with the authoritative guidance for debt instruments, a loss on extinguishment is equal to the difference between the reacquisition price and the net carrying amount of the extinguished debt, including any unamortized debt discount or issuance costs. Following this activity, $450.0 million in aggregate principal amount of our 2020 Senior Notes remains outstanding.
6.0% Senior Notes due 2024
In June 2016, we issued $300.0 million aggregate principal amount of 6.0% Senior Notes due on July 1, 2024 (the "2024 Senior Notes") in a private placement. The proceeds from the 2024 Senior Notes were approximately $297.5 million, net of issuance costs. The 2024 Senior Notes bear interest at 6.0% per year, payable in cash semi-annually in arrears. The 2024 Senior Notes are unsecured senior obligations and are guaranteed on an unsecured senior basis by our Subsidiary Guarantors. The 2024 Senior Notes and the guarantees rank equally in right of payment with all of our and the Subsidiary Guarantors’ existing and future unsecured senior debt, and rank senior in right of payment to all of our and the Subsidiary Guarantors’ future unsecured subordinated debt. The 2024 Senior Notes and guarantees effectively rank junior to all our secured debt and that of the Subsidiary Guarantors to the extent of the value of the collateral securing such debt and to all liabilities, including trade payables, of our subsidiaries that have not guaranteed the 2024 Senior Notes.

12


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

1.0% Convertible Debentures due 2035
In December 2015, we issued $676.5 million in aggregate principal amount of 1.0% Senior Convertible Debentures due in 2035 (the “1.0% 2035 Debentures”) in a private placement. We used a portion of the proceeds to repurchase $38.3 million in aggregate principal on our 2.75% Senior Convertible Debentures due in 2031 and to repay the aggregate principal balance of $472.5 million on the term loan. Upon the repurchase and repayment of debts in December 2015, we recorded an extinguishment loss of $4.9 million in other expense, net, in the accompanying consolidated statements of operations. The 1.0% 2035 Debentures bear interest at 1.0% per year, payable in cash semi-annually in arrears. The 1.0% 2035 Debentures mature on December 15, 2035, subject to the right of the holders to require us to redeem the 1.0% 2035 Debentures on December 15, 2022, 2027, or 2032. The 1.0% 2035 Debentures are general senior unsecured obligations and rank equally in right of payment with all of our existing and future unsecured, unsubordinated indebtedness and senior in right of payment to any indebtedness that is contractually subordinated to the 1.0% 2035 Debentures. The 1.0% 2035 Debentures will be effectively subordinated to indebtedness and other liabilities of our subsidiaries. The initial conversion price is approximately $27.22 per share. At issuance, we allocated $495.4 million to long-term debt, and $181.1 million has been recorded as additional paid-in capital, which is being amortized to interest expense using the effective interest rate method through December 2022. As of December 31, 2017, none of the conversion criteria were met for the 1.0% 2035 Debentures. If the conversion criteria were met, we could be required to repay all or some of the aggregate principal amount in cash prior to the maturity date.
2.75% Convertible Debentures due 2031
In October 2011, we issued $690.0 million in aggregate principal amount of 2.75% Senior Convertible Debentures due in 2031 (the “2031 Debentures”) in a private placement. The 2031 Debentures bear interest at 2.75% per year, payable in cash semi-annually in arrears. The 2031 Debentures mature on November 1, 2031, subject to the right of the holders to require us to redeem the 2031 Debentures on November 1, 2017, 2021, and 2026. The 2031 Debentures are general senior unsecured obligations and rank equally in right of payment with all of our existing and future unsecured, unsubordinated indebtedness and senior in right of payment to any indebtedness that is contractually subordinated to the 2031 Debentures. The 2031 Debentures will be effectively subordinated to indebtedness and other liabilities of our subsidiaries. The initial conversion price is approximately $32.30 per share. At issuance, we allocated $533.6 million to long-term debt, and $156.4 million has been recorded as additional paid-in capital, which is being amortized to interest expense using the effective interest rate method through November 2017.
In June 2015, we entered into separate privately negotiated agreements with certain holders of our 2031 Debentures to exchange, in a private placement, $256.2 million in aggregate principal amount of our 2031 Debentures for approximately $263.9 million in aggregate principal amount of our 1.5% 2035 Debentures. In December 2015, we entered into separate privately negotiated agreements with certain holders of our 2031 Debentures to repurchase $38.3 million in aggregate principal with proceeds received from the issuance of our 1.0% 2035 Debentures. In March 2017, we entered into separate privately negotiated agreements with certain holders of our 2031 Debentures to repurchase $17.8 million in aggregate principal with proceeds received from the issuance of our 1.25% Senior Convertible Debentures issued in March 2017. Following these activities, $377.7 million in aggregate principal amount of our 2031 Debentures remained outstanding as of September 30, 2017, which was included within the total current liabilities.
In November 2017, holders of approximately $331.2 million in aggregate principal amount of the outstanding 2031 Debentures exercised their right to require us to repurchase such debentures. Following the repurchase, $46.6 million in aggregate principal amount of the 2031 Debentures remains outstanding. On or after November 6, 2017, we have the right to call for redemption of some or all of the remaining outstanding 2031 Debentures.
1.25% Convertible Debentures due 2025
In March 2017, we issued $350.0 million in aggregate principal amount of 1.25% Senior Convertible Debentures due in 2025 (the “1.25% 2025 Debentures”) in a private placement. The proceeds were approximately $343.6 million, net of issuance costs. We used a portion of the proceeds to repurchase 5.8 million shares of our common stock for $99.1 million and $17.8 million in aggregate principal on our 2031 Debentures. We used the remaining net proceeds, together with cash on hand to redeem and retire $331.2 million of our outstanding 2031 Debentures in November 2017. The 1.25% 2025 Debentures bear interest at 1.25% per year, payable in cash semi-annually in arrears, beginning on October 1, 2017. The 1.25% 2025 Debentures mature on April 1, 2025. The 1.25% 2025 Debentures are general senior unsecured obligations and rank equally in right of payment with all of our existing and future unsecured, unsubordinated indebtedness and senior in right of payment to any indebtedness that is contractually subordinated to the 1.25% 2025 Debentures. The 1.25% 2025 Debentures will be effectively subordinated to indebtedness and other liabilities of our subsidiaries.

13


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

We account separately for the liability and equity components of the 1.25% 2025 Debentures in accordance with authoritative guidance for convertible debt instruments that may be settled in cash upon conversion. The guidance requires the carrying amount of the liability component to be estimated by measuring the fair value of a similar liability that does not have an associated conversion feature and record the remainder in stockholders’ equity. At issuance, we allocated $252.1 million to long-term debt, and $97.9 million has been recorded as additional paid-in capital, which is being amortized to interest expense using the effective interest rate method through April 1, 2025.
If converted, the principal amount of the 1.25% 2025 Debentures is payable in cash and any amounts payable in excess of the principal amount will (based on an initial conversion rate, which represents an initial conversion price of approximately $22.22 per share, subject to adjustment under certain circumstances) be paid in cash or shares of our common stock, at our election, only in the following circumstances and to the following extent: (i) prior to October 1, 2024, on any date during any fiscal quarter beginning after June 30, 2017 (and only during such fiscal quarter) if the closing sale price of our common stock was more than 130% of the then current conversion price for at least 20 trading days in the period of the 30 consecutive trading days ending on the last trading day of the previous fiscal quarter; (ii) at any time on or after October 1, 2024, (iii) during the five consecutive business-day period immediately following any five consecutive trading-day period in which the trading price for $1,000 principal amount of the 1.25% 2025 Debentures for each day during such five trading-day period was less than 98% of the closing sale price of our common stock multiplied by the then current conversion rate; or (iv) upon the occurrence of specified corporate transactions, as described in the indenture for the 1.25% 2025 Debentures. We may not redeem the 1.25% 2025 Debentures prior to the maturity date. If we undergo a fundamental change or non-stock change of control (as described in the indenture for the 1.25% 2025 Debentures) prior to maturity, holders will have 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 amount of the 1.25% 2025 Debentures to be purchased plus any accrued and unpaid interest, including any additional interest to, but excluding, the repurchase date. As of December 31, 2017, none of the conversion criteria were met for the 1.25% 2025 Debentures. If the conversion criteria were met, we could be required to repay all or some of the aggregate principal amount in cash prior to the maturity date.
1.50% Convertible Debentures due 2035
In June 2015, we issued $263.9 million in aggregate principal amount of 1.50% Senior Convertible Debentures due in 2035 (the “1.5% 2035 Debentures”) in exchange for $256.2 million in aggregate principal amount of our 2031 Debentures. The 1.5% 2035 Debentures were issued at 97.09% of the principal amount, which resulted in a discount of $7.7 million. The 1.5% 2035 Debentures bear interest at 1.50% per year, payable in cash semi-annually in arrears. The 1.5% 2035 Debentures mature on November 1, 2035, subject to the right of the holders to require us to redeem the 1.5% 2035 Debentures on November 1, 2021, 2026, or 2031. The 1.5% 2035 Debentures are general senior unsecured obligations and rank equally in right of payment with all of our existing and future unsecured, unsubordinated indebtedness and senior in right of payment to any indebtedness that is contractually subordinated to the 1.5% 2035 Debentures. The 1.5% 2035 Debentures will be effectively subordinated to indebtedness and other liabilities of our subsidiaries. The initial conversion price is approximately $23.26 per share. At issuance, we allocated $208.6 million to long-term debt, and $55.3 million has been recorded as additional paid-in capital, which is being amortized to interest expense using the effective interest rate method through November 2021. As of December 31, 2017, none of the conversion criteria were met for the 1.5% 2035 Debentures. If the conversion criteria were met, we could be required to repay all or some of the aggregate principal amount in cash prior to the maturity date.
Revolving Credit Facility
Our revolving credit agreement (the “Revolving Credit Facility”), which expires on April 15, 2021, provides for aggregate borrowing commitments of $242.5 million, including the revolving facility loans, the swingline loans and issuance of letters of credit. As of December 31, 2017, after taking into account the outstanding letters of credit of $4.5 million, we had $238.0 million available for additional borrowing under the Revolving Credit Facility. The borrowing outstanding under the Revolving Credit Facility bears interest at either (i) LIBOR plus an applicable margin of 1.50% or 1.75%, or (ii) the alternative base rate plus an applicable margin of 0.50% or 0.75%. The Revolving Credit Facility is secured by substantially all our assets. The Revolving Credit Facility contains customary affirmative and negative covenants and conditions to borrowing, as well as customary events of default. As of December 31, 2017, we are in compliance with all the debt covenants.
11. Stockholders' Equity
Share Repurchases
On April 29, 2013, our Board of Directors approved a share repurchase program for up to $500.0 million of our outstanding shares of common stock. On April 29, 2015, our Board of Directors approved an additional $500.0 million under our share repurchase program. Under the terms of the share repurchase program, we have the ability to repurchase shares from time to time through a

14


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

variety of methods, which may include open market purchases, privately negotiated transactions, block trades, accelerated stock repurchase transactions, or any combination of such methods. The share repurchase program does not require us to acquire any specific number of shares and may be modified, suspended, extended or terminated by us at any time without prior notice. The timing and the amount of any purchases will be determined by management based on an evaluation of market conditions, capital allocation alternatives, and other factors.
There were no share repurchases for the three months ended December 31, 2017 or 2016. Since the commencement of the program, we have repurchased an aggregate of 46.5 million shares for $806.6 million. The amount paid in excess of par value is recognized in additional paid in capital. Shares were retired upon repurchase. As of December 31, 2017, approximately $193.4 million remained available for future repurchases under the program.
12. Net Income (Loss) Per Share
The following table sets forth the computation for basic and diluted net income (loss) per share (dollars in thousands, except per share amounts): 
 
 
Three Months Ended December 31,
 
2017
 
2016
Numerator:
 
 
 
 
Net income (loss)
 
$
53,228

 
$
(23,929
)
Denominator:
 
 
 
 
Weighted average common shares outstanding - Basic
 
291,367

 
288,953

Dilutive effect of employee stock compensation plans
 
4,628

 

Weighted average common shares outstanding — diluted
 
295,995

 
288,953

Net income (loss) per share:
 
 
 
 
Basic
 
$
0.18

 
$
(0.08
)
Diluted
 
$
0.18

 
$
(0.08
)

For the three months ended December 31, 2017 and 2016, respectively, 0.1 million and 7.1 million shares of anti-dilutive equity instruments issued under our employee stock compensation plans were excluded from the computation of diluted net income (loss) per share. 2.2 million and 2.8 million shares of contingently issuable awards were excluded from the determination of dilutive net income per share as the conditions were not met if the end of the reporting period would be the end of the performance period. For the three months ended December 31, 2016, there was no dilutive effect of equity instruments as the impact of these items was anti-dilutive due to the net loss incurred during the period. 
13. Stock-Based Compensation
We recognize stock-based compensation expense over the requisite service period. Our share-based awards are classified within equity. The amounts included in the condensed consolidated statements of operations relating to stock-based compensation are as follows (dollars in thousands): 
 
Three Months Ended December 31,
2017
 
2016
Cost of professional services and hosting
$
7,407

 
$
8,410

Cost of product and licensing
266

 
92

Cost of maintenance and support
1,204

 
977

Research and development
9,696

 
8,490

Sales and marketing
10,676

 
11,969

General and administrative
8,737

 
9,192

Total
$
37,986

 
$
39,130


15


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock Options
The table below summarizes activities related to stock options for the three months ended December 31, 2017:
 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value(a)
Outstanding at September 30, 2017
23,807

 
$
15.39

 
 
 
 
Exercised
(1,859
)
 
$
3.41

 
 
 
 
Outstanding at December 31, 2017
21,948

 
$
16.40

 
2.8 years
 
$
0.1
 million
Exercisable at December 31, 2017
21,939

 
$
16.41

 
2.8 years
 
$
0.1
 million
Exercisable at December 31, 2016
1,050,038

 
$
16.29

 
1.0 year
 
$
0.2
 million
(a) 
The aggregate intrinsic value in this table represents any excess of the closing market price of our common stock as of December 31, 2017 ($16.35) over the exercise price of the underlying options.
The aggregate intrinsic value of stock options exercised during the three months ended December 31, 2017 and 2016 was $0.02 million and $0.7 million, respectively.

Restricted Units
Restricted units are not included in issued and outstanding common stock until the shares are vested and released. The purchase price for vested restricted units is $0.001 per share. The table below summarizes activities relating to restricted units for the three months ended December 31, 2017:
 
Number of Shares Underlying Restricted Units — Contingent Awards
 
Number of Shares Underlying Restricted Units — Time-Based Awards
Outstanding at September 30, 2017
5,043,931

 
6,477,164

Granted
688,999

 
4,263,946

Earned/released
(1,687,862
)
 
(3,614,185
)
Forfeited
(893,287
)
 
(168,642
)
Outstanding at December 31, 2017
3,151,781

 
6,958,283

Weighted average remaining recognition period of outstanding restricted units
1.2 years

 
1.8 years

Unrecognized stock-based compensation expense of outstanding restricted units
$45.0 million
 
$79.8 million
Aggregate intrinsic value of outstanding restricted units(a)
$51.5 million
 
$113.9 million
                    
(a) 
The aggregate intrinsic value in this table represents any excess of the closing market price of our common stock as of December 31, 2017 ($16.35) over the purchase price of the underlying restricted units.
A summary of the weighted-average grant-date fair value of restricted units granted, and the aggregate intrinsic value of restricted units vested during the periods noted is as follows: 
 
Three Months Ended December 31,
2017
 
2016
Weighted-average grant-date fair value per share
$
14.92

 
$
15.90

Total intrinsic value of shares vested (in millions)
$
84.7

 
$
88.3



16


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

14. Income Taxes
The components of loss before income taxes are as follows (dollars in thousands):
 
Three Months Ended December 31,
2017
 
2016
Domestic
$
(40,031
)
 
$
(47,583
)
Foreign
14,738

 
34,007

Loss before income taxes
$
(25,293
)
 
$
(13,576
)
The components of (benefit) provision for income taxes are as follows (dollars in thousands):
 
Three Months Ended December 31,
2017
 
2016
Domestic
$
(80,866
)
 
$
4,159

Foreign
2,345

 
6,194

(Benefit) provision for income taxes
$
(78,521
)
 
$
10,353

Effective tax rate
310.4
%
 
(76.3
)%
On December 22, 2017, the Tax Cuts and Jobs Act ("TCJA") was signed into law. The TCJA significantly revises the U.S. corporate income tax by, among other things, lowering corporate income tax rates, implementing a hybrid territorial tax system, and imposing a one-time repatriation tax on foreign cash and earnings.
We are currently assessing the impact of the realization of deferred tax assets, remeasurement of deferred taxes at lower rates, and the provision for a one-time repatriation tax. Based on our preliminary assessment, we recorded a provisional amount of income tax benefit for the three months ended December 31, 2017, reflecting a benefit of approximately $96 million related to changes in the carrying value of certain deferred tax assets and liabilities, offset in part by an expense of approximately $14 million related to deemed repatriation of foreign cash and earnings. The provisional amounts above were based upon the estimate of (i) temporary differences at the end of the upcoming tax year, (ii) the timing of the temporary differences expected to reverse, (iii) foreign earnings and profits, and (iv) foreign income taxes. The assessment is incomplete as of December 31, 2017. As our assessment is ongoing, these amounts may materially change as we revise our assumptions and estimates based on new information available to us, changes in our interpretations, additional guidance to be issued, and actions we may take as a result of the TCJA.
Additionally, we are still evaluating the full impact of other provisions of the TCJA, which may materially increase or decrease our income tax provision. The assessment is expected to be completed no later than the first quarter of fiscal year 2019.
15. Commitments and Contingencies
Litigation and Other Claims
Similar to many companies in the software industry, we are involved in a variety of claims, demands, suits, investigations and proceedings that arise from time to time relating to matters incidental to the ordinary course of our business, including at times actions with respect to contracts, intellectual property, employment, benefits and securities matters. At each balance sheet date we evaluate contingent liabilities associated with these matters in accordance with ASC 450 “Contingencies.” If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgments are required for the determination of probability and the range of the outcomes, and estimates are based only on the best information available at the time. Due to the inherent uncertainties involved in claims and legal proceedings and in estimating losses that may arise, actual outcomes may differ from our estimates. Contingencies deemed not probable or for which losses were not estimable in one period may become probable, or losses may become estimable in later periods, which may have a material impact on our results of operations and financial position. As of December 31, 2017, accrued losses were not material to our condensed consolidated financial statements, and we do not expect any pending matter to have a material impact on our condensed consolidated financial statements.
Guarantees and Other
We include indemnification provisions in the contracts we enter with customers and business partners. Generally, these provisions require us to defend claims arising out of our products’ infringement of third-party intellectual property rights, breach of contractual obligations and/or unlawful or otherwise culpable conduct. The indemnity obligations generally cover damages, costs and attorneys’ fees arising out of such claims. In most, but not all cases, our total liability under such provisions is limited to either the value of

17


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the contract or a specified, agreed upon amount. In some cases, our total liability under such provisions is unlimited. In many, but not all cases, the term of the indemnity provision is perpetual. While the maximum potential amount of future payments we could be required to make under all the indemnification provisions is unlimited, we believe the estimated fair value of these provisions is minimal due to the low frequency with which these provisions have been triggered.
We indemnify our directors and officers to the fullest extent permitted by Delaware law, which provides among other things, indemnification to directors and officers for expenses, judgments, fines, penalties and settlement amounts incurred by such persons in their capacity as a director or officer of the company, regardless of whether the individual is serving in any such capacity at the time the liability or expense is incurred. Additionally, in connection with certain acquisitions, we agreed to indemnify the former officers and members of the boards of directors of those companies, on similar terms as described above, for a period of six years from the acquisition date. In certain cases, we purchase director and officer insurance policies related to these obligations, which fully cover the six-year period. To the extent that we do not purchase a director and officer insurance policy for the full period of any contractual indemnification, and such directors and officers do not have coverage under separate insurance policies, we would be required to pay for costs incurred, if any, as described above.
16. Segment and Geographic Information
During the first quarter of fiscal year 2018, we commenced a reorganization of our segment reporting structure based on the growth of each business and the evolving industry vertical in which it participates. Such reorganization will allow our Chief Operating Decision Maker ("CODM") greater focus on implementing strategic initiatives and identifying future investment opportunities. In January 2018, we publicly announced that, in addition to the previously communicated intent to establish the automotive business as a separate reportable segment and business line, we will also merge the Communications Service Provider (CSP, or Mobile Operator Services) business line into the Enterprise segment to form a consolidated focus on our business in the telecommunications market. In connection with the ongoing reorganization, we are currently implementing changes to our reporting processes to facilitate operating segment reporting. As a transition, during the first quarter of fiscal year 2018, segment information compiled and presented to our CODM still reflects the existing segment structure. As a result, segment information for the three months ended December 31, 2017 and 2016 below was presented in manner consistent with the level of discrete financial information included within our CODM review package. We expect that the reorganization efforts will be completed in the second quarter of fiscal year 2018, and the presentation of our segment information will reflect the reorganized segment reporting structure upon completion of the reorganization. Additionally, we are continuing the process of identifying and assessing other initiatives to better align our segment reporting structure with our long-term strategies.
Our CODM regularly reviewed segment revenues and segment profits for performance evaluation and resources allocation. Segment revenues include certain acquisition-related adjustments for revenues that would otherwise have been recognized without the acquisition. Segment profits reflect controllable costs directly related to each segment and the allocation of certain corporate expenses such as, corporate sales and marketing expenses and research and development project costs that benefit multiple segments. Certain items such as stock-based compensation, amortization of intangible assets, acquisition-related costs, net, restructuring and other charges, net, other expenses, net and certain unallocated corporate expenses are excluded from segment profits, which allow for more meaningful comparisons to the financial results of the historical operations for the performance evaluation and resources allocation by our CODM.
The Healthcare segment is primarily engaged in clinical speech and clinical language understanding solutions that improve the clinical documentation process, from capturing the complete patient record to improving clinical documentation and quality measures for reimbursement.
The Mobile segment is primarily engaged in providing a broad portfolio of specialized virtual assistants and connected services built on voice recognition, text-to-speech, natural language understanding, dialog, and text input technologies.
The Enterprise segment is primarily engaged in using speech, natural language understanding, and artificial intelligence to provide automated customer solutions and services for voice, mobile, web and messaging channels.
The Imaging segment is primarily engaged in software solutions and expertise that help professionals and organizations to gain optimal control of their document and information processes through scanning and print management.


18


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

We do not track our assets by operating segment. Consequently, it is not practical to show assets or depreciation by operating segment. The following table presents segment results along with a reconciliation of segment profit to loss before income taxes (dollars in thousands): 
 
Three Months Ended
 
December 31,
 
2017
 
2016
Segment revenues:
 
 
 
Healthcare
$
245,535

 
$
239,208

Mobile
89,829

 
91,784

Enterprise
117,831

 
112,938

Imaging
55,630

 
52,089

Total segment revenues
508,825

 
496,019

Less: acquisition-related revenues adjustments
(7,180
)
 
(8,361
)
Total revenues
501,645

 
487,658

Segment profit:
 
 
 
Healthcare
77,419

 
78,567

Mobile
25,423

 
33,471

Enterprise
38,935

 
31,958

Imaging
15,643

 
17,616

Total segment profit
157,420

 
161,612

Corporate expenses and other, net
(44,665
)
 
(30,959
)
Acquisition-related revenues
(7,180
)
 
(8,361
)
Stock-based compensation
(37,986
)
 
(39,130
)
Amortization of intangible assets
(38,420
)
 
(43,401
)
Acquisition-related costs, net
(5,561
)
 
(9,026
)
Restructuring and other charges, net
(14,801
)
 
(6,703
)
Other expenses, net
(34,100
)
 
(37,608
)
Loss before income taxes
$
(25,293
)
 
$
(13,576
)
No country outside of the United States provided greater than 10% of our total revenues. Revenues, classified by the major geographic areas in which our customers are located, were as follows (dollars in thousands): 
 
Three Months Ended
 
December 31,
 
2017
 
2016
United States
$
364,286

 
$
349,170

International
137,359

 
138,488

Total revenues
$
501,645

 
$
487,658



19


NUANCE COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

17. Supplemental Cash Flow Information

Cash paid for Interest and Income Taxes:
 
Three Months Ended December 31,
 
2017
 
2016
 
(Dollars in thousands)
Interest paid
$
27,281

 
$
11,069

Income taxes paid
$
4,600

 
$
4,205

Non-Cash Investing and Financing Activities:
From time to time, we issue shares of our common stock in connection with our business and asset acquisitions, including shares issued as payment for acquisitions, shares initially held in escrow, and shares issued as payment for contingent consideration, which is discussed in Note 3.


20

Table of Contents


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis is intended to help the reader understand the results of operations and financial condition of our business. Management’s Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes to the condensed consolidated financial statements.

CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q including the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk” under Items 2 and 3, respectively, of Part I of this report, and the sections entitled “Legal Proceedings” and “Risk Factors,” under Items 1 and 1A, respectively, of Part II of this report, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks, uncertainties and assumptions that, if they never materialize or if they prove incorrect, could cause 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 bookings, revenues, cost of revenues, research and development expenses, selling, general and administrative expenses, amortization of intangible assets and gross margin;
our strategy relating to our segments;
our transformation program to reduce costs and optimize processes;
market trends;
technological advancements;
the potential of future product releases;
our product development plans and the timing, amount and impact of investments in research and development;
future acquisitions, and anticipated benefits from acquisitions;
international operations and localized versions of our products; and
the conduct, timing and outcome of 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 other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. 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 Quarterly Report on Form 10-Q.
You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.
OVERVIEW
Business Overview
We are a leading provider of voice recognition and natural language understanding solutions. Our solutions and technologies are used in the healthcare, mobile, consumer, enterprise customer service, and imaging markets. We are seeing several trends in our markets, including (i) the growing adoption of cloud-based, connected services and highly interactive mobile applications, (ii) deeper integration of virtual assistant capabilities and services, and (iii) the continued expansion of our core technology portfolio from speech recognition to natural language understanding, semantic processing, domain-specific reasoning, dialog management capabilities, artificial intelligence, and biometric speaker authentication.
Business Trends
Healthcare. Within our healthcare business, our customers are shifting away from solely using hosted transcription services towards more integrated solutions that combine both Dragon Medical cloud solutions and hosted transcription services. The volume processed in our hosted transcription services has continued to decline as customers implement electronic medical record systems and our Dragon Medical solutions. This negative trend was partially offset by new customer wins and higher demands for integrated solutions. Additionally, customers continued to shift away from perpetual licenses towards hosting solutions, which enable the expansion of our Dragon Medical cloud solutions to include new clinical language understanding and Artificial Intelligence ("AI") innovations, providing real time queries to the physician at the point of care. 

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Table of Contents

Mobile. Our Mobile segment continued to benefit from the increasing demands for specialized virtual assistants and connected car services built on voice recognition and natural language understanding as automotive manufacturers compete to incorporate specialized virtual assistants in their product offerings to deliver a more integrated and personalized driving experience. We continue to strengthen our position in the fast-growing connected car market by partnering with new customers and expanding our offerings to existing customers. The positive trend in automotive is offset in part by the negative effect of the consolidation of the mobile devices industry and the current headwinds in our Mobile Operator Services.
Enterprise. Strong demands for our omni-channel engagement solutions powered by AI continued to fuel revenue growth within our Enterprise segment. Additionally, the segment benefited from the strengths in our digital messaging solutions and our Engines and Analytics offers, along with solid performance in our professional services. We continued to enhance our technology capabilities with intelligent self-service and artificial intelligence for customer service, extend the market for our on-demand omni-channel enterprise solutions into international markets, expand our sales and solutions for biometrics, and expand our core products and services portfolio.
Imaging. The imaging market is evolving to include more networked solutions to multi-function printing ("MFP") devices, as well as more mobile access to those networked solutions, and away from packaged software. We are investing to merge the scan and print technology platforms to improve mobile access to our solutions and technologies, expand our distribution channels and embedded relationships, and expand our language coverage for optical character recognition ("OCR") in order to drive a more comprehensive and compelling offering to our partners.
Key Metrics
A summary of key financial metrics for the three months ended December 31, 2017, as compared to the three months ended December 31, 2016, is as follows:
Total revenues increased by $14.0 million to $501.6 million;
Net income increased by $77.2 million to $53.2 million;
Gross margins decreased by 0.5 percentage points to 55.9%;
Operating margins decreased by 3.2 percentage points to 1.8%; and
Cash provided by operating activities decreased by $38.8 million to $86.1 million.
As of December 31, 2017, as compared to December 31, 2016:
Total deferred revenue increased by 9.7% from $802.5 million to $880.6 million primarily driven by continued growth of our automotive connected services.
A summary of key operating metrics for the three months ended December 31, 2017, as compared to the three months ended December 31, 2016, is as follows:
Net new bookings increased by 10.0% from one year ago to $418.4 million. The net new bookings growth was primarily driven by our automotive business and Enterprise solutions.
Bookings represent the estimated gross revenue value of transactions at the time of contract execution, except for maintenance and support offerings. For fixed price contracts, the bookings value represents the gross total contract value. For contracts where revenue is based on transaction volume, the bookings value represents the contract price multiplied by the estimated future transaction volume during the contract term, whether or not such transaction volumes are guaranteed under a minimum commitment clause. Actual results could be different than our initial estimate. The maintenance and support bookings value represents the amounts the customer is invoiced in the period. Because of the inherent estimates required to determine bookings and the fact that the actual resultant revenue may differ from our initial bookings estimates, we consider bookings one indicator of potential future revenue and not as an arithmetic measure of backlog.
Net new bookings represents the estimated revenue value at the time of contract execution from new contractual arrangements or the estimated revenue value incremental to the portion of value that will be renewed under pre-existing arrangements.
Recurring revenue represented 70.8% and 72.4% of total revenue for three months ended December 31, 2017 and December 31, 2016, respectively. Recurring revenue represents the sum of recurring hosting, product and licensing, and maintenance and support revenues as well as the portion of professional services revenue delivered under ongoing contracts. Recurring product and licensing revenue comprises term-based and ratable licenses as well as revenues from royalty arrangements.

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Table of Contents

Annualized line run-rate in our on-demand healthcare solutions decreased by 28% from a year ago to approximately 3.3 billion lines per year. The decrease was primarily due to the continued erosion in our transcription services and the impact of the malware incident that occurred in the third quarter of fiscal year 2017. The annualized line run-rate is determined using billed equivalent line counts in a given quarter, multiplied by four.
Estimated three-year value of total on-demand contracts at December 31, 2017 decreased by 6% from a year ago to approximately $2.3 billion. The decrease was primarily due to the continued erosion in our transcription services and the impact of the malware incident, offset by growth in our Dragon Medical cloud and automotive solutions. We determine this value as of the end of the period reported, by using our estimate of three years of anticipated future revenue streams under signed on-demand contracts then in place, whether or not they are guaranteed through a minimum commitment clause. Our estimate is based on assumptions used in evaluating the contracts and determining sales compensation, adjusted for changes in estimated launch dates, actual volumes achieved, and other factors deemed relevant. For contracts with an expiration date beyond three years, we include only the value expected within three years. For other contracts, we assume renewal consistent with historic renewal rates unless there is a known cancellation. Contracts are generally priced by volume of usage and typically have no or low minimum commitments. Actual revenue could vary from our estimates due to factors such as cancellations, non-renewals or volume fluctuations.
Cybersecurity & Data Privacy Matters
On June 27, 2017, Nuance was a victim of the global NotPetya malware incident (the “Malware Incident”). The NotPetya malware affected certain Nuance systems, including systems used by our healthcare customers, primarily for transcription services, as well as systems used by our imaging division to receive and process orders. For fiscal year 2017, we estimate that we lost approximately $68.0 million in revenues, primarily in our Healthcare segment, due to the service disruption and the reserves we established for customer refund credits related to the Malware Incident. Additionally, we incurred incremental costs of approximately $24.0 million for fiscal year 2017 as a result of our remediation and restoration efforts, as well as incremental amortization expenses. Although the direct effects of the Malware Incident were remediated during fiscal year 2017, as explained below, the Malware Incident had a continued effect on our results of operations in the first quarter of fiscal year 2018 including contributing to: a year-over-year decline in the annualized line run-rate in our on-demand healthcare solutions and in the estimated three-year value of on-demand contracts; a year-over-year decline in hosted revenue and an increase in restructuring and other charges. In addition, we expect to expend additional resources during fiscal year 2018 and beyond to continue to enhance and upgrade information security.
In addition, in December 2017, an unauthorized third party illegally accessed reports hosted on a Nuance transcription platform. This incident was limited in scope to records of approximately 45,000 individuals and was isolated to a single transcription platform that was promptly shutdown. Customers using that platform were notified of the incident and were migrated to our eScription transcription platforms. We also notified law enforcement authorities and have cooperated in their investigation into the matter. This incident did not have a material effect on our financial results for the first quarter of fiscal year 2018 and is not expected to have a material effect on our financial results for future periods. Future cybersecurity or data privacy incidents could have a material adverse effect on our results of operations.  See “Risk Factors - Cybersecurity and data privacy incidents or breaches may damage client relations and inhibit our growth.”.
RESULTS OF OPERATIONS
Total Revenues
The following tables show total revenues by product type and by geographic location, based on the location of our customers, in dollars and percentage change (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Professional services and hosting
$
259.0

 
$
253.4

 
$
5.6

 
2.2
 %
Product and licensing
161.8

 
151.8

 
10.1

 
6.6
 %
Maintenance and support
80.8

 
82.5

 
(1.7
)
 
(2.0
)%
Total Revenues
$
501.6

 
$
487.7

 
$
14.0

 
2.9
 %
United States
$
364.3

 
$
349.2

 
$
15.1

 
4.3
 %
International
137.4

 
138.5

 
(1.1
)
 
(0.8
)%
Total Revenues
$
501.6

 
$
487.7

 
$
14.0

 
2.9
 %
The geographic split for the three months ended December 31, 2017, was 73% of total revenues in the United States and 27% internationally, as compared to 72% of total revenues in the United States and 28% internationally for the same period last year.

23

Table of Contents

Professional Services and Hosting Revenue
Professional services revenue primarily consists of consulting, implementation and training services for customers. Hosting revenue primarily relates to delivering on-demand hosted services, such as medical transcription, automated customer care applications, mobile operator services, mobile infotainment and search and transcription, over a specified term. The following table shows professional services and hosting revenue, in dollars and as a percentage of total revenues (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Professional services revenue
$
73.9

 
$
60.1

 
$
13.8

 
22.9
 %
Hosting revenue
185.1

 
193.3

 
(8.1
)
 
(4.2
)%
Professional services and hosting revenue
$
259.0

 
$
253.4

 
$
5.6

 
2.2
 %
As a percentage of total revenue
51.6
%
 
52.0
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Hosting revenue decreased by $8.1 million, or 4.2%. The decreases were primarily due to lower hosting revenue in our Healthcare segment due to the continued erosion in transcription services, and the negative impact of the Malware Incident, offset in part by the positive effect of customers' transition to our Dragon cloud-based solutions.
Professional services revenue increased by $13.8 million, or 22.9%. The increases were primarily due to higher revenue from professional services related to Dragon Medical offerings in our Healthcare segment.
As a percentage of total revenue, professional services and hosting revenue decreased from 52.0% to 51.6%, primarily due to lower hosting revenue in our Healthcare segment discussed above.
Product and Licensing Revenue
Product and licensing revenue primarily consists of sales and licenses of our technology. The following table shows product and licensing revenue, in dollars and as a percentage of total revenues (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Product and licensing revenue
$
161.8

 
$
151.8

 
$
10.1

 
6.6
%
As a percentage of total revenue
32.3
%
 
31.1
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Product and licensing revenue increased by $10.1 million, or 6.6%. As a percentage of total revenue, product and licensing revenue increased from 31.1% to 32.3%. The increases were primarily due to higher product and licensing revenue in our Healthcare segment, primarily due to higher revenue from diagnostics solutions due to recent acquisitions and the growth in clinical documentation improvement solutions.
Maintenance and Support Revenue
Maintenance and support revenue primarily consists of technical support and maintenance services. The following table shows maintenance and support revenue, in dollars and as a percentage of total revenues (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Maintenance and support revenue
$
80.8

 
$
82.5

 
$
(1.7
)
 
(2.0
)%
As a percentage of total revenue
16.1
%
 
16.9
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Maintenance and support revenue decreased by $1.7 million, or 2.0%. As a percentage of total revenue, maintenance and support revenue decreased from 16.9% to 16.1%. The decreases were primarily due to lower maintenance and support revenue in Healthcare as customers continued to transition from product licenses to cloud-based solutions.

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Table of Contents

COSTS AND EXPENSES
Cost of Professional Services and Hosting Revenue
Cost of professional services and hosting revenue primarily consists of compensation for services personnel, outside consultants and overhead, as well as the hardware, infrastructure and communications fees that support our hosting solutions. The following table shows the cost of professional services and hosting revenue, in dollars and as a percentage of professional services and hosting revenue (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Cost of professional services and hosting revenue
$
172.5

 
$
164.9

 
$
7.6

 
4.6
%
As a percentage of professional services and hosting revenue
66.6
%
 
65.1
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
The increase in cost of professional services and hosting revenue was primarily due to the growth in our Dragon Medical offerings, offset in part by the decline in transcription services revenue. Gross margins decreased by 1.5 percentage points primarily due to the gross margin decline in our transcription services, and the increase in healthcare consulting service engagements that contributed lower margin, offset in part by a favorable shift in revenue mix towards higher margin Dragon Medical offerings from lower margin transcription services.
Cost of Product and Licensing Revenue
Cost of product and licensing revenue primarily consists of material and fulfillment costs, manufacturing and operations costs and third-party royalty expenses. The following table shows the cost of product and licensing revenue, in dollars and as a percentage of product and licensing revenue (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Cost of product and licensing revenue
$
19.1

 
$
18.4

 
$
0.7

 
3.8
%
As a percentage of product and licensing revenue
11.8
%
 
12.1
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Cost of product and licensing revenue increased by $0.7 million, or 3.8%. Gross margins increased 0.3 percentage points, primarily driven by margin improvement in Dragon Medical perpetual licenses due to growth in international markets.
Cost of Maintenance and Support Revenue
Cost of maintenance and support revenue primarily consists of compensation for product support personnel and overhead. The following table shows the cost of maintenance and support revenue, in dollars and as a percentage of maintenance and support revenue (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Cost of maintenance and support revenue
$
14.2

 
$
13.6

 
$
0.6

 
4.7
%
As a percentage of maintenance and support revenue
17.6
%
 
16.5
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Cost of maintenance and support revenue increased by $0.6 million, or 4.7%, primarily due to lower maintenance and support revenue. Gross margins decreased by 1.1 percentage points primarily due to lower margin on Dragon Medical maintenance and support services.

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Table of Contents

Research and Development Expense
Research and development ("R&D") expense primarily consists of salaries, benefits, and overhead relating to engineering staff as well as third party engineering costs. The following table shows research and development expense, in dollars and as a percentage of total revenues (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Research and development expense
$
73.4

 
$
66.3

 
$
7.0

 
10.6
%
As a percentage of total revenue
14.6
%
 
13.6
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Research and development expense increased by $7.0 million, or 10.6%, primarily due to higher compensation expenses as a result of higher R&D headcount as we continue to enhance our R&D capability and invest in new technologies while optimizing our cost structure by shifting certain R&D activities to lower cost regions.
Sales and Marketing Expense
Sales and marketing expense includes salaries and benefits, commissions, advertising, direct mail, public relations, tradeshow costs and other costs of marketing programs, travel expenses associated with our sales organization and overhead. The following table shows sales and marketing expense, in dollars and as a percentage of total revenues (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Sales and marketing expense
$
102.0

 
$
101.5

 
$
0.4

 
0.4
%
As a percentage of total revenue
20.3
%
 
20.8
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
Sales and marketing expense increased by $0.4 million, or essentially flat, as the increase in travel and entertainment expenses were offset by the lower compensation expense.
General and Administrative Expense
General and administrative expense primarily consists of personnel costs for administration, finance, human resources, general management, fees for external professional advisers including accountants and attorneys, and provisions for doubtful accounts. The following table shows general and administrative expense, in dollars and as a percentage of total revenues (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
General and administrative expense
$
52.9

 
$
39.8

 
$
13.1

 
32.9
%
As a percentage of total revenue
10.5
%
 
8.2
%
 
 
 
 
Three Months Ended December 31, 2017 compared to Three Months Ended December 31, 2016
General and administrative expense increased by $13.1 million, or 32.9%, primarily due to higher professional fees related to identifying and evaluating strategic initiatives, higher expenses related to upgrading our technological infrastructure, and higher compensation expense related to increased administrative headcount.

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Amortization of Intangible Assets
Amortization of acquired patents and technologies are included in cost of revenue and the amortization of acquired customer and contractual relationships, non-compete agreements, acquired trade names and trademarks, and other intangibles are included in operating expenses. Customer relationships are amortized on an accelerated basis based upon the pattern in which the economic benefits of the customer relationships are being realized. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortization expense was recorded as follows (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Cost of revenue
$
15.4

 
$
15.5

 
$
(0.2
)
 
(1.2
)%
Operating expenses
23.1

 
27.9

 
(4.8
)
 
(17.2
)%
Total amortization expense
$
38.4

 
$
43.4

 
$
(5.0
)
 
(11.5
)%
As a percentage of total revenue
7.7
%
 
8.9
%
 
 
 
 
The decrease in total amortization of intangible assets for the three months ended December 31, 2017, as compared to the three months ended December 31, 2016, is primarily due to certain intangible assets which became fully amortized during fiscal year 2017.
Acquisition-Related Costs, Net
Acquisition-related costs include costs related to business acquisitions. These costs consist of (i) transition and integration costs, including retention payments, transitional employee costs, earn-out payments, and other costs related to integration activities; (ii) professional service fees, including financial advisory, legal, accounting, and other outside services incurred in connection with acquisition activities, and disputes and regulatory matters related to acquired entities; and (iii) fair value adjustments to acquisition-related contingencies. A summary of the acquisition-related costs is as follows (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
2017
 
2016
Transition and integration costs
$
4.1

 
$
3.7

 
$
0.4

 
9.5
 %
Professional service fees
0.5

 
5.0

 
(4.5
)
 
(89.8
)%
Acquisition-related adjustments
1.0

 
0.3

 
0.7

 
230.4
 %
Total acquisition-related costs, net
$
5.6

 
$
9.0

 
$
(3.5
)
 
(38.4
)%
As a percentage of total revenue
1.1
%
 
1.9
%
 
 
 
 
Acquisition-related costs, net for the three months ended December 31, 2017 decreased by $3.5 million, primarily due to the decrease in professional services fees driven by reduced acquisition activities in the first quarter of fiscal year 2018.
Restructuring and Other Charges, Net
While restructuring and other charges, net are excluded from segment profits, the table below presents the restructuring and other charges, net associated with each segment (dollars in thousands):
 
Three Months Ended December 31,
 
2017
 
2016
 
Personnel
 
Facilities
 
Total Restructuring
 
Other Charges
 
Total
 
Personnel
 
Facilities
 
Total Restructuring
 
Other Charges
 
Total
Healthcare
$
2,513

 
$
25

 
$
2,538

 
$

 
$
2,538

 
$
1,984

 
$
277

 
$
2,261

 
$

 
$
2,261

Mobile
400

 
11

 
411

 

 
411

 
213

 

 
213

 

 
213

Enterprise
262

 
2,360

 
2,622

 

 
2,622

 
424

 
607

 
1,031

 

 
1,031

Imaging
1,223

 
9

 
1,232

 

 
1,232

 
361

 
351

 
712

 

 
712

Corporate
485

 
(740
)
 
(255
)
 
8,253

 
7,998

 
669

 
664

 
1,333

 
1,153

 
2,486

Total
$
4,883

 
$
1,665

 
$
6,548

 
$
8,253

 
$
14,801

 
$
3,651

 
$
1,899

 
$
5,550

 
$
1,153

 
$
6,703

Fiscal Year 2018
During the three months ended December 31, 2017, we recorded restructuring charges of $6.5 million, which included $4.9 million related to the termination of approximately 160 employees and $1.7 million related to certain excess facilities. These actions were

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part of our initiatives to reduce costs and optimize processes. We expect the remaining outstanding severance of $1.0 million to be substantially paid during fiscal year 2018, and the remaining balance of $8.8 million related to excess facilities to be paid through fiscal year 2025, in accordance with the terms of the applicable leases.
Additionally, during the three months ended December 31, 2017, we recorded $2.3 million related to the transition agreement of our CEO, and $6.0 million related to our remediation and restoration efforts after the malware incident that occurred in the third quarter of fiscal year 2017. The cash payments associated with the transition agreement are expected to be made during fiscal years 2018 and 2019.
Fiscal Year 2017
During the three months ended December 31, 2016, we recorded restructuring charges of $5.6 million. The restructuring charges for the three months ended December 31, 2016 included $3.7 million related to the termination of approximately 90 employees and $1.9 million related to certain excess facilities. These actions were part of our initiatives to reduce costs and optimize processes. The restructuring charges also included $1.9 million related to excess facilities. In addition, during the three months ended December 31, 2016, we recorded $1.2 million related to the transition agreement of our CEO.

Other Expense, Net
A summary of other expenses, net is as follows (dollars in millions): 
 
Three Months Ended
 
Dollar
Change
 
Percent
Change
December 31,
 
2017
 
2016
 
Interest income
$
2.2

 
$
1.0

 
$
1.2

 
114.3
 %
Interest expense
(36.1
)
 
(38.0
)
 
2.0

 
(5.1
)%
Other expense, net
(0.2
)
 
(0.6
)
 
0.4

 
(63.6
)%
Total other expense, net
$
(34.1
)
 
$
(37.6
)
 
$
3.5

 
(9.3
)%
As a percentage of total revenue
6.8
%
 
7.7
%
 
 
 
 

Interest expense for the three months ended December 31, 2017 decreased $2.0 million, as compared to three months ended December 31, 2016, was mainly due to the repurchase of $600.0 million in aggregate principal amount of our 2020 Senior Notes in January 2017. The decrease was partially offset by the issuance of $500.0 million 5.625% Senior Notes in the December 2016, the net proceeds