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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _____________________________________________
Form 10-Q
 _____________________________________________
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2020
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)
 _____________________________________________
DE
 
94-3156479
(State or Other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
 
1 Wayside Road
Burlington,
 
MA
 
01803
(Address of principal executive offices)
 
 
 
(Zip Code)
Registrant’s telephone number, including area code:
(781565-5000
 _____________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock, par value $0.001
NUAN
Nasdaq Stock Market LLC
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      No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes      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
 
Accelerated Filer
Non-accelerated Filer
 
Smaller Reporting Company
 
 
 
Emerging Growth 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  
The number of shares of the Registrant’s Common Stock, outstanding as of July 31, 2020 was 282,302,995.
 




NUANCE COMMUNICATIONS, INC.
TABLE OF CONTENTS
 
 
 
 
 
Page
Item 1.
 
Condensed Consolidated Financial Statements:
 
 
 
 
Consolidated Statements of Operations for the three and nine months ended June 30, 2020 and 2019
 
 
 
Consolidated Statements of Comprehensive Income for the three and nine months ended June 30, 2020 and 2019
 
 
 
Consolidated Balance Sheets at June 30, 2020 and September 30, 2019
 
 
 
Consolidated Statements of Stockholders’ Equity for the three and nine months ended June 30, 2020 and 2019
 
 
 
Consolidated Statements of Cash Flows for the nine months ended June 30, 2020 and 2019
 
 
 
Notes to Condensed Consolidated Financial Statements
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
 
Item 1.
 
 
Item 1A.
 
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
Item 5.
 
 
Item 6.
 
 
 
 
Certifications
 
 







NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2020
 
2019
 
2020
 
2019
 
(Unaudited)
(In thousands, except per share amounts)
Revenues:
 
 
 
 
 
 
 
Hosting and professional services
$
225,304

 
$
232,860

 
$
691,295

 
$
678,104

Product and licensing
48,722

 
78,184

 
243,501

 
252,299

Maintenance and support
64,372

 
66,393

 
191,172

 
203,293

Total revenues
338,398

 
377,437

 
1,125,968

 
1,133,696

Cost of revenues:
 
 
 
 
 
 
 
Hosting and professional services
119,797

 
138,367

 
388,783

 
409,259

Product and licensing
10,672

 
18,693

 
54,166

 
60,471

Maintenance and support
7,278

 
8,141

 
23,037

 
24,813

Amortization of intangible assets
6,435

 
6,569

 
19,678

 
20,606

Total cost of revenues
144,182

 
171,770

 
485,664

 
515,149

Gross profit
194,216

 
205,667

 
640,304

 
618,547

Operating expenses:
 
 
 
 
 
 
 
Research and development
55,237

 
47,074

 
169,699

 
139,698

Sales and marketing
64,351

 
65,331

 
201,847

 
200,384

General and administrative
37,665

 
45,834

 
114,355

 
129,157

Amortization of intangible assets
11,845

 
13,364

 
36,215

 
41,030

Acquisition-related costs, net
758

 
788

 
3,605

 
5,440

Restructuring and other charges, net
1,920

 
1,947

 
14,932

 
26,446

Total operating expenses
171,776

 
174,338

 
540,653

 
542,155

Income from operations
22,440

 
31,329

 
99,651

 
76,392

Other income (expense):
 
 
 
 
 
 
 
Interest income
606

 
3,762

 
4,304

 
9,987

Interest expense
(23,680
)
 
(28,359
)
 
(71,124
)
 
(91,777
)
Other income (expense), net
636

 
3,301

 
(13,092
)
 
2,324

Income (loss) before income taxes
2

 
10,033

 
19,739

 
(3,074
)
(Benefit) provision for income taxes
(16,660
)
 
10,720

 
(31,794
)
 
12,129

Net income (loss) from continuing operations
16,662

 
(687
)
 
51,533

 
(15,203
)
Net income (loss) from discontinued operations

 
9,946

 
(6,192
)
 
120,884

Net income
$
16,662

 
$
9,259

 
$
45,341

 
$
105,681

 
 
 
 
 
 
 
 
Net income (loss) per common share - basic:
 
 
 
 
 
 
 
Continuing operations
$
0.06

 
$

 
$
0.18

 
$
(0.05
)
Discontinued operations

 
0.03

 
(0.02
)
 
0.42

Total net income per basic common share
$
0.06

 
$
0.03

 
$
0.16

 
$
0.37

 
 
 
 
 
 
 
 
Net income (loss) per common share - diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.06

 
$

 
$
0.18

 
$
(0.05
)
Discontinued operations

 
0.03

 
(0.02
)
 
0.42

Total net income per diluted common share
$
0.06

 
$
0.03

 
$
0.16

 
$
0.37

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
281,281

 
285,942

 
282,674

 
285,064

Diluted
287,852

 
285,942

 
288,096

 
285,064








See accompanying notes.

3

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2020
 
2019
 
2020
 
2019
 
(Unaudited)
 
(In thousands)
Net income
$
16,662

 
$
9,259

 
$
45,341

 
$
105,681

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
6,909

 
3,541

 
(4,205
)
 
494

Cerence Spin-off

 

 
12,331

 

Pension adjustments

 
32

 
2,007

 
(282
)
Unrealized gain (loss) on marketable securities
486

 
78

 
(42
)
 
234

Total other comprehensive income, net
7,395


3,651

 
10,091

 
446

Comprehensive income
$
24,057

 
$
12,910

 
$
55,432

 
$
106,127











































See accompanying notes.

4

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS 
 
June 30,
2020
 
September 30,
2019
 
(Unaudited)
 
(In thousands, except per
share amounts)
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
240,555

 
$
560,961

Marketable securities
69,283

 
186,555

Accounts receivable, less allowances for doubtful accounts of $12,283 and $9,797
215,272

 
240,673

Prepaid expenses and other current assets
145,831

 
175,166

Current assets of discontinued operations

 
91,858

Total current assets
670,941

 
1,255,213

Marketable securities
2,986

 
17,287

Land, building and equipment, net
133,755

 
121,203

Goodwill
2,129,736

 
2,127,896

Intangible assets, net
235,703

 
291,371

Right-of-use assets
107,553

 

Other assets
265,412

 
316,215

Long-term assets of discontinued operations

 
1,236,608

Total assets
$
3,546,086

 
$
5,365,793

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

 
$
1,142,870

Contingent and deferred acquisition payments
16,083

 
17,470

Accounts payable
65,511

 
90,826

Accrued expenses and other current liabilities
179,844

 
249,570

Deferred revenue
261,406

 
214,223

Current liabilities of discontinued operations

 
130,117

Total current liabilities
522,844

 
1,845,076

Long-term debt
1,524,825

 
793,536

Deferred revenue, net of current portion
105,632

 
133,783

Deferred tax liabilities
61,306

 
54,216

Operating lease liabilities
105,333

 

Other liabilities
75,817

 
79,378

Long-term liabilities of discontinued operations

 
286,654

Total liabilities
2,395,757

 
3,192,643

Commitments and contingencies (Note 15)

 

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock, $0.001 par value per share; 560,000 shares authorized; 285,125 and 289,680 shares issued and 281,375 and 285,930 shares outstanding, respectively
285

 
290

Additional paid-in capital
1,537,785

 
2,597,889

Treasury stock, at cost (3,751 shares)
(16,788
)
 
(16,788
)
Accumulated other comprehensive loss
(122,682
)
 
(132,773
)
Accumulated deficit
(248,271
)
 
(293,612
)
Total Nuance Communications, Inc. stockholders’ equity
1,150,329

 
2,155,006

Noncontrolling interests

 
18,144

Total stockholders’ equity
1,150,329

 
2,173,150

Total liabilities and stockholders’ equity
$
3,546,086

 
$
5,365,793


See accompanying notes.

5

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY


For the three months ended June 30, 2020
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Noncontrolling Interests
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
 
(In thousands)
Balance at March 31, 2020
284,832

 
$
285

 
$
1,520,734

 
3,751

 
$
(16,788
)
 
$
(130,077
)
 
$
(264,933
)
 
$

 
$
1,109,221

Issuance of common stock under employee stock plans
474

 

 
10

 

 

 

 

 

 
10

Cancellation of restricted stock, and repurchase of common stock at cost for employee tax withholding
(181
)
 

 
(3,510
)
 

 

 

 

 

 
(3,510
)
Stock-based compensation

 

 
20,551

 

 

 

 

 

 
20,551

Net income

 

 

 

 

 

 
16,662

 

 
16,662

Other comprehensive income

 

 

 

 

 
7,395

 

 

 
7,395

Balance at June 30, 2020
285,125

 
$
285

 
$
1,537,785

 
3,751

 
$
(16,788
)
 
$
(122,682
)
 
$
(248,271
)
 
$

 
$
1,150,329

For the nine months ended June 30, 2020
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Noncontrolling Interests
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
 
(In thousands)
Balance at September 30, 2019
289,680

 
$
290

 
$
2,597,889

 
3,751

 
$
(16,788
)
 
$
(132,773
)
 
$
(293,612
)
 
$
18,144

 
$
2,173,150

Cerence Spin-off

 

 
(922,567
)
 

 

 
12,331

 

 
(18,144
)
 
(928,380
)
Issuance of common stock under employee stock plans
7,194

 
7

 
7,263

 

 

 

 

 

 
7,270

Cancellation of restricted stock, and repurchase of common stock at cost for employee tax withholding
(2,292
)
 
(2
)
 
(40,115
)
 

 

 

 

 

 
(40,117
)
Stock-based compensation


 


 
110,644

 

 

 

 

 

 
110,644

Repurchases and retirement of common stock
(9,457
)
 
(10
)
 
(169,208
)
 

 

 

 

 

 
(169,218
)
Repurchases of convertible notes (a)

 

 
(46,121
)
 

 

 

 

 

 
(46,121
)
Net income

 

 

 

 

 

 
45,341

 

 
45,341

Other comprehensive loss

 

 

 

 

 
(2,240
)
 

 

 
(2,240
)
Balance at June 30, 2020
285,125

 
$
285

 
$
1,537,785

 
3,751

 
$
(16,788
)
 
$
(122,682
)
 
$
(248,271
)
 
$

 
$
1,150,329

                     
(a) According to ASC 470-20, cash consideration paid to repurchase and retire our convertible notes was first allocated to debt component based on the actual fair value on the trading date, and the remaining consideration was allocated to additional paid-in capital.

6

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)
For the three months ended June 30, 2019
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
(In thousands)
Balance at March 31, 2019
290,038

 
$
290

 
$
2,592,708

 
3,751

 
$
(16,788
)
 
$
(120,463
)
 
$
(411,000
)
 
$
2,044,747

Issuance of common stock under employee stock plans
646

 
1

 
(1
)
 

 

 

 

 

Cancellation of restricted stock, and repurchase of common stock at cost for employee tax withholding
(247
)
 

 
(4,292
)
 

 

 

 

 
(4,292
)
Stock-based compensation

 

 
19,247

 

 

 

 

 
19,247

Repurchase and retirement of common stock
(1,707
)
 
(2
)
 
(29,612
)
 

 

 

 

 
(29,614
)
Net income

 

 

 

 

 

 
9,259

 
9,259

Other comprehensive income

 

 

 

 

 
3,651

 

 
3,651

Balance at June 30, 2019
288,730

 
$
289

 
$
2,578,050

 
3,751

 
$
(16,788
)
 
$
(116,812
)
 
$
(401,741
)
 
$
2,042,998

For the nine months ended June 30, 2019
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
(In thousands)
Balance at September 30, 2018
291,504

 
$
291

 
$
2,597,693

 
3,751

 
$
(16,788
)
 
$
(122,863
)
 
$
(740,837
)
 
$
1,717,496

Adoption of ASC 606

 

 

 

 

 

 
233,415

 
233,415

Issuance of common stock under employee stock plans
7,225

 
8

 
8,635

 

 

 

 

 
8,643

Cancellation of restricted stock, and repurchase of common stock at cost for employee tax withholding
(2,229
)
 
(2
)
 
(35,850
)
 

 

 

 

 
(35,852
)
Stock-based compensation

 

 
128,499

 

 

 

 

 
128,499

Repurchase and retirement of common stock
(7,770
)
 
(8
)
 
(120,927
)
 

 

 

 

 
(120,935
)
Reclassification of currency translation differences into earnings as a result of the disposition of our Imaging business

 

 

 

 

 
5,605

 

 
5,605

Net income

 

 

 

 

 

 
105,681

 
105,681

Other comprehensive income

 

 

 

 

 
446

 

 
446

Balance at June 30, 2019
288,730

 
$
289

 
$
2,578,050

 
3,751

 
$
(16,788
)
 
$
(116,812
)
 
$
(401,741
)
 
$
2,042,998




See accompanying notes.

7

Table of Contents

NUANCE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Nine Months Ended June 30,
 
2020
 
2019
 
(Unaudited)
(In thousands)
Cash flows from operating activities:
 
 
 
Net income (loss) from continuing operations
$
51,533

 
$
(15,203
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation
27,990

 
37,117

Amortization
55,893

 
61,636

Stock-based compensation
98,030

 
84,476

Non-cash interest expense
37,269

 
37,011

Deferred tax benefit
(55,626
)
 
(5,126
)
Loss on extinguishment of debt
18,656

 
910

Other
2,905

 
(651
)
Changes in operating assets and liabilities, excluding effects of acquisitions:
 
 
 
Accounts receivable
26,264

 
12,318

Prepaid expenses and other assets
5,030

 
(14,760
)
Accounts payable
(15,868
)
 
8,269

Accrued expenses and other liabilities
(84,762
)
 
2,847

Deferred revenue
19,706

 
16,448

  Net cash provided by operating activities - continuing operations
187,020

 
225,292

  Net cash (used in) provided by operating activities - discontinued operations
(13,307
)
 
71,902

Net cash provided by operating activities
173,713

 
297,194

Cash flows from investing activities:
 
 
 
Capital expenditures
(45,550
)
 
(32,243
)
Proceeds from disposition of businesses, net of transaction fees

 
407,043

Purchases of marketable securities and other investments
(157,976
)
 
(256,332
)
Proceeds from sales and maturities of marketable securities and other investments
290,584

 
262,914

Other
1,374

 
(3,102
)
Net cash provided by investing activities
88,432

 
378,280

Cash flows from financing activities:
 
 
 
Repurchase and redemption of debt
(513,642
)
 
(300,000
)
Net distribution from Cerence upon the spin-off
139,090

 

Payments for repurchase of common stock
(169,218
)
 
(120,935
)
Proceeds from issuance of common stock from employee stock plans
7,204

 
8,643

Proceeds from the revolving credit facility
230,000

 

Repayment of the revolving credit facility
(230,000
)
 

Payments for taxes related to net share settlement of equity awards
(39,968
)
 
(42,562
)
Other financing activities
(2,840
)
 
(1,442
)
Net cash used in financing activities
(579,374
)
 
(456,296
)
Effects of exchange rate changes on cash and cash equivalents
(3,177
)
 
1,236

Net (decrease) increase in cash and cash equivalents
(320,406
)
 
220,414

Cash and cash equivalents at beginning of period
560,961

 
315,963

Cash and cash equivalents at end of period
$
240,555

 
$
536,377











See accompanying notes.

8

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


1. Organization and Presentation
Nuance Communications, Inc. ("we", "Nuance", "our", "us", or the "Company") is a pioneer and leader in conversational and cognitive artificial intelligence ("AI") innovations that bring intelligence to everyday work and life. Our solutions and technologies can understand, analyze and respond to human language to increase productivity and amplify human intelligence. Our solutions are used by businesses in the healthcare, financial services, telecommunications and travel industries, among others. We had three reportable segments as of June 30, 2020: Healthcare, Enterprise, and Other. See Note 17 for a description of each of these segments.
As more fully described in Note 4, on October 1, 2019, we completed the spin-off of our Automotive business as an independent public company, Cerence Inc. ("Cerence"). The historical results of our Automotive business are included within discontinued operations for all the historical periods presented.
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, 2019. The results of operations for the interim periods presented are not necessarily indicative of the results for the entire fiscal year or any future period.
As more fully described in Note 14, our financial results for the three months ended March 31, 2020 have been revised for a tax adjustment resulting from implementation of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).
2. Summary of Significant Accounting Policies
Recently Adopted Accounting Standards
Leases
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, "Leases" ("ASC 842"), which became effective for fiscal years beginning after December 15, 2018 and interim periods therein, with early adoption permitted. ASC 842 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 initially required the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. We adopted ASC 842 in the first quarter of fiscal year 2020.
In July 2018, the FASB issued ASU 2018-10, "Codification Improvements to Topic 842, Leases" and ASU 2018-11, "Leases Topic 842 Targeted Improvements", which provide an additional (and optional) transition method whereby the new lease standard is applied at the adoption date and recognized as an adjustment to retained earnings. Additionally, in March 2019, the FASB issued ASU 2019-01, "Codification Improvements to Topic 842", which provides guidance in the following areas: (1) determining the fair value of the underlying asset by lessors that are not manufacturers or dealers and (2) clarification of interim disclosure requirements during transition. We adopted ASC 842, as amended, as of October 1, 2019 under the optional transition method and elected the package of practical expedients under the transition guidance.
As a result of the adoption, we recognized $120 million of operating lease right-of-use assets, and approximately $140 million of operating lease obligations. Approximately $20 million of deferred rent balances were reclassified against the costs of the right-of-use assets. The cumulative-effect adjustment to retained earnings as of October 1, 2019 was immaterial. The adoption of the guidance did not have a material impact on our condensed consolidated statement of operations or consolidated statement of cash flows.
Income Taxes
In January 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("AOCI"), which became effective for fiscal years beginning after December 15, 2018 and interim periods therein. The guidance gives entities the option to reclassify to retained earnings the tax effects resulting from the Tax Cuts and Jobs Act ("TCJA") related to items in AOCI. The guidance may be applied retrospectively to each period in which the effect of the TCJA is recognized in the period of adoption. The adoption of the guidance did not have a material impact on our condensed consolidated financial statements.

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

Issued Accounting Standards Not Yet Adopted
Internal-Use Software
In August 2018, the FASB issued ASU 2018-15, "Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract", which is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The guidance requires that implementation costs related to a hosting arrangement that is a service contract be capitalized and amortized over the term of the hosting arrangement, starting when the module or component of the hosting arrangement is ready for its intended use. The guidance will be applied retrospectively to each period presented. We do not expect the implementation to have a material impact on our condensed consolidated financial statements.
3. Revenue Recognition
We derive revenue from the following sources: (1) hosting services, (2) software licenses, including royalties, (3) maintenance and support ("M&S"), (4) professional services, and (5) sale of hardware. Revenue is reported net of applicable sales and use tax, value-added tax and other transaction taxes imposed on the related transaction including mandatory government charges that are passed through to our customers. We account for a contract when both parties have approved and committed to the contract, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and the collectibility of the consideration is probable.
The majority of our arrangements with customers typically contain multiple products and services. We account for individual products and services separately if they are distinct--that is, if a product or service is separately identifiable from other items in the contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer.
We recognize revenue after applying the following five steps:
identification of the contract, or contracts, with a customer;
identification of the performance obligations in the contract, including whether they are distinct within the context of the contract;
determination of the transaction price, including the constraint on variable consideration;
allocation of the transaction price to the performance obligations in the contract; and
recognition of revenue when, or as, performance obligations are satisfied.
We allocate the transaction price of the arrangement based on the relative estimated standalone selling price ("SSP") of each distinct performance obligation. In determining SSP, we maximize observable inputs and consider a number of data points, including:
the pricing of standalone sales (in the instances where available);
the pricing established by management when setting prices for deliverables that are intended to be sold on a standalone basis;
contractually stated prices for deliverables that are intended to be sold on a standalone basis; and
other pricing factors, such as the geographical region in which the products are sold and expected discounts based on the customer size and type.
We only include estimated amounts of variable consideration in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. We reduce transaction prices for estimated returns and other allowances that represent variable consideration under ASU No. 2014-09, "Revenue from Contracts with Customers: Topic 606" ("ASC 606"), which we estimate based on historical return experience and other relevant factors and record a reduction to revenue and accounts receivable. Other forms of contingent revenue or variable consideration are infrequent.
Revenue is recognized when control of these products and services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those services.
We assess the timing of the transfer of products or services to the customer as compared to the timing of payments to determine whether a significant financing component exists. In accordance with the practical expedient in ASC 606-10-32-18, we do not assess the existence of a significant financing component when the difference between payment and transfer of deliverables is a

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

year or less. If the difference in timing arises for reasons other than the provision of financing to either the customer or us, no financing component is deemed to exist. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our services, not to receive or provide financing from or to customers. We do not consider set-up fees nor other upfront fees paid by our customers to represent a financing component.
Certain products are sold through distributors or resellers. Certain distributors and resellers have been granted right of return and selling incentives which are accounted for as variable consideration when estimating the amount of revenue to be recognized. Returns and credits are estimated at the contract inception and updated at the end of each reporting period as additional information becomes available. In accordance with the practical expedient in ASC 606-10-10-4, we apply a portfolio approach to estimate the variable consideration associated with this group of customers.
Reimbursements for out-of-pocket costs generally include, but are not limited to, costs related to transportation, lodging and meals. Revenue from reimbursed out-of-pocket costs is accounted for as variable consideration.
Shipping and handling activities are not considered a contract performance obligation. We record shipping and handling costs billed to customers as revenue with offsetting costs recorded as cost of revenue.
Performance Obligations
Hosting
Hosting services, which allow our customers to use the hosted software over the contract period without taking possession of the software, are provided on a usage basis as consumed or on a fixed fee subscription basis. Our hosting contract terms generally range from one to five years.
As each day of providing services is substantially the same and the customer simultaneously receives and consumes the benefits as access is provided, we have determined that our hosting services arrangements are a single performance obligation comprised of a series of distinct services. These services include variable consideration, which is typically a function of usage. We recognize revenue as each distinct service period is performed (i.e., recognized as incurred).
Subscription-based revenue represents a single promise to stand-ready to provide access to our hosting services. Revenue is recognized over time on a ratable basis over the hosting contract term, which generally ranges from one to five years.
Software Licenses
On-premise software licenses sold with non-distinct professional services to customize and/or integrate the underlying software are accounted for as a combined performance obligation. Revenue from the combined performance obligation is recognized over time based upon the progress towards completion of the project, which is measured based on the labor hours already incurred to date as compared to the total estimated labor hours.
Revenue from distinct on-premise software licenses, which do not require professional services to customize and/or integrate the software license, is recognized at the point in time when the software is made available to the customer and control is transferred.
Revenue from software licenses sold on a royalty basis, where the license of intellectual property is the predominant item to which the royalty relates, is recognized in the period the usage occurs in accordance with the practical expedient in ASC 606-10-55-65(A).
Maintenance and Support
Our M&S contracts generally include telephone support and the right to receive unspecified upgrades and updates on a when-and-if available basis. M&S revenue is recognized over time on a ratable basis over the contract period because we transfer control evenly by providing a stand-ready service.
Professional Services
Revenue from distinct professional services, including training, is recognized over time based upon the progress towards completion of the project, which is measured based on the labor hours already incurred to date as compared to the total estimated labor hours.
Hardware
Hardware revenue is recognized at the point in time when control is transferred to the customer, which is typically upon delivery.

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

Significant Judgments
Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Our license contracts often include professional services to customize and/or integrate the licenses into the customer’s environment. Judgment is required to determine whether the license is considered distinct and accounted for separately, or not distinct and accounted for together with professional services.
Judgments are required to determine the SSP for each distinct performance obligation. When SSP is directly observable, we estimate SSP based upon the historical transaction prices, adjusted for geographic considerations, customer classes, and customer relationship profiles. In instances where SSP is not directly observable, we determine SSP using information that may include market conditions and other observable inputs. We may have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining SSP. D