Cerence Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Management’s Discussion and Analysis of Financial Condition and Results of Operations, (the "MD&A"), describes the principal factors, based on management’s assessment, which have a material impact on our results of operations, financial condition and liquidity, as well as our critical accounting policies and estimates. Our MD&A generally includes a discussion of results of operations, financial condition, liquidity and capital resources related to year-over-year comparisons between fiscal years ended September 30, 2021, and 2020, as well as fiscal years ended September 30, 2020, and 2019. The following discussion and analysis presented below should be read in conjunction with the Consolidated and Combined Financial Statements and the corresponding notes, and included elsewhere in this Form 10-K. The information presented in this section includes forward-looking statements, which are described in detail in the section titled “Cautionary Statement Concerning Forward-Looking Statements.” The matters discussed in these forward-looking statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those made, projected, or implied in the forward-looking statements. See the section titled “Risk Factors” for a discussion of the risks, uncertainties, and assumptions associated with these statements. Overview Cerence builds AI powered virtual assistants for the mobility/transportation market. Our primary target is the automobile market, but our solutions can apply to all forms of transportation including but not limited to two-wheel vehicles, planes, tractors, cruise ships and elevators. Our solutions power natural conversational and intuitive interactions between automobiles, drivers and passengers, and the broader digital world. We possess one of the world’s most popular software platforms for building automotive virtual assistants. Our customers include all major OEMs or their tier 1 suppliers worldwide. We deliver our solutions on a white-label basis, enabling our customers to deliver customized virtual assistants with unique, branded personalities and ultimately strengthening the bond between automobile brands and end users. Our vision is to enable a more enjoyable, safer journey for everyone. Our principal offering is our software platform, which our customers use to build virtual assistants that can communicate, find information and take action across an expanding variety of categories. Our software platform has a hybrid architecture combining edge software components with cloud-connected components. Edge software components are installed on a vehicle’s head unit and can operate without access to external networks and information. Cloud-connected components are comprised of certain speech and natural language understanding related technologies, AI-enabled personalization and context-based response frameworks, and content integration platform. We generate revenue primarily by selling software licenses and cloud-connected services. Our edge software components are typically sold under a traditional per unit perpetual software license model, in which a per unit fee is charged for each software instance installed on an automotive head unit. We typically license cloud-connected software components in the form of a service to the vehicle end user, which is paid for in advance. In addition, we generate professional services revenue from our work with our customers during the design, development and deployment phases of the vehicle model lifecycle and through maintenance and enhancement projects. We have existing relationships with all major OEMs or their tier 1 suppliers, and while our customer contracts vary, they generally represent multi-year engagements, giving us visibility into future revenue. Impact of COVID-19 on our Business As the full impact of the COVID-19 pandemic on our business continues to develop, we are closely monitoring the global situation. We are unable to predict the full impact that COVID-19 will have on our operations, liquidity and financial results, and, depending on the magnitude and duration of the COVID-19 pandemic, such impact may be material. Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends. For further discussion of the business risks associated with COVID-19, see Item 1A, Risk Factors, within this Form 10-K report. Business Trends We experienced total revenue growth of 17.0% and 9.1%, during fiscal year 2021 and fiscal year 2020, respectively, primarily driven by our connected and professional services revenues due to increased market penetration of our connected and professional services solutions. License revenues increased during fiscal 2021 due to higher volume of licensing royalties as the global auto industry recovered from the COVID-19 pandemic and OEMs increased production. 34 During fiscal year 202 1 , t otal cost of revenues decreased by 6.3% , primarily driven by our cost savings initiatives . T otal operating expenses grew by 12.4% during fiscal year 20 2 1 , primarily driven by innovation initiatives in order to increase our competitive position in the market. Our R&D expenses increased 26.1% , as our R&D and engineering workforces refocused on developing new products and advancing our core technologies. Restructuring and other costs, net decreased $11.4 million as expenditures to establish the Cerence business as a standalone public company were not repeated in fiscal 2021. W e anticipate that our R&D expenses will continue to represent a majority of our operating expenses as we focus on innovation and serving our customers. Basis of Presentation Fiscal years 2021 and 2020 The accompanying consolidated financial statements of the Company have been prepared in accordance with GAAP, and the rules and regulations of the SEC. The consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the consolidated results of operations and financial position for the fiscal years presented. All such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of the Company, as well as those of its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation. During the second quarter of fiscal 2021, we identified and corrected immaterial errors related to previously issued consolidated financial statements. In order to present the impact of the resulting adjustments, previously issued financial statements have been revised. See Note 19 – Impact on Previously Issued Financial Statements for Immaterial Adjustments in the Notes to the Consolidated and Combined Financial Statements included in Item 8, Financial Statements and Supplementary Data, within this Form 10-K for additional details. Accordingly, the tables presented in the MD&A reflect the impact of those revisions. The errors had no impact on the discussions related to year-over-year comparisons between fiscal years 2020 and 2019. Fiscal year 2019 Standalone financial statements had not been historically prepared for the Cerence business. The accompanying combined financial statements have been prepared from Nuance Communications, Inc. (“Nuance” or “Parent”)’s historical accounting records and are presented on a “carve out” basis to include the historical financial position, results of operations and cash flows applicable to the Cerence business. As a direct ownership relationship did not exist among all the various business units comprising the Cerence business, Nuance’s investment in the Cerence business was shown in lieu of stockholders’ equity in the combined financial statements. The Combined Statement of Operations included all revenues and costs directly attributable to Cerence as well as an allocation of expenses related to functions and services performed by centralized Parent organizations. These corporate expenses have been allocated to the Cerence business based on direct usage or benefit, where identifiable, with the remainder allocated on a pro rata basis of revenues, headcount, number of transactions or other measures as determined appropriate. The Combined Statement of Cash Flows presented these corporate expenses that are cash in nature as cash flows from operating activities, as this was the nature of these costs at the Parent. Non-cash expenses allocated from the Parent included corporate depreciation and amortization and stock-based compensation included as add-back adjustments to reconcile net income to net cash provided by operations. The combined financial statements included the allocation of certain assets and liabilities that have historically been held at the Nuance corporate level or by shared entities, but which are specifically identifiable or allocable to the Cerence business. These shared assets and liabilities have been allocated to the Cerence business on the basis of direct usage when identifiable, or allocated on a pro rata basis of revenue, headcount or other systematic measures that reflect utilization of the services provided to or benefits received by Cerence. The Parent used a centralized approach to cash management and financing its operations. Accordingly, none of the cash, cash equivalents, marketable securities, foreign currency hedges or debt and related interest expense had been allocated to the Cerence business in the combined financial statements. The Parent’s short and long-term debt had not been pushed down to the Cerence business’s combined financial statements because the Cerence business was not the legal obligor of the debt and the Parent’s borrowings were not directly attributable to the Cerence business. Transactions between the Parent and the Cerence business are considered to be effectively settled in the combined financial statements at the time the transaction was recorded. The total net effect of the settlement of these intercompany transactions was reflected in the Combined Statement of Cash Flows as a financing activity and in the Combined Balance Sheet as net parent investment. All of the allocations and estimates in the combined financial statements are based on assumptions which management believed are reasonable. However, the combined financial statements included herein may not be indicative of the financial position, results of operations and cash flows if the Cerence business had been a separate, standalone entity during the period presented. 35 Key Metrics In evaluating our financial condition and operating performance, we focus on revenue, operating margins, and cash flow from operations. For the fiscal year 2021 as compared to fiscal year 2020: • Total revenue increased by $56.2 million, or 17.0%, from $331.0 million to $387.2 million. • Operating margin increased 8.9 percentage points from 6.8% to 15.7%. • Cash provided by operating activities increased by $29.6 million, or 66.1%, from $44.8 million to $74.4 million. For fiscal year 2020 as compared to fiscal year 2019: • Total revenue increased by $27.7 million, or 9.1%, from $303.3 million to $331.0 million. • Operating margin increased by 3.2 percentage points from 3.6% to 6.8%. • Cash provided by operating activities decreased by $43.3 million, or 49.1%, from $88.1 million to $44.8 million. Operating Results The following table shows the Consolidated Statements of Operations for the fiscal years 2021 and 2020 and the Combined Statement of Operations for the fiscal year 2019 (dollars in thousands): Year Ended September 30, 2021 2020 2019 Revenues: License $ 202,183 $ 164,268 $ 172,379 Connected services 109,534 97,469 78,690 Professional services 75,465 69,230 52,246 Total revenues 387,182 330,967 303,315 Cost of revenues: License 3,544 2,783 2,069 Connected services 25,727 31,768 37,562 Professional services 64,287 64,963 51,214 Amortization of intangibles 7,516 8,337 8,498 Total cost of revenues 101,074 107,851 99,343 Gross profit 286,108 223,116 203,972 Operating expenses: Research and development 112,070 88,899 93,061 Sales and marketing 38,683 33,398 36,261 General and administrative 56,979 49,386 25,926 Amortization of intangible assets 12,690 12,544 12,524 Restructuring and other costs, net 5,092 16,458 24,404 Acquisition-related costs — — 944 Total operating expenses 225,514 200,685 193,120 Income from operations 60,594 22,431 10,852 Interest income 109 585 — Interest expense (13,997 ) (22,737 ) — Other income (expense), net 1,563 (23,319 ) 332 Income (loss) before income taxes 48,269 (23,040 ) 11,184 Provision for (benefit from) income taxes 2,376 (4,724 ) (89,084 ) Net income (loss) $ 45,893 $ (18,316 ) $ 100,268 36 Our revenue consists primarily of license revenue, connected services revenue and revenue from professional services. License revenue primarily consists of license royalties associated with our edge software components, with costs of license revenue primarily consisting of third-party royalty expenses for certain external technologies we leverage. Connected services revenue represents the subscription fee that provides access to our connected services components, including the customization and construction of our connected services solutions. Cost of connected service revenue primarily consists of labor costs of software delivery services, infrastructure, and communications fees that support our connected services solutions. Professional services revenue is primarily comprised of porting, integrating, and customizing our embedded solutions, with costs primarily consisting of compensation for services personnel, contractors and overhead. Our operating expenses include R&D, sales and marketing and general and administrative expenses. R&D expenses primarily consist of salaries, benefits, and overhead relating to research and engineering staff. Sales and marketing expenses includes salaries, benefits, and commissions related to our sales, product marketing, product management, and business unit management teams. General and administrative expenses primarily consist of personnel costs for administration, finance, human resources, general management, fees for external professional advisers including accountants and attorneys, and provisions for credit losses. Amortization of acquired patents and core technology are included within cost of revenues whereas the amortization of other intangible assets, such as acquired customer relationships, trade names and trademarks, are included within operating expenses. Customer relationships are amortized over their estimated economic lives based on the pattern of economic benefits expected to be generated from the use of the asset. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. Restructuring and other costs, net include restructuring expenses as well as other charges that are unusual in nature, are the result of unplanned events, and arise outside the ordinary course of our business. Acquisition-related costs include transition and integration costs, professional service fees, and fair value adjustments related to business and asset acquisitions, including potential acquisitions. Total other expense, net consists primarily of foreign exchange gains (losses), losses on the extinguishment of debt and interest expense related to Existing Facilities, Notes, and Senior Credit Facilities. Fiscal Year 2021 Compared with Fiscal Year 2020 and Fiscal Year 2020 Compared with Fiscal Year 2019 Total Revenues The following table shows total revenues by product type, including the corresponding percentage change (dollars in thousands): Year Ended September 30, % Change % Change 2021 % of Total 2020 % of Total 2019 % of Total 2021 vs. 2020 2020 vs. 2019 License $ 202,183 52.2% $ 164,268 49.6% $ 172,379 56.8% 23.1 % (4.7 )% Connected services 109,534 28.3% 97,469 29.5% 78,690 26.0% 12.4 % 23.9 % Professional services 75,465 19.5% 69,230 20.9% 52,246 17.2% 9.0 % 32.5 % Total revenues $ 387,182 $ 330,967 $ 303,315 17.0 % 9.1 % 37 Fiscal Year 2021 Compared with Fiscal Year 2020 Total revenues fiscal year 2021 were $387.2 million, an increase of $56.2 million, or 17.0%, from $331.0 million from fiscal year 2020. The increase in revenues occurred across all product types. License Revenue License revenue for fiscal year 2021 was $202.2 million, an increase of $37.9 million, or 23.1%, from $164.3 million for fiscal year 2020. The increase in license revenue was primarily due to higher volume of licensing royalties as the global auto industry recovered from the COVID-19 pandemic and OEMs increased production. As a percentage of total revenue, license revenue increased by 2.6 percentage points from 49.6% for fiscal year 2020 to 52.2% for fiscal year 2021. Currently, the global automotive industry is experiencing a semiconductor shortage. We are unable to predict the full extent this will have on our business, including our license revenue. Connected Services Revenue Connected services revenue for fiscal year 2021 was $109.5 million, an increase of $12.0 million, or 12.4%, from $97.5 million for fiscal year 2020. This increase was primarily driven by continued market penetration from our connected services solutions as our customers increasingly deploy hybrid solutions. As a percentage of total revenue, connected services revenue decreased by 1.2 percentage points from 29.5% for fiscal year 2020 to 28.3% for fiscal year 2021. Professional Services Revenue Professional services revenue for fiscal year 2021 was $75.5 million, an increase of $6.3 million, or 9.0%, from $69.2 million for fiscal year 2020. This increase was primarily driven by demand for the integration and customization services related to our edge software and the timing of services rendered. As a percentage of total revenue, professional services revenue decreased by 1.4 percentage points from 20.9% for fiscal year 2020 to 19.5% for fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 Our total revenues for fiscal year 2020 were $331.0 million, an increase of $27.7 million, or 9.1%, from $303.3 million from fiscal year 2019. This growth was primarily driven by increased demand for our connected and professional solutions. License Revenue License revenue for fiscal year 2020 was $164.3 million, a decrease of $8.1 million, or 4.7%, from $172.4 million for fiscal year 2019. The decrease in license revenue was driven by the COVID-19 pandemic, which resulted in declining reported royalties from ongoing agreements. As a percentage of total revenue, license revenue decreased by 7.2 percentage points from 56.8% for fiscal year 2019 to 49.6% for fiscal year 2020. Connected Services Revenue Connected services revenue for fiscal year 2020 was $97.5 million, an increase of $18.8 million, or 23.9%, from $78.7 million for fiscal year 2019. This increase was primarily driven by continued market penetration from our connected services solutions as our customers increasingly deploy hybrid solutions. As a percentage of total revenue, connected services revenue increased by 3.5 percentage points from 26.0% for fiscal year 2019 to 29.5% for fiscal year 2020. Professional Services Revenue Professional services revenue for fiscal year 2020 was $69.2 million, an increase of $17.0 million, or 32.5%, from $52.2 million for fiscal year 2019. This increase was primarily driven by demand for the integration and customization services related to our edge software and the timing of services rendered. As a percentage of total revenue, professional services revenue increased by 3.7 percentage points from 17.2% for fiscal year 2019 to 20.9% for fiscal year 2020. 38 Total Cost of Revenues and Gross Profits The following table shows total cost of revenues by product type and the corresponding percentage change (dollars in thousands): Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 License $ 3,544 $ 2,783 $ 2,069 27.3 % 34.5 % Connected services 25,727 31,768 37,562 (19.0 )% (15.4 )% Professional services 64,287 64,963 51,214 (1.0 )% 26.8 % Amortization of intangibles 7,516 8,337 8,498 (9.8 )% (1.9 )% Total cost of revenues $ 101,074 $ 107,851 $ 99,343 (6.3 )% 8.6 % The following table shows total gross profit by product type and the corresponding percentage change (dollars in thousands): Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 License $ 198,639 $ 161,485 $ 170,310 23.0 % (5.2 )% Connected services 83,807 65,701 41,128 27.6 % 59.7 % Professional services 11,178 4,267 1,032 162.0 % 313.5 % Amortization of intangibles (7,516 ) (8,337 ) (8,498 ) (9.8 )% (1.9 )% Total gross profit $ 286,108 $ 223,116 $ 203,972 28.2 % 9.4 % Fiscal Year 2021 Compared with Fiscal Year 2020 Total cost of revenues for fiscal year 2021 were $101.1 million, a decrease of $6.8 million, or 6.3%, from $107.9 million for fiscal year 2020. The decrease in cost of revenues resulted primarily from our cost savings initiatives implemented in the second half of fiscal 2020. We experienced an increase in total gross profit of $63.0 million, or 28.2%, from $223.1 million to $286.1 million. The increase was primarily driven by our license and connected services solutions. Cost of License Revenue Cost of license revenue for fiscal year 2021 was $3.5 million, an increase of $0.7 million, or 27.3%, from $2.8 million for fiscal year 2020. Cost of license revenues increased due to third-party royalty expenses associated with external technologies we leverage in our edge software components. As a percentage of total cost of revenue, cost of license revenue increased by 0.9 percentage points from 2.6% for fiscal year 2020 to 3.5% for fiscal year 2021. License gross profit increased by $37.2 million, or 23.0%, primarily due to license revenue growth during fiscal year 2021. Cost of Connected Services Revenue Cost of connected services revenue for fiscal year 2021 was $25.7 million, a decrease of $6.1 million, or 19.0%, from $31.8 million for fiscal year 2020. Cost of connected services revenue decreased primarily due to a $1.8 million decrease in salary-related expenditures, $1.8 million decrease in third-party contractor costs, $1.7 million decrease from lower internal allocated labor, $1.7 million decrease in depreciation costs, $0.7 million decrease in cloud infrastructure costs and $0.5 million decrease in stock-based compensation. These decreases were partly offset by a $3.2 million increase in amortization of costs previously deferred. As a percentage of total cost of revenue, cost of connected service revenue decreased by 4.0 percentage points from 29.5% for fiscal year 2020 to 25.5% for fiscal year 2021. Connected services gross profit increased $18.1 million, or 27.6%, from $65.7 million to $83.8 million which was primarily due to connected services revenue growth and cost savings initiatives. 39 Cost of Professional Services Revenue Cost of professional services revenue for fiscal year 2021 was $64.3 million, a decrease of $0.7 million, or 1.0%, from $65.0 million for fiscal year 2020. Cost of professional services revenue decreased primarily due to $5.1 million in lower internal allocated labor, and a $1.9 million decrease in third-party contractor cost. The decrease was partly offset by a $3.2 million increase in salary-related expenditures and $2.3 million increase in amortization of costs previously deferred. As a percentage of total cost of revenue, cost of professional services revenue increased by 3.4 percentage points from 60.2% for fiscal year 2020 to 63.6% for fiscal year 2021. Professional services gross profit increased $6.9 million, or 162.0%, from $4.3 million to $11.2 million which was primarily due to increases in professional services revenue recognized and continued cost reduction measures. Fiscal Year 2020 Compared with Fiscal Year 2019 Our total cost of revenues for fiscal year 2020 were $107.9 million, an increase of $8.6 million, or 8.6%, from $99.3 million for fiscal year 2019. The increase in cost of revenues resulted primarily from our investments in professional services staff to meet customer program demands. We experienced an increase in gross profit of $19.1 million, or 9.4%, from $204.0 million to $223.1 million which was primarily driven by increased demand for our connected services solutions and professional services. Cost of License Revenue Cost of license revenue for fiscal year 2020 were $2.8 million, an increase of $0.7 million, or 34.5%, from $2.1 million for fiscal year 2019. Cost of license revenues increased due to third-party royalty expenses associated with external technologies we leverage in our edge software components. As a percentage of total cost of revenue, cost of license revenue increased by 0.5 percentage points from 2.1% for fiscal year 2019 to 2.6% for fiscal year 2020. License gross profit decreased $8.8 million, or 5.2%, from $170.3 million to $161.5 million, which was primarily due to declines in license revenue recognized during the year. Cost of Connected Services Revenue Cost of connected services revenue for fiscal year 2020 were $31.8 million, a decrease of $5.8 million, or 15.4%, from $37.6 million for fiscal year 2019. Cost of connected services revenue decreased primarily as a result of lower internal allocated costs. As a percentage of total cost of revenue, cost of connected service revenue decreased by 8.3 percentage points from 37.8% for fiscal year 2019 to 29.5% for fiscal year 2020. Connected services gross profit increased $24.6 million, or 59.7%, from $41.1 million to $65.7 million, which was primarily due to connected services revenue growth on relatively fixed cloud infrastructure costs. Cost of Professional Services Revenue Cost of professional services revenue for fiscal year 2020 were $65.0 million, an increase of $13.8 million, or 26.8%, from $51.2 million for fiscal year 2019. Cost of professional services revenue increased primarily due to our investments in professional services staff to meet customer program demands. Investments included increases in internally allocated labor costs of $4.3 million, compensation-related expenses of $3.3 million, and stock-based compensation expenses of $3.1 million. As a percentage of total cost of revenue, cost of professional services revenue increased by 8.6 percentage points from 51.6% for fiscal year 2019 to 60.2% for fiscal year 2020. Professional services gross profit increased $3.3 million, or 313.5%, from $1.0 million to $4.3 million, which was primarily due to increases in professional services revenue recognized and continued cost reduction measures. Operating Expenses The tables below show each component of operating expense. Other income (expense), net and provision for income taxes are non-operating expenses and presented in a similar format (dollars in thousands). 40 R&D Expenses Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Research and development $ 112,070 $ 88,899 $ 93,061 26.1 % (4.5 )% Fiscal Year 2021 Compared with Fiscal Year 2020 Historically, R&D expenses are our largest operating expense as we continue to build on our existing software platforms and develop new technologies. R&D expenses for fiscal year 2021 were $112.1 million, an increase of $23.2 million, or 26.1%, from $88.9 million for fiscal year 2020. The increase in R&D expenses was primarily attributable to a $11.5 million increase in salary-related expenditures driven by headcount growth, as well as a $5.4 million increase in third-party contractor costs, a $2.6 million increase in stock-based compensation and a $6.5 million reduction in labor allocated to support our customer projects partially offset by a $5.1 million increase of capitalized cost associated with internally developed software. As a percentage of total operating expenses, R&D expenses increased by 5.4 percentage points from 44.3% for fiscal year 2020 to 49.7% for fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 R&D expenses for fiscal year 2020 were $88.9 million, a decrease of $4.2 million, or 4.5%, from $93.1 million for fiscal year 2019. In response to the COVID-19 pandemic, we shifted a portion of our R&D workforce to support our professional service teams, which led to a decline in R&D expenses as a result of internal labor cost allocations. R&D costs also declined due to capitalization of costs associated with internally developed software of $2.7 million and reduction of stock-based compensation of $2.0 million. The decline in R&D expenses were partially offset by a $0.8 million increase in contractor costs. As a percentage of total operating expenses, R&D expenses decreased by 3.9 percentage points from 48.2% for fiscal year 2019 to 44.3% for fiscal year 2020. Sales & Marketing Expenses Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Sales and marketing $ 38,683 $ 33,398 $ 36,261 15.8 % (7.9 )% Fiscal Year 2021 Compared with Fiscal Year 2020 Sales and marketing expenses for fiscal year 2021 were $38.7 million, an increase of $5.3 million, or 15.8%, from $33.4 million for fiscal year 2020. The increase in sales and marketing expenses was primarily attributable to $3.1 million increase in salary related expenses, $3.0 million increase related to stock-based compensation, and $0.4 million related to commission expenses. The increase was partly offset by a reduction of $0.9 million in travel-related expenditures as a result of COVID-19 and $0.7 million in marketing spending. As a percentage of total operating expenses, sales and marketing expenses increased by 0.6 percentage points from 16.6% for fiscal year 2020 to 17.2% for fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 Sales and marketing expenses for fiscal year 2020 were $33.4 million, a decrease of $2.9 million, or 7.9%, from $36.3 million for fiscal year 2019. Sales and marketing expenses decreased primarily due lower compensation related expenses, including $1.9 million attributed to salary-related expenses and $2.7 million related to commission expenses. We also experienced a reduction of $1.1 million in travel-related expenditures as a result of COVID-19. The decrease was partly offset by stock-based compensation expenses, which increased $3.4 million. As a percentage of total operating expenses, sales and marketing expenses decreased by 2.2 percentage points from 18.8% for fiscal year 2019 to 16.6% for fiscal year 2020. General & Administrative Expenses Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 General and administrative $ 56,979 $ 49,386 $ 25,926 15.4 % 90.5 % 41 Fiscal Year 2021 Compared with Fiscal Year 2020 General and administrative expenses for fiscal year 2021 were $57.0 million, an increase of $7.6 million, or 15.4%, from $49.4 million for fiscal year 2020. The increase in general and administrative expenses was primarily attributable to $7.5 million increase in stock-based compensation, a $2.1 million increase in depreciation, a $1.8 million increase in professional service fees and a $1.4 million increase in salary-related expenses. The increases were partly offset by a $1.2 million decrease in third-party contractor costs, a $1.1 million decreases in bad debt expenses and $0.6 million decrease in travel-related expenditures as a result of COVID-19. As a percentage of total operating expenses, general and administrative expenses increased by 0.7 percentage points from 24.6% for fiscal year 2020 to 25.3% for fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 General and administrative expenses for fiscal year 2020 were $49.4 million, an increase of $23.5 million, or 90.5%, from $25.9 million for fiscal year 2019. General and administrative expenses increased primarily due to our operation as a standalone public company during fiscal year 2020. We incurred higher compensation related expenses, including $8.5 million attributed to salary-related expenses and $12.5 attributed to stock-based compensation expenses. In addition, professional service expenses increased $3.0 million. As a percentage of total operating expenses, general and administrative expenses increased by 11.2 percentage points from 13.4% for fiscal year 2019 to 24.6% for fiscal year 2020. Amortization of Intangible Assets Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Cost of revenues $ 7,516 $ 8,337 $ 8,498 (9.8 )% (1.9 )% Operating expense 12,690 12,544 12,524 1.2 % 0.2 % Total amortization $ 20,206 $ 20,881 $ 21,022 (3.2 )% (0.7 )% Fiscal Year 2021 Compared with Fiscal Year 2020 Intangible asset amortization for fiscal year 2021 was $20.2 million, a decrease of $0.7 million, or 3.2%, from $20.9 million for fiscal year 2020. The decrease primarily relates to certain intangible assets having been fully amortized during fiscal year 2020. As a percentage of total cost of revenues, intangible asset amortization within cost of revenues decreased by 0.3 percentage points from 7.7% for fiscal year 2020 to 7.4% for fiscal year 2021. As a percentage of total operating expenses, intangible asset amortization expenses within operating expenses decreased by 0.7 percentage points from 6.3% for fiscal year 2020 to 5.6% for fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 Intangible asset amortization for fiscal year 2020 was $20.9 million, a decrease of $0.1 million, or 0.7%, from $21.0 million for fiscal year 2019. The decrease primarily relates to the composition of intangible assets allocated to the Cerence business prior to Spin-Off. As a percentage of total cost of revenues, intangible asset amortization within cost of revenues decreased by 0.9 percentage points from 8.6% for fiscal year 2019 to 7.7% for fiscal year 2020. As a percentage of total operating expenses, intangible asset amortization expenses within operating expenses decreased by 0.2 percentage points from 6.5% for fiscal year 2019 to 6.3% for fiscal year 2020. 42 Restructuring and Other Costs, Net Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Restructuring and other costs, net $ 5,092 $ 16,458 $ 24,404 (69.1 )% (32.6 )% Fiscal Year 2021 Compared with Fiscal Year 2020 Restructuring and other costs, net for fiscal year 2021 were $5.1 million, a decrease of $11.4 million, from $16.5 million for fiscal year 2020. The decrease in restructuring and other costs, net was primarily driven by a $10.6 million decrease in expenditures to establish the Cerence business as a standalone public company. As a percentage of total operating expense, restructuring and other costs, net decreased by 5.9 percentage points from 8.2% for fiscal year 2020 to 2.3% for fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 Restructuring and other costs, net for fiscal year 2020 were $16.5 million, a decrease of $7.9 million, from $24.4 million for fiscal year 2019. Restructuring and other costs, net decreased primarily due to the winding down of separation costs to establish the Cerence business as a standalone public company, which decreased $10.8 million. The decrease was partly offset by the $3.6 million increase in severance charges related to the elimination of personnel across multiple functions and the $1.1 million increase in facilities related charges. As a percentage of total operating expense, restructuring and other costs, net decreased by 4.4 percentage points from 12.6% for fiscal year 2019 to 8.2% for fiscal year 2020. Acquisition-related Costs Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Acquisition-related costs $ - $ - $ 944 — (100.0 )% Fiscal Year 2020 Compared with Fiscal Year 2019 There were no acquisition-related costs for fiscal year 2020, which resulted in a decrease of $0.9 million, from $0.9 million for fiscal year 2019. Acquisition costs decreased as a direct result of integration, legal, and other professional fees incurred resulting from the acquisition of Voicebox on April 2, 2018. As a percentage of total operating expense, acquisition-related costs decreased by 0.5 percentage points from 0.5% for fiscal year 2019 to 0.0% for fiscal year 2020. Total Other Expense, Net Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Interest income $ 109 $ 585 $ - (81.4 )% — Interest expense (13,997 ) (22,737 ) - (38.4 )% — Other income (expense), net 1,563 (23,319 ) 332 (106.7 )% (7123.8 )% Total other income (expense), net $ (12,325 ) $ (45,471 ) $ 332 (72.9 )% (13796.1 )% Fiscal Year 2021 Compared with Fiscal Year 2020 Total other expense, net for fiscal year 2021 was $12.3 million, a decrease of $33.2 million from $45.5 million of expense for fiscal year 2020. The decrease in interest expense and other income (expense), net is primarily attributed to our debt refinancing in June 2020. During fiscal year 2020, we recognized a $19.3 million loss on the extinguishment of debt. 43 Fiscal Year 20 20 Compared with Fiscal Year 201 9 Total other expense, net for fiscal year 2020 was $45.5 million, an increase of $45.8 million from total other income, net of $0.3 million for fiscal year 2019. The increase was primarily attributable to $22.7 million in interest expense related to our debt financings during fiscal year 2020, a $19.3 million loss on the extinguishment of debt related to our Existing Facilities and $1.2 million of expense related to a decrease in an asset corresponding with the release of indemnified pre-Spin-Off liabilities for uncertain tax positions. Provision for (Benefit from) Income Taxes Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Provision for (benefit from) income taxes $ 2,376 $ (4,724 ) $ (89,084 ) (150.3 )% (94.7 )% Effective income tax rate% 4.9 % 20.5 % (796.5 )% Fiscal Year 2021 Compared with Fiscal Year 2020 Our effective income tax rate for fiscal year 2021 was 4.9%, compared to 20.5% for fiscal year 2020. Consequently, our provision for income taxes for fiscal year 2021 was $2.4 million, a net change of $7.1 million, or 150.3%, from a benefit from income taxes of $4.7 million for fiscal year 2020. The effective tax rate for the fiscal year 2021 differed from the U.S. federal statutory rate of 21.0%, primarily due to our composition of jurisdictional earnings, U.S. inclusions of foreign taxable income as a result of changes in applicable tax laws in 2017, and an income tax benefit of approximately $15.9 million related to an increase in tax rates in the Netherlands enacted in the first quarter of fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 Our effective income tax rate for fiscal year 2020 was 20.5%, compared to negative 796.5% for fiscal year 2019. Consequently, our benefit from income taxes for fiscal year 2020 was $4.7 million, a net change of $84.4 million, or 94.7%, from $89.1 million for fiscal year 2019. The effective income tax rate for fiscal year 2020 differed from the U.S. statutory rate of 21.0% primarily due to our composition of jurisdictional earnings, U.S. inclusions of foreign taxable income as a result of changes in applicable tax laws in 2017, and an income tax benefit of approximately $5.0 million related to an increase in tax rates in the Netherlands enacted in the first quarter of fiscal year 2020. Liquidity and Capital Resources Financial Condition As of September 30, 2021, we had $166.2 million in cash, cash equivalents, and marketable securities. Cash equivalents include highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less. Marketable securities include commercial paper and corporate bonds. As of September 30, 2021, our net working capital, excluding deferred revenue and deferred costs, was $194.0 million. This balance is representative of the short-term net cash inflows based on the working capital at that date. Sources and Material Cash Requirements Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flows we generated from our operations. The primary uses of cash include costs of revenues, funding of R&D activities, capital expenditures and debt obligations. Our ability to fund future operating needs will depend on our ability to generate positive cash flows from operations and finance additional funding in the capital markets as needed. Based on our history of generating positive cash flows and the $166.2 million of cash, cash equivalents and marketable securities as of September 30, 2021, we believe we will be able to meet our liquidity needs over the next 12 months. We believe we will meet longer-term expected future cash requirements and obligations, through a combination of cash flows from operating activities, available cash balances, and available credit via our Revolving Facility. 44 The following table presents our material cash requirements for future periods: Material Cash Requirements Due by the Year Ended September 30, 2022 2023 - 2024 2025 - 2026 Thereafter Total Notes $ - $ - $ 175,000 $ - $ 175,000 Interest payable on the Notes (a) 5,246 10,507 3,507 - 19,260 Senior Credit Facilities 6,250 23,438 87,500 - 117,188 Interest payable on Senior Credit Facilities (b) 2,708 4,762 839 - 8,309 Operating leases 5,289 7,835 3,844 1,521 18,489 Operating leases under restructuring (c) 100 24 396 198 718 Finance leases 480 885 415 - 1,780 Total material cash requirements $ 20,073 $ 47,451 $ 271,501 $ 1,719 $ 340,744 (a) Interest per annum is due and payable semiannually and is determined based on the outstanding principal as of September 30, 2021. (b) Interest per annum is due and payable monthly and is determined based on the outstanding principal as of September 30, 2021. (c) Contractual lease commitments are shown net of sublease income related to certain facilities. As of September 30, 2021, we anticipate sublease income of $2.3 million through fiscal year 2024. We sponsor certain defined benefit plans that are offered primarily by certain of our foreign subsidiaries. Many of these plans were assumed as part of the Spin-Off or are required by local regulatory requirements. We may deposit funds for these plans with insurance companies, third-party trustees, or into government-managed accounts consistent with local regulatory requirements, as applicable. The aggregate net liability of our defined benefit plans as of September 30, 2021 was $8.7 million. As the impact of the COVID-19 pandemic on the economy and our operations evolves, we will continue to assess our liquidity needs. Should we need to secure additional sources of liquidity, we believe that we could finance our needs through the issuance of equity securities or debt offerings. However, we cannot guarantee that we will be able to obtain financing through the issuance of equity securities or debt offerings on reasonable terms. The COVID-19 pandemic has negatively impacted the global economy and created significant volatility and disruption of financial markets. An extended period of economic disruption could materially affect our business, results of operations, ability to meet debt covenants, access to sources of liquidity and financial condition. 3.00% Senior Convertible Notes due 2025 On June 2, 2020, in an effort to refinance our debt structure, we issued $175.0 million in aggregate principal amount of 3.00% Convertible Senior Notes due 2025 (the “Notes”), including the initial purchasers’ exercise in full of their option to purchase an additional $25.0 million principal amount of the Notes, between us and U.S. Bank National Association, as trustee (the “Trustee”), in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). The net proceeds from the issuance of the Notes were $169.8 million after deducting transaction costs. We used net proceeds from the issuance of the Notes to repay a portion of our indebtedness under the Credit Agreement, dated October 1, 2019, by and among us, the lenders and issuing banks party thereto and Barclays Bank PLC, as administrative agent (the “Existing Facility”). The Notes are senior, unsecured obligations and will accrue interest payable semiannually in arrears on June 1 and December 1 of each year, beginning on December 1, 2020, at a rate of 3.00% per year. The Notes will mature on June 1, 2025, unless earlier converted, redeemed, or repurchased. The Notes are convertible into cash, shares of our common stock or a combination of cash and shares of our common stock, at our election. As of September 30, 2021, the if-converted value of the Notes exceeds its principal amount by $274.5 million. A holder of Notes may convert all or any portion of its Notes at its option at any time prior to the close of business on the business day immediately preceding March 1, 2025 only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ending on September 30, 2020 (and only during such fiscal quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any ten consecutive trading day period (the “measurement period”) in which the “trading price” per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; (3) if we call such Notes for redemption, at any time prior to the close of business on the business day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events. On or after March 1, 2025 until the close of business on the second scheduled trading day immediately preceding the maturity date, a holder may convert all or any portion of its Notes at any time, regardless of the foregoing. 45 The conversion rate will initially be 26.7271 shares of our common stock per $1,000 principal amount of Notes (equivalent to an initial conversion price of approximately $37.42 per share of our common stock). The conversion rate is subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, following certain corporate events that occur prior to the maturity date or if we deliver a notice of redemption, we will, in certain circumstances, increase the conversion rate for a holder who elects to convert its Notes in connection with such a corporate event or convert its Notes called for redemption in connection with such notice of redemption, as the case may be. We may not redeem the Notes prior to June 5, 2023. We may redeem for cash all or any portion of the Notes, at our option, on a redemption date occurring on or after June 5, 2023 and on or before the 31st scheduled trading day immediately before the maturity date, if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date on which we provide notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the Notes. If we undergo a “fundamental change”, subject to certain conditions, holders may require us to repurchase for cash all or any portion of their Notes at a fundamental change repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date. The indenture governing the Notes contains customary terms and covenants, including that upon certain events of default occurring and continuing, either the Trustee or the holders of not less than 25% in aggregate principal amount of the Notes then outstanding may declare the entire principal amount of all the Notes plus accrued special interest, if any, to be immediately due and payable. At issuance, we accounted for the Notes by allocating proceeds from the Notes into debt and equity components according to the accounting standards for convertible debt instruments that may be fully or partially settled in cash upon conversion. The initial carrying amount of the debt component, which approximates its fair value, was estimated by using an interest rate for nonconvertible debt, with terms similar to the Notes. The excess of the principal amount of the Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The debt discount is accreted to the carrying value of the Notes over their expected term as interest expense using the interest method. Upon issuance of the Notes, we recorded $155.3 million as debt and $19.7 million as additional paid-in capital in stockholders’ equity. We incurred transaction costs of $5.6 million relating to the issuance of the Notes. In accounting for these costs, we allocated the costs of the offering between debt and equity in proportion to the fair value of the debt and equity recognized. The transaction costs allocated to the debt component of approximately $5.0 million were recorded as a direct deduction from the face amount of the Notes and are being amortized as interest expense over the term of the Notes using the interest method. The transaction costs allocated to the equity component of approximately $0.6 million were recorded as a decrease in additional paid-in capital. The interest expense recognized related to the Notes for the fiscal years ended September 30, 2021 and 2020 was as follows (dollars in thousands): Year Ended September 30, 2021 2020 Contractual interest expense $ 5,246 $ 1,753 Amortization of debt discount 3,527 1,131 Amortization of issuance costs 887 285 Total interest expense related to the Notes $ 9,660 $ 3,169 The conditional conversion feature of the Notes was triggered during the fiscal year ended September 30, 2021, and the Notes were convertible as of September 30, 2021, with no Notes being converted. Whether any of the Notes will be converted in future quarters will depend on the satisfaction of one or more of the conversion conditions in the future. If one or more holders elect to convert their Notes at a time when any such Notes are convertible, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional shares), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. 46 Senior Credit Facilities On June 12, 2020 (the “Financing Closing Date”), in connection with our effort to refinance our existing indebtedness, we entered into a Credit Agreement, by and among the Borrower, the lenders and issuing banks party thereto and Wells Fargo Bank, N.A., as administrative agent (the “Credit Agreement”), consisting of a four-year senior secured term loan facility in the aggregate principal amount of $125.0 million (the “Term Loan Facility”). The net proceeds from the issuance of the Term Loan Facility were $123.0 million, which together with proceeds from the Notes was intended to pay in full all indebtedness under the Existing Facility, and paid fees and expenses in connection with the Senior Credit Facilities. We also entered into a senior secured first-lien revolving credit facility in an aggregate principal amount of $50.0 million (the “Revolving Facility” and, together with the Term Loan Facility, the “Senior Credit Facilities”), which shall be drawn on in the event that our working capital and other cash needs are not supported by our operating cash flow. As of September 30, 2021, there were no amounts outstanding under the Revolving Facility. Our obligations under the Credit Agreement are jointly and severally guaranteed by certain of our existing and future direct and indirect wholly owned domestic subsidiaries, subject to certain exceptions customary for financings of this type. All obligations are secured by substantially all of our tangible and intangible personal property and material real property, including a perfected first-priority pledge of all (or, in the case of foreign subsidiaries or subsidiaries (“FSHCO”) that own no material assets other than equity interests in foreign subsidiaries that are “controlled foreign corporations” or other FSHCOs, 65%) of the equity securities of our subsidiaries held by any loan party, subject to certain customary exceptions and limitations. On December 17, 2020 (the “Amendment No. 1 Effective Date”), we entered into Amendment No. 1 to the Credit Agreement (the “Amendment”). The Amendment extended the scheduled maturity date of the revolving credit and term facilities from June 12, 2024 to April 1, 2025. The Amendment revised certain interest rates in the Credit Agreement. Following delivery of a compliance certificate for the first full fiscal quarter after the Amendment No. 1 Effective Date, the applicable margins for the revolving credit and term facilities is subject to a pricing grid based upon the net total leverage ratio as follows (i) if the net total leverage ratio is greater than 3.00 to 1.00, the applicable margin is LIBOR plus 3.00% or ABR plus 2.00%; (ii) if the net total leverage ratio is less than or equal to 3.00 to 1.00 but greater than 2.50 to 1.00, the applicable margin is LIBOR plus 2.75% or ABR plus 1.75%; (iii) if the net total leverage ratio is less than or equal to 2.50 to 1.00 but greater than 2.00 to 1.00, the applicable margin is LIBOR plus 2.50% or ABR plus 1.50%; (iv) if the net total leverage ratio is less than or equal to 2.00 to 1.00 but greater than 1.50 to 1.00, the applicable margin is LIBOR plus 2.25% or ABR plus 1.25%; and (v) if the net total leverage ratio is less than or equal to 1.50 to 1.00, the applicable margin is LIBOR plus 2.20% or ABR plus 1.00%. As a result of the Amendment, the applicable LIBOR floor was reduced from 0.50% to 0.00%. From the Amendment No. 1 Effective Date until the fiscal quarter ended December 31, 2020, the interest rate was LIBOR plus 2.50%. For the three months ended March 31, 2021, the interest rate was LIBOR plus 2.25%. For the three months ended June 30, 2021, the interest rate was LIBOR plus 2.25%. For the three months ended September 30, 2021, the interest rate was LIBOR plus 2.25%. Total interest expense relating to the Senior Credit Facilities for the fiscal year ended September 30, 2021 and 2020 was $4.1 million and $1.5 million, respectively, reflecting the coupon and accretion of the discount. In addition, the quarterly commitment fee required to be paid based on the unused portion of the Revolving Facility is subject to a pricing grid based upon the net total leverage ratio as follows (i) if the net total leverage ratio is greater than 3.00 to 1.00, the unused line fee is 0.500%; (ii) if the net total leverage ratio is less than or equal to 3.00 to 1.00 but greater than 2.50 to 1.00, the unused line fee is 0.450%; (iii) if the net total leverage ratio is less than or equal to 2.50 to 1.00 but greater than 2.00 to 1.00, the unused line fee is 0.400%; (iv) if the net total leverage ratio is less than or equal to 2.00 to 1.00 but greater than 1.50 to 1.00, the unused line fee is 0.350%; and (v) if the net total leverage ratio is less than or equal to 1.50 to 1.00, the unused line fee is 0.300%. The Amendment revised the amount by which we are obligated to make quarterly principal payments. Through the fiscal quarter ending December 31, 2022, we are obligated to make quarterly principal payments in an aggregate amount equal to 1.25% of the original principal amount of the Term Loan Facility. From the fiscal quarter ending March 31, 2023 and for each fiscal quarter thereafter, we are obligated to make quarterly principal payments in an aggregate amount equal to 2.50% of the original principal amount of the Term Loan Facility, with the balance payable at the maturity date thereof. Borrowings under the Credit Agreement are prepayable at our option without premium or penalty. We may request, and each lender may agree in its sole discretion, to extend the maturity date of all or a portion of the Senior Credit Facilities subject to certain conditions customary for financings of this type. The Credit Agreement also contains certain mandatory prepayment provisions in the event that we incur certain types of indebtedness or receives net cash proceeds from certain non-ordinary course asset sales or other dispositions of property, in each case subject to terms and conditions customary for financings of this type. 47 The Credit Agreement contains certain affirmative and negative covenants customary for financings of this type that, among other things, limit our and our subsidiaries’ ability to incur additional indebtedness or liens, to dispose of assets, to make certain fundamental changes, to designate subsidiaries as unrestricted, to make certain investments, to prepay certain indebtedness and to pay dividends, or to make other distributions or redemptions/repurchases, in respect of our and our subsidiaries’ equity interests. In addition, the Credit Agreement contains financial covenants, each tested quarterly, (1) a net secured leveraged ratio of not greater than 3.25 to 1.00; (2) a net total leverage ratio of not greater than 4.25 to 1.00; and (3) minimum liquidity of at least $75 million. The Credit Agreement also contains events of default customary for financings of this type, including certain customary change of control events. As of September 30, 202 1 , we were in compliance with all Credit Agreement covenants. Cash Flows Cash flows from operating, investing and financing activities for the fiscal years ended September 30, 2021, 2020, and 2019, as reflected in the audited Consolidated and Combined Statements of Cash Flows included in Item 8 of this Form 10-K, are summarized in the following table (dollars in thousands): Year Ended September 30, % Change % Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 Net cash provided by operating activities $ 74,389 $ 44,789 $ 88,071 66.1 % (49.1 )% Net cash used in investing activities (41,631 ) (30,675 ) (4,517 ) 35.7 % 579.1 % Net cash (used in) provided by financing activities (41,505 ) 121,553 (83,554 ) (134.1 )% (245.5 )% Effect of foreign currency exchange rates on cash and cash equivalents 1,108 400 — 177.0 % 100.0 % Net changes in cash and cash equivalents $ (7,639 ) $ 136,067 $ — (105.6 )% 100.0 % Net Cash Provided by Operating Activities Fiscal Year 2021 Compared with Fiscal Year 2020 Net cash provided by operating activities for fiscal year 2021 was $74.4 million, a net increase of $29.6 million, or 66.1%, from net cash provided by operating activities of $44.8 million for fiscal year 2020. The change in cash flows were primarily due to: • An increase of $62.0 million from income before non-cash charges • A decrease of $22.7 million due to unfavorable changes in working capital primarily related to cash outflows from accrued expenses and other liabilities; and • A decrease of $9.7 million from changes in deferred revenue. Deferred revenue represents a significant portion of our net cash provided by operating activities and, depending on the nature of our contracts with customers, this balance can fluctuate significantly from period to period. We expect our deferred revenue balances to decrease in the future, including due to a wind-down of a legacy connected service relationship with a major OEM, since the majority of cash from the contract has been collected. We do not expect any changes in deferred revenue to affect our ability to meet our obligations. Fiscal Year 2020 Compared with Fiscal Year 2019 Net cash provided by operating activities for fiscal year 2020 was $44.8 million, a decrease of $43.3 million, or 49.1%, from $88.1 million for fiscal year 2019. The net decrease in cash provided by operating activities stems from unfavorable changes in working capital. Outflows in prepaids and other assets and accounts payable increased by $21.5 million and $12.6 million, respectively. The timing of billings and collections resulted in $14.3 million additional cash inflows from accounts receivable compared to prior year. Net Cash Used in Investing Activities Fiscal Year 2021 Compared with Fiscal Year 2020 Net cash used in investing activities for the fiscal year 2021 was $41.6 million, an increase of $10.9 million, or 35.7%, from $30.7 million for fiscal year 2020. The change in cash flows were driven by: • $26.1 million net purchase of marketable securities for fiscal year 2021 48 • $2.6 million paid in connection with equity investments during the fiscal year 2021 • $2.0 million paid related to debt securities; and • A decrease of $7.0 million in capital expenditures. Fiscal Year 2020 Compared with Fiscal Year 2019 Net cash used in investing activities for fiscal year 2020 was $30.7 million, an increase of $26.2 million, or 579.1%, from $4.5 million for fiscal year 2019. The increase in cash outflows is due to the purchase of property and equipment to support the standalone operations of the Company and the purchase of marketable securities, in the amount of $11.7 million. Net Cash (Used in) Provided by Financing Activities Fiscal Year 2021 Compared with Fiscal Year 2020 Net cash used in financing activities for the fiscal year 2021 was $41.5 million, a net change of $163.1 million, from cash provided by financing activities of $121.6 million for fiscal year 2020. The change in cash flows were primarily due to: • $249.7 million proceeds from the issuance of the Existing Facilities during the first quarter of fiscal year 2020; • $169.8 million proceeds from the issuance of the Notes during the quarter ended June 30, 2020; • $123.0 million proceeds from the issuance of the Senior Credit Facilities during the quarter ended June 30, 2020; • $27 1.6 million principal payments of long-term debt during the fiscal year 2020; • $153.0 million distribution paid to Nuance related to our Spin-Off during the first quarter of fiscal year 2020; and • $ 45.8 million payment of tax related withholdings due to the net settlement of equity awards during the fiscal year 2021. Fiscal Year 2020 Compared with Fiscal Year 2019 Net cash provided by financing activities for fiscal year 2020 was $121.6 million, an increase of $205.1 million, or 245.5%, from net cash used in financing activities of $83.6 million for fiscal year 2019. The increase in cashflows were the result of $169.8 million net proceeds from the issuance of the Notes, $123.0 million net proceeds from the issuance of the Senior Credit Facilities, and $249.7 million net proceeds from the issuance of the Existing Facilities. The increase in cashflows were partly offset by $271.6 million in principal payments of long-term debt, $6.4 million payments of debt issuance costs, and the $153.0 million distribution paid to Nuance. Issued Accounting Standards Not Yet Adopted Refer to Note 3 to the accompanying audited Consolidated and Combined Financial Statements included elsewhere in this Form 10-K for a description of certain issued accounting standards that have not been adopted by us and may impact our results of operations in future reporting periods. Critical Accounting Policies, Judgments and Estimates The preparation of financial statements in conformity with GAAP, requires management to make estimates and assumptions that have a material impact on the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, assumptions and judgments, including those related to revenue recognition; allowance for credit losses and doubtful accounts; accounting for deferred costs; accounting for internally developed software; the valuation of goodwill and intangible assets; accounting for business combinations; accounting for stock-based compensation; accounting for income taxes; accounting for leases; accounting for convertible debt; and loss contingencies. Our management bases its estimates on historical 49 experience, market participant fair value considerations, projected future cash flows, and various other factors that are believed to be reasonable under the circumstances. Actual results could differ from these estimates. We believe the following critical accounting policies most significantly affect the portrayal of our financial condition and the results of our operations. These policies require our most difficult and subjective judgements. Revenue Recognition We primarily derive revenue from the following sources: (1) royalty-based software license arrangements, (2) connected services, and (3) professional services. 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 collectability of consideration is probable. Our arrangements with customers may 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, the performance obligations are satisfied. We allocate the transaction price of the arrangement based on the relative estimated standalone selling price, or 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 or services are sold and expected discounts based on the customer size and type. We only include estimated amounts 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 that represent variable consideration under ASC 606, which we estimate based on historical return experience and other relevant factors, and record a corresponding refund liability as a component of accrued expenses and other current liabilities. Other forms of contingent revenue or variable consideration are infrequent. Revenue is recognized when control of these products or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those products or 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 year or less. If the difference in timing arises for reasons other than the provision of finance 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. 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. 50 Performance Obligations License Embedded software and technology licenses operate without access to the external networks and information. Embedded licenses sold with non-distinct professional services to customize and/or integrate the underlying software and technology 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 embedded software and technology 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 and technology is made available to the customer and control is transferred. For income statement presentation purposes, we separate distinct embedded license revenue from professional services revenue based on their relative SSPs. Revenue from embedded software and technology licenses sold on a royalty basis, where the license of non-exclusive intellectual property is the predominant item to which the royalty relates, is recognized in the period the usage occurs in accordance with ASC 606-10-55-65(A). For usage-based royalty arrangements, which include fixed consideration related to a minimum usage guarantees, the fixed consideration is recognized when the software is made available to the customer. Connected Services Connected 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. Subscription basis revenue represents a single promise to stand-ready to provide access to our connected services. Our connected services 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 connected services arrangements are a single performance obligation comprised of a series of distinct services. These services include variable consideration, typically a function of usage. We recognize revenue as each distinct service period is performed (i.e., recognized as incurred). Our connected service arrangements generally include services to develop, customize, and stand-up applications for each customer. In determining whether these services are distinct, we consider dependence of the cloud service on the up-front development and stand-up, as well as availability of the services from other vendors. We have concluded that the up-front development, stand-up and customization services are not distinct performance obligations, and as such, revenue for these activities is recognized over the period during which the cloud-connected services are provided, and is included within connected services revenue. There can be instances where the customer purchases a software license that allows them to take possession of the software to enable hosting by the customer or a third-party. For such arrangements, the performance obligation of the license is completed at a point in time once the customer takes possession of the software. 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. Significant Judgements 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. Furthermore, hybrid contracts that contain both embedded and connected license and professional services are analyzed to determine if the products and services are distinct or have stand=alone functionality to determine the revenue treatment. Judgments are required to determine the SSP for each distinct performance obligation. When the SSP is directly observable, we estimate the SSP based upon the historical transaction prices, adjusted for geographic considerations, customer classes, and customer relationship profiles. In instances where the SSP is not directly observable, we determine the 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 51 size of the customer and geographic region in determining the SSP. Determining the SSP for performance obligations which we never sell separately also requires significant judgment. In estimating the SSP, we consider the likely price that would have resulted from established pricing practices had the deliverable been offered separately and the prices a customer would likely be willing to pay. For contracts that contain future royalties, the allocation of SSP is determined using any fixed payments as well as the forecasted volume usage associated with royalties. Contract Acquisition Costs In conjunction with the adoption of ASC 606, we are required to capitalize certain contract acquisition costs. The capitalized costs primarily relate to paid commissions. In accordance with the practical expedient in ASC 606-10-10-4, we apply a portfolio approach to estimate contract acquisition costs for groups of customer contracts. We elect to apply the practical expedient in ASC 340-40-25-4 and will expense contract acquisition costs as incurred where the expected period of benefit is one year or less. Contract acquisition costs are deferred and amortized on a straight-line basis over the period of benefit, which we have estimated to be between one and eight years. The period of benefit was determined based on an average customer contract term, expected contract renewals, changes in technology and our ability to retain customers, including canceled contracts. We assess the amortization term for all major transactions based on specific facts and circumstances. Contract acquisition costs are classified as current or noncurrent assets based on when the expense will be recognized. The current and noncurrent portions of contract acquisition costs are included in prepaid expenses and other current assets and in other assets, respectively. As of September 30, 2021 and 2020, we had $6.9 million and $5.6 million of contract acquisition costs. We had amortization expense of $1.9 million, $1.5 million, and $0.7 million related to these costs during the fiscal years ended September 30, 2021, 2020, and 2019. There was no impairment related to contract acquisition costs. Capitalized Contract Costs We capitalize incremental costs incurred to fulfill our contracts that (i) relate directly to the contract, (ii) are expected to generate resources that will be used to satisfy our performance obligation under the contract, and (iii) are expected to be recovered through revenue generated under the contract. Our capitalized costs consist primarily of setup costs, such as costs to standup, customize and develop applications for each customer, which are incurred to satisfy our stand-ready obligation to provide access to our connected offerings. These contract costs are expensed to cost of revenue as we satisfy our stand-ready obligation over the contract term which we estimate to be between one and eight years, on average. The contract term was determined based on an average customer contract term, expected contract renewals, changes in technology, and our ability to retain customers, including canceled contracts. We classify these costs as current or noncurrent based on the timing of when we expect to recognize the expense. The current and noncurrent portions of capitalized contract fulfillment costs are presented as deferred costs. As of September 30, 2021 and 2020, we had $37.8 million and $45.4 million of capitalized contract costs. We had amortization expense of $15.4 million, $12.0 million and $10.6 million related to these costs during the fiscal years ended September 30, 2021, 2020 and 2019, respectively. There was no impairment related to contract fulfillment costs capitalized. Trade Accounts Receivable and Contract Balances We classify our right to consideration in exchange for deliverables as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional (i.e., only the passage of time is required before payment is due). We present such receivables in Accounts receivable, net in our Consolidated Balance Sheets at their net estimated realizable value. We maintain an allowance for credit losses to provide for the estimated amount of receivables that may not be collected. The allowance is based upon an assessment of customer creditworthiness, historical payment experience, the age of outstanding receivables and other applicable factors. Our contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. Contract assets include unbilled amounts from long-term contracts when revenue recognized exceeds the amount billed to the customer, and right to payment is not solely subject to the passage of time. Contract assets are included in Prepaid expenses and other current assets. As of September 30, 2021, we had $59.1 million of contract assets. Our contract liabilities, or deferred revenue, consist of advance payments and billings in excess of revenues recognized. We classify deferred revenue as current or noncurrent based on when we expect to recognize the revenues. As of September 30, 2021, we had $276.7 million of deferred revenue. 52 Business Combinations We determine and allocate the purchase price of an acquired company to the tangible and intangible assets acquired and liabilities assumed as of the business combination date. Results of operations and cash flows of acquired companies are included in our operating results from the date of acquisition. The purchase price allocation process requires us to use significant estimates and assumptions as of the date of the business acquisition, including fair value estimates such as: • estimated fair values of intangible assets; • estimated fair values of legal performance commitments to customers, assumed from the acquiree under existing contractual obligations (classified as deferred revenue) at the date of acquisition; • estimated income tax assets and liabilities assumed from the acquiree; and • estimated fair value of pre-acquisition contingencies from the acquiree. While we use our best estimates and assumptions to determine the fair values of assets acquired and liabilities assumed at the date of acquisition, our estimates and assumptions are inherently uncertain and subject to refinement. As a result, within the measurement period, which is generally one year from the date of acquisition, we record adjustments to the assets acquired and liabilities assumed against goodwill in the period the amounts are determined. Adjustments identified subsequent to the measurement period are recorded within Acquisition-related costs, net. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: • future expected cash flows from software license sales, support agreements, consulting contracts, connected services, other customer contracts and acquired developed technologies and patents; • expected costs to develop in-process R&D projects into commercially viable products and the estimated cash flows from the projects when completed; • the acquired company’s brand and competitive position, as well as assumptions about the period during which the acquired brand will continue to be used in the combined company’s product portfolio; and • discount rates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. In connection with the purchase price allocations for our acquisitions, we estimate the fair market value of legal performance commitments to customers, which are classified as deferred revenue. The estimated fair market value of these obligations is determined and recorded as of the acquisition date. We may identify certain pre-acquisition contingencies. If, during the purchase price allocation period, we are able to determine the fair values of a pre-acquisition contingencies, we will include that amount in the purchase price allocation. If we are unable to determine the fair value of a pre-acquisition contingency at the end of the measurement period, we will evaluate whether to include an amount in the purchase price allocation based on whether it is probable a liability had been incurred and whether an amount can be reasonably estimated. Subsequent to the end of the measurement period, any adjustment to amounts recorded for a pre-acquisition contingency will be included within acquisition-related cost, net in the period in which the adjustment is determined. Goodwill Impairment Analysis Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill is not amortized but tested annually for impairment or when indicators of impairment are present. The test for goodwill impairment involves a qualitative assessment of impairment indicators. If indicators are present, a quantitative test of impairment is performed. Goodwill impairment, if any, is determined by comparing the reporting unit’s fair value to its carrying value. An impairment loss is recognized in an amount equal to the excess of the reporting unit’s carrying value over its fair value, up to the amount of goodwill allocated to the reporting unit. Goodwill is tested for impairment annually on July 1, the first day of the fourth quarter of the fiscal year. There was no goodwill impairment in any of the periods presented. 53 For the purpose of testing goodwill for impairment, all goodwill acquired in a business combination is assigned to one or more reporting units. A reporting unit represents an operating segment or a component within an operating segment for which discrete financial information is available and is regularly reviewed by segment management for performance assessment and resource allocation. Components of similar economic characteristics are aggregated into one reporting unit for the purpose of goodwill impairment assessment. Reporting units are identified annually and re-assessed periodically for recent acquisitions or any changes in segment reporting structure. Upon consideration of our compo nents , we have concluded that our goodwill is associated with one reporting unit. The fair value of a reporting unit is generally determined using a combination of the income approach and the market approach. For the income approach, fair value is determined based on the present value of estimated future after-tax cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future after-tax cash flows and estimate the long-term growth rates based on our most recent views of the long-term outlook for each reporting unit. Actual results may differ from those assumed in our forecasts. We derive our discount rates using a capital asset pricing model and analyzing published rates for industries relevant to our reporting units to estimate the weighted average cost of capital. We adjust the discount rates for the risks and uncertainty inherent in the respective businesses and in our internally developed forecasts. For the market approach, we use a valuation technique in which values are derived based on valuation multiples of comparable publicly traded companies. We assess each valuation methodology based upon the relevance and availability of the data at the time we perform the valuation and weight the methodologies appropriately. Long-Lived Assets with Definite Lives Our long-lived assets consist principally of technology, customer relationships, internally developed software, land, building, and equipment. Customer relationships are amortized over their estimated economic lives based on the pattern of economic benefits expected to be generated from the use of the asset. Other definite-lived assets are amortized over their estimated economic lives using the straight-line method. The remaining useful lives of long-lived assets are re-assessed periodically at the asset group level for any events and circumstances that may change the future cash flows expected to be generated from the long-lived asset or asset group. Internally developed software consists of capitalized costs incurred during the application development stage, which include costs related design of the software configuration and interfaces, coding, installation and testing. Costs incurred during the preliminary project stage and post-implementation stage are expensed as incurred. Internally developed software is amortized over the estimated useful life, commencing on the date when the asset is ready for its intended use. Land, building and equipment are stated at cost and depreciated over their estimated useful lives. Leasehold improvements are depreciated over the shorter of the related lease term or the estimated useful life. Depreciation is computed using the straight-line method. Repair and maintenance costs are expensed as incurred. The cost and related accumulated depreciation of sold or retired assets are removed from the accounts and any gain or loss is included in the results of operations for the period. Long-lived assets with definite lives are tested for impairment whenever events or changes in circumstances indicate the carrying value of a specific asset or asset group may not be recoverable. We assess the recoverability of long-lived assets with definite lives at the asset group level. Asset groups are determined based upon the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. When the asset group is also a reporting unit, goodwill assigned to the reporting unit is also included in the carrying amount of the asset group. For the purpose of the recoverability test, we compare the total undiscounted future cash flows from the use and disposition of the assets with its net carrying amount. When the carrying value of the asset group exceeds the undiscounted future cash flows, the asset group is deemed to be impaired. The amount of the impairment loss represents the excess of the asset or asset group’s carrying value over its estimated fair value, which is generally determined based upon the present value of estimated future pre-tax cash flows that a market participant would expect from use and disposition of the long-lived asset or asset group. There were no long-lived asset impairments in any of the periods presented. Stock-Based Compensation We grant equity awards to certain employees which include stock options and restricted awards in accordance with provisions of the Cerence 2019 Equity Incentive Plan (“Equity Incentive Plan”). We account for stock-based compensation through recognition of the fair value of the stock-based compensation as a charge against earnings. The fair value for time-based restricted stock units and performance-based restricted stock units is based on the closing share price of our common stock on the date of grant. For performance-based restricted stock units, the compensation cost is recognized based on the number of units expected to vest upon the achievement of the performance conditions. We recognize stock-based compensation as an expense on a straight-line basis, over the requisite service period. We account for forfeitures as they occur, rather than applying an estimated forfeiture rate. 54 Income Taxes Fiscal years 2021 and 2020 We account for income taxes using the assets and liabilities method, as prescribed by ASC No. 740, Income Taxes , or ASC 740. Deferred Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carry amount of assets and liabilities and their respective tax bases. The method also requires the recognition of future tax benefits such as net operating loss carryforwards, to the extent that realization of such benefits is more likely than not after consideration of all available evidence. As the income tax returns are not due and filed until after the completion of our annual financial reporting requirements, the amounts recorded for the current period reflect estimates for the tax-based activity for the period. In addition, estimates are often required with respect to, among other things, the appropriate state and foreign income tax rates to use, the potential utilization of operating loss carry-forwards and valuation allowance required, if any, for tax assets that may not be realizable in the future. Tax laws and tax rates vary substantially in these jurisdictions and are subject to change given the political and economic climate. We report and pay income tax based on operational results and applicable law. Our tax provision contemplates tax rates currently in effect to determine both our currency and deferred tax positions. Any significant fluctuations in rates or changes in tax laws could cause our estimates of taxes we anticipate either paying or recovering in the future to change. Such changes could lead to either increases or decreases in our effective tax rates. We have historically estimated the future tax consequences of certain items, including bad debts and accruals that cannot be deducted for income tax purposes until such expenses are paid or the related assets are disposed. We believe the procedures and estimates used in our accounting for income taxes are reasonable and in accordance with established tax law. The income tax estimates used have not resulted in material adjustments to income tax expense in subsequent period when the estimates are adjusted to the actual filed tax return amounts. Deferred tax assets and liabilities are measured used enacted tax rates expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered or settled. With respect to earnings expected to be indefinitely reinvested offshore, we do not accrue tax for the repatriations of such foreign earnings. Valuation Allowance We regularly review our deferred tax assets for recoverability considering historically profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. If positive evidence regarding projected future taxable income, exclusive of reversing taxable temporary differences, existed it would be difficult for it to outweigh objective negative evidence of recent financial reporting losses. Uncertain Tax Positions We operate in multiple jurisdictions through wholly owned subsidiaries and our global structure is complex. The estimates of our uncertain tax positions involve judgements and assessment of the potential tax implications related to legal entity restructuring, intercompany transfer and acquisition or divestures. We recognize tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Our tax positions are subject to audit by taxing authorities across multiple global jurisdictions and the resolution of such audits may span multiple years. Tax laws is complex and often subject to varied interpretations, accordingly, the ultimate outcome with respect to taxes we may own may differ from the amounts recognized. Fiscal year 2019 Income taxes as presented herein attribute current and deferred income taxes of Nuance to the Cerence business’s standalone financial statements in a manner that is systematic, rational, and consistent with the asset and liability method prescribed by ASC 740. Accordingly, the Cerence business’s income tax provision was prepared following the “Separate Return Method.” The Separate Return Method applies ASC 740 to the standalone financial statements of each member of the consolidated group as if the group member were a separate taxpayer and a standalone enterprise. As a result, actual tax transactions included in the consolidated financial statements of Nuance may not be included in the combined financial statements of the Cerence business. Similarly, the tax treatment of certain items reflected in the combined financial statements of Cerence may not be reflected in the consolidated financial statements 55 and tax returns of Nuance; therefore, such items as net operating losses, credit carryforwards and valuation allowances may exist in the standalone financial statements that may or may not exist in Nuance’s consolidated financial statements. The breadth of the Cerence business’s operations and the global complexity of tax regulations require assessments of uncertainties and judgments in estimating taxes that the Cerence business would have paid if it had been a separate taxpayer. The final taxes that would have been paid are dependent upon many factors, including negotiations with taxing authorities in various jurisdictions, outcomes of tax litigation and resolution of disputes arising from federal, state and international tax audits in the normal course of business. The provision for income taxes was determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. This method also requires the recognition of future tax benefits relating to net operating loss carryforwards and tax credits, to the extent that realization of such benefits is more likely than not after consideration of all available evidence. The provision for income taxes represented income taxes paid by Nuance or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax basis of the Cerence business’s assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. In assessing the need for a valuation allowance, we considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weights assigned to the positive and negative evidence are commensurate with the extent to which the evidence may be objectively verified. If positive evidence regarding projected future taxable income, exclusive of reversing taxable temporary differences, existed, it would be difficult for it to outweigh objective negative evidence of recent financial reporting losses. In general, the taxable income (loss) of the various Cerence business entities was included in Nuance’s consolidated tax returns, where applicable in jurisdictions around the world. As such, separate income tax returns were not prepared for any Cerence business entities. Consequently, income taxes currently payable are deemed to have been remitted to Nuance, in cash, in the period the liability arose and income taxes currently receivable are deemed to have been received from Nuance in the period that a refund could have been recognized by the Cerence business had the Cerence business been a separate taxpayer. Leases We have entered into a number of facility and equipment leases which qualify as operating leases under GAAP. We also have a limited number of equipment leases that also qualify as finance leases. We determine if contracts with vendors represent a lease or have a lease component under GAAP at contract inception. Our leases have remaining terms ranging from less than one year to seven years. Some of our leases include options to extend or terminate the lease prior to the end of the agreed upon lease term. For purposes of calculating lease liabilities, lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. Operating leases are included in Operating lease right of use assets, Short-term operating lease liabilities, and Long-term operating lease liabilities on our Consolidated Balance Sheets as of September 30, 2021 and 2020. Finance leases are included in Property and equipment, net, Accrued expenses and other current liabilities, and Other liabilities on our Consolidated Balance Sheets as of September 30, 2021 and 2020. Lease costs for minimum lease payments is recognized on a straight-line basis over the lease term. For operating leases, costs are included within Cost of revenues, Research and development, Sales and marketing, and General and administrative lines on the Consolidated and Combined Statements of Operations. For financing leases, amortization of the finance right of use assets is included within Research and development, Sales and marketing, and General and administrative lines on the Consolidated and Combined Statements of Operations, and interest expense is included within Interest expense. For operating leases, the related cash payments are included in the operating cash flows on the Consolidated and Combined Statements of Cash Flows. For financing leases, the related cash payments for the principal portion of the lease liability are included in the financing cash flows on the Consolidated and Combined Statement of Cash Flows and the related cash payments for the interest portion of the lease liability are included in the operating cash flows on the Consolidated and Combined Statement of Cash Flows. Convertible Debt We bifurcate the debt and equity (the contingently convertible feature) components of our convertible debt instruments in a manner that reflects our nonconvertible debt borrowing rate at the time of issuance. The equity components of our convertible debt instruments are recorded within stockholders’ equity with an allocated issuance premium or discount. The debt issuance premium or discount is amortized to Interest expense in our Consolidated and Combined Statement of Operations using the effective interest method over the expected term of the convertible debt. 56 We assess the short-term and long-term classification of our convertible debt on each balance sheet date. Whenever the holders have a contractual right to convert, the carrying amount of the convertible debt is reclassified to current liabilities , with the corresponding equity components classified from additional paid-in-capital to mezzanine equity, as needed. Loss Contingencies We may be subject to legal proceedings, lawsuits and other claims relating to labor, service, intellectual property, and other matters that arise from time to time in the ordinary course of business. On a quarterly basis, we review the status of each significant matter and assess our potential financial exposure. 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. Due to the inherent uncertainties, estimates are based only on the best information available at the time. Actual outcomes may differ from our estimates. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions may have a material impact on our results of operations and financial position.