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# UNITED STATES 
SECURITIES AND
EXCHANGE COMMISSION 
WASHINGTON, D.C. 20549

# FORM 10-Q

# [X] QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE 
SECURITIES EXCHANGE ACT OF 1934

# FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003

OR

# [ ] TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE 
SECURITIES EXCHANGE ACT OF 1934

# FOR THE TRANSITION
PERIOD FROM ________________ TO ________________.

COMMISSION FILE
NUMBER 000-30203

# NUANCE COMMUNICATIONS,
INC.

(EXACT NAME OF
REGISTRANT AS SPECIFIED IN ITS CHARTER)

|DELAWARE                 | 94-3208477                          
|------------------------ | ------------------------------------
|(STATE OF INCORPORATION) | (IRS EMPLOYER IDENTIFICATION NUMBER)

1005 HAMILTON AVENUE
MENLO PARK, CALIFORNIA 94025
(650) 847-0000 
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)

Indicate by check mark whether
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period
that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]

Indicate by check mark whether the
registrant is an accelerate filer (as defined in Rule 12b-2 of the Exchange Act) YES [X]
NO [ ]

34,897,866 shares of the
registrants common stock, $0.001 par value, were outstanding as of October 31, 2003.

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# NUANCE COMMUNICATIONS,INC. & SUBSIDIARIES

# FORM 10-Q, SEPTEMBER 30, 2003

# CONTENTS

|ITEM  NUMBER |                                                                                                              | PAGE
|------------ | ------------------------------------------------------------------------------------------------------------ | ----
|             | PART I: FINANCIAL INFORMATION                                                                                |     
|             |                                                                                                              |     
|Item 1.      | Financial Statements                                                                                         |     
|             | Condensed Consolidated Balance Sheets:     September 30, 2003 and December 31, 2002                          | 1   
|             | Condensed Consolidated Statements of Operations:     Three and nine months ended September 30, 2003 and 2002 | 2   
|             | Condensed Consolidated Statements of Cash Flows:     Nine months ended September 30, 2003 and 2002           | 3   
|             | Notes to Condensed Consolidated Financial Statements                                                         | 4   
|             |                                                                                                              |     
|Item 2.      | Management's Discussion and Analysis of      Financial Condition and Results of Operations                   | 16  
|             |                                                                                                              |     
|Item 3.      | Quantitative and Qualitative Disclosures about Market Risk                                                   | 35  
|             |                                                                                                              |     
|Item 4.      | Controls and procedures                                                                                      | 35  
|             |                                                                                                              |     
|             | PART II: OTHER INFORMATION                                                                                   |     
|             |                                                                                                              |     
|Item 1.      | Legal Proceedings                                                                                            | 36  
|             |                                                                                                              |     
|Item 4.      | Submission of matters to a vote of security holders                                                          | 36  
|             |                                                                                                              |     
|Item 6.      | Exhibits and Reports on Form 8-K                                                                             | 37  
|             |                                                                                                              |     
|SIGNATURES   | 38                                                                                                          
|             |                                                                                                              |     

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# PART
I:  FINANCIAL INFORMATION

# ITEM 1: FINANCIAL
STATEMENTS

# NUANCE COMMUNICATIONS,
INC. & SUBSIDIARIES 
CONDENSED CONSOLIDATED
BALANCE SHEETS 
(IN THOUSANDS, EXCEPT
SHARE AND PER SHARE AMOUNTS) (Unaudited)

|                                                                                                                                                                         | September 30,2003 | December 31,2002
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------- | ----------------
|ASSETS                                                                                                                                                                   |                   |                 
|Current assets:                                                                                                                                                          |                   |                 
|Cash and cash equivalents                                                                                                                                                |                   | $   30,077      
|Short-term investments                                                                                                                                                   |                   | 77,536          
|Accounts receivable, net of allowance for doubtful accounts of $679                  and $670, respectively                                                              |                   | 10,563          
|Insurance claim receivable                                                                                                                                               |                   | 11,000          
|Prepaid expenses and other current assets                                                                                                                                |                   | 6,757           
|                                                                                                                                                                         |                   |                 
|Total current assets                                                                                                                                                     |                   | 135,933         
|Property and equipment, net                                                                                                                                              |                   | 4,344           
|Intangible assets, net                                                                                                                                                   |                   | 1,096           
|Restricted cash                                                                                                                                                          |                   | 11,106          
|Long-term investments                                                                                                                                                    |                   | --              
|Other assets                                                                                                                                                             |                   | 235             
|                                                                                                                                                                         |                   |                 
|Total assets                                                                                                                                                             |                   | $  152,714      
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                                     |                  
|Current liabilities:                                                                                                                                                     |                  
|Accounts payable                                                                                                                                                         |                   | $     708       
|Accrued liabilities                                                                                                                                                      |                   | 5,442           
|Current restructuring accrual                                                                                                                                            |                   | 9,736           
|Accrued vacation                                                                                                                                                         |                   | 1,692           
|Legal settlement payable                                                                                                                                                 |                   | 11,000          
|Deferred revenue                                                                                                                                                         |                   | 7,764           
|Current portion of capital lease                                                                                                                                         |                   | 43              
|Total current liabilities                                                                                                                                                |                   | 36,385          
|Long-term restructuring accrual                                                                                                                                          |                   | 45,172          
|Other long-term liabilities                                                                                                                                              |                   | 15              
|Total liabilities                                                                                                                                                        |                   | 81,572          
|Commitments (Note 8)                                                                                                                                                     |                   |                 
|Stockholders Equity                                                                                                                                                     |                   |                 
|Common stock, $0.001 par value, 250,000,000 shares authorized;           
    34,544,009 shares and 34,182,244 shares issued and outstanding,   
           respectively |                   | 35              
|Additional paid-in capital                                                                                                                                               |                   | 328,832         
|Deferred stock compensation                                                                                                                                              |                   | (9)             
|Accumulated other comprehensive income                                                                                                                                   |                   | 294             
|Accumulated deficit                                                                                                                                                      |                   | (258,010)       
|Total stockholders equity                                                                                                                                               |                   | 71,142          
|Total liabilities and stockholders equity                                                                                                                               |                   | $   152,714     

The accompanying notes are an
integral part of these condensed consolidated financial statements.

1

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# NUANCE COMMUNICATIONS,
INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)

|                                                            | Three Months Ended | Nine Months Ended
|----------------------------------------------------------- | ------------------ | -----------------
|                                                            |                    |                  
|                                                            |                    |                  
|Revenue:                                                    |                    |                  
|License                                                     |                    |                  
|Service                                                     |                    |                  
|Maintenance                                                 |                    |                  
|                                                            |                    |                  
|Total revenue                                               |                    |                  
|                                                            |                    |                  
|Cost of revenue:                                            |                    |                  
|License                                                     |                    |                  
|Service (1)                                                 |                    |                  
|Maintenance (1)                                             |                    |                  
|                                                            |                    |                  
|Total cost of revenue                                       |                    |                  
|                                                            |                    |                  
|Gross profit                                                |                    |                  
|                                                            |                    |                  
|Operating expenses:                                         |                    |                  
|Sales and marketing (1)                                     |                    |                  
|Research and development (1)                                |                    |                  
|General and administrative (1)                              |                    |                  
|Non-cash stock-based compensation                           |                    |                  
|Restructuring charges                                       |                    |                  
|Asset impairments                                           |                    |                  
|                                                            |                    |                  
|Total operating expenses                                    |                    |                  
|                                                            |                    |                  
|Loss from operations                                        |                    |                  
|Interest and other income, net                              |                    |                  
|                                                            |                    |                  
|Loss before income taxes                                    |                    |                  
|Provision (benefits) from income taxes                      |                    |                  
|                                                            |                    |                  
|Net loss                                                    |                    |                  
|                                                            |                    |                  
|Basic and diluted net loss per share                        |                    |                  
|Shares used to compute basic and diluted net loss per share |                    |                  
|(1) Excludes non-cash stock-based compensation as follows:  |                    |                  
|Service and maintenance cost of revenue                     |                    |                  
|Sales and marketing                                         |                    |                  
|Research and development                                    |                    |                  
|General and administrative                                  |                    |                  
|Total non-cash stock-based compensation                     |                    |                  

The accompanying notes are an
integral part of these condensed consolidated financial statements.

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# NUANCE COMMUNICATIONS
INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)  (UNAUDITED)

|                                                                          | Nine Months Ended
|------------------------------------------------------------------------- | -----------------
|                                                                          | September 30,    
|                                                                          | 2003             
|Cash flows from operating activities:                                     |                  
|Net loss                                                                  |                  
|Adjustments to reconcile net loss to net cash used in operating activites |                  
|Depreciation and amortization                                             |                  
|Non-cash stock-based compensation                                         |                  
|Allowance for doubtful accounts                                           |                  
|Changes in operating assets and liabilities:                              |                  
|Accounts receivable                                                       |                  
|Insurance claim receivable                                                |                  
|Prepaid expenses, other current assets and other assets                   |                  
|Accounts payable                                                          |                  
|Accrued liabilities and other                                             |                  
|Restructuring accrual                                                     |                  
|Legal settlement payable                                                  |                  
|Deferred revenue                                                          |                  
|Net cash used in operating activities                                     |                  
|Cash flows from investing activities:                                     |                  
|Purchase of investments                                                   |                  
|Maturities of investments                                                 |                  
|Purchase of property and equipment                                        |                  
|Purchase of technology                                                    |                  
|Increase in restricted cash                                               |                  
|Net cash prodided by (used in) investing activities                       |                  
|Cash flows from financing activities:                                     |                  
|Proceeds from employee stock purchase plan                                |                  
|Proceeds from exercise of stock options                                   |                  
|Proceeds from issuance of common stock                                    |                  
|Repurchase of common stock                                                |                  
|Net cash provided by financing activities                                 |                  
|Effect of exchange rate fluctuations on cash and cash equivalents         |                  
|Net decrease in cash and cash equivalents                                 |                  
|Cash and cash equivalents, beginning of period                            |                  
|Cash and cash equivalents, end of period                                  |                  
|Supplementary disclosures of cash flow information:                       |                  
|Cash paid during the priod for:                                           |                  
|Interest                                                                  |                  
|Income taxes                                                              |                  
|Suplementary disclosures of non-cash transactions:                        |                  
|Unrealized gain (loss) on available-for-sale securities                   |                  
|Issuance of escrow shares                                                 |                  

The accompanying notes are an
integral part of these condensed consolidated financial statements.

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# NUANCE COMMUNICATIONS,
INC. & SUBSIDIARIES   NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                                            (UNAUDITED)

# 1.     ORGANIZATION
AND OPERATIONS

Nuance Communications, Inc. (the
Company) was incorporated on July 15, 1994 in the State of California, and
subsequently reincorporated in March 2000 in the State of Delaware to develop, market and
support software that enables enterprises and telecommunications carriers to automate the
delivery of information and services over the telephone. The Companys software
platform consists of software servers that run on industry-standard hardware and perform
speech recognition, natural language understanding and voice authentication. The Company
sells its products through a combination of resellers, original equipment manufacturers,
and system integrators and directly to end-users.

# 2.    SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES

Reclassification

Amounts in the condensed consolidated
financial statements for the preceding periods have been reclassified to conform to the
current periods presentation.

Basis of Presentation

The unaudited condensed consolidated
financial statements have been prepared by the Company in accordance with instructions to
Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures
normally included in annual financial statements prepared under accounting principles
generally accepted in the United States of America have been condensed or omitted pursuant
to these instructions and regulations. In the opinion of management, the financial
statements reflect all adjustments, consisting only of normal recurring adjustments
considered necessary for a fair presentation of the consolidated financial position as of
September 30, 2003 and December 31, 2002, the results of operations for the three and nine
months ended September 30, 2003 and 2002 and cash flow for the nine months ended September
30, 2003 and 2002. The results for the periods presented are not necessarily indicative of
the results to be expected for the full year or for any future periods. The accompanying
condensed consolidated financial statements should be read in conjunction with the audited
consolidated financial statements contained in the Companys Form 10-K filed with the
Securities and Exchange Commission on March 31, 2003.

Principles of Consolidation

The condensed consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant inter-company
transactions and balances have been eliminated.

Use of Estimates

The preparation of the consolidated
financial statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the reported amounts
of revenue and expenses during the reporting period. Such estimates include, but are not
limited to: allowance for doubtful accounts, restructuring accrual, income taxes,
contingencies and percentage of completion estimates of certain revenue contracts. Actual
results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly
liquid investments with maturity of three months or less, when purchased, to be cash
equivalents. Cash and cash equivalents consist of money market accounts, certificates of
deposit and deposits with banks. Cash and cash equivalents are recorded at cost which
approximates fair value.

Investments

The Companys investments are
comprised of U.S. Treasury notes, U.S. Government agency bonds, corporate notes and bonds
and commercial paper. Investments with maturities of less than one year are considered to
be short-term. All investments are held in the Companys name at major financial
institutions. As of September 30, 2003, all of the Companys investments are
classified as available-for-sale and carried at fair value, which is determined based on
quoted market prices, with net unrealized gain or loss included in Accumulated other
comprehensive income, in the accompanying Condensed Consolidated Balance Sheets.

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Property and Equipment

Property and equipment are stated at
cost and are depreciated using the straight-line method over the estimated useful lives of
the assets as follows:

| | Computer equipment and software | 2-3 years                                     
| | ------------------------------- | ----------------------------------------------
| | Furniture and fixtures          | 5 years                                       
| | Leasehold improvements          | Shorter of lease term or estimated useful life

Restricted Cash

The restricted cash represents investments in certificates of deposit thereon. The restricted cash secures letters of credit
required by landlords to meet rent deposit requirements for certain leased facilities.

Intangible Assets

Intangible assets are carried at cost less accumulated amortization. Amortization is computed using the straight-line method over
the estimated lives of the respective assets, generally 18 months to five years. The Company adopted Statement of Financial
Accounting Standards ("SFAS") No.142, "Goodwill and Intangible Assets" beginning on January 1, 2002. As of that date, goodwill and
intangible assets with indefinite lives are not amortized but are tested for impairment annually using a fair value approach, or
whenever there is an impairment indicator; other intangible assets are valued and amortized over their estimated lives. Goodwill
is not subject to amortization. At September 30, 2003 and December 31, 2002, the Company had no goodwill.

Impairment of Long-lived Assets

The Company continually monitors events and changes in circumstances that could indicate carrying amounts of the long-lived
assets, including intangible assets, may not be recoverable. When such events or changes in circumstances occur, the Company
assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered
through undiscounted expected future cash flow. If the total of the future undiscounted net cash flow is less than the carrying
amount of these assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value
of the assets in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets".

Revenue Recognition

Revenues are generated from licenses, services and maintenance. All revenues generated from our worldwide operations are reviewed
at our corporate headquarters, located in the United States. The Company applies the provisions of Statement of Position ("SOP")
97-2, "Software Revenue Recognition," as amended by SOP 98-9 "Modification of SOP 97-2, Software Revenue Recognition, With Respect
to Certain Transactions" to all transactions involving the sale of software products. The Company also recognizes some revenue
based on SOP 81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts".

The Company's license revenue consists of license fees for the software products. The license fees for the Company's software
products are calculated using two variables, one of which is the estimated maximum number of simultaneous end-user connections or
"ports" to an application running on our software and the other of which is the value attributed to the functional use of the
software.

For licensed products requiring significant customization, we generally recognize license revenue using the
percentage-of-completion method of accounting over the period that services are performed. For all license and service agreements
accounted for under the percentage-of-completion method, we determine progress to completion based on actual direct labor hours
incurred to date as a percentage of the estimated total direct labor hours required to complete the project. We periodically
evaluate the actual status of each project to ensure that the estimates to complete each contract remain accurate. A provision for
estimated losses on contracts is made in the period in which the loss becomes probable and can be reasonably estimated. To date,
these losses have not been significant. Costs incurred in advance of billings are recorded as costs in excess of related billings
on uncompleted contracts. If the amount of revenue recognized exceeds the amounts billed to customers, the excess amount is
recorded as unbilled accounts receivable. If the amount billed exceeds the amount of revenue recognized, the excess amount is
recorded as deferred revenue. Revenue recognized in any period is dependent on our percentage completion of projects in progress.
Significant management judgment and discretion are used to estimate total direct labor hours. Any changes in or deviation from
these estimates could have a material effect on the amount of revenue we recognize in any period.

For licensed products which do not require significant customization of components, the Company recognizes revenue from the sale
of software licenses when:

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|. | persuasive evidence of an arrangement exists;                          
|- | -----------------------------------------------------------------------
|  |                                                                        
|. | the software and corresponding authorization codes have been delivered;
|  |                                                                        
|. | the fee is fixed and determinable;                                     
|  |                                                                        
|. | collection of the resulting receivable is probable.                    

The Company uses a signed contract and purchase order or royalty report as evidence of an arrangement for license orders.

Products delivered with acceptance criteria or return rights are not recognized as revenue until all criteria are achieved. If
undelivered products or services exist that are essential to the functionality of the delivered product in an arrangement,
delivery is not considered to have occurred. Delivery is accomplished through electronic distribution of the authorization codes
or "keys". The software was previously delivered to the customer either electronically or on a CD-ROM. Occasionally the customer
will require that we secure their acceptance of the system in addition to the delivery of the keys. Such acceptance, when
required, typically consists of a demonstration to the customer that, upon implementation, the software performs in accordance
with specified system parameters, such as recognition accuracy or task completion rates. In cases of absence of such required
acceptance, the Company will defer revenue recognition until signed acceptance is obtained.

The Company assesses whether the fee is fixed and determinable based on the payment terms associated with the transaction. The
Company assesses collectibility of the transaction based on a number of factors, including the customer's past payment history and
its current financial position. If the Company determines that collection of a fee is not probable, the Company defers recognition
of the revenue until the time collection becomes reasonably assured, which is generally upon receipt of the cash payment.

The Company uses the residual method to recognize revenue when a license agreement includes one or more elements to be delivered
at a future date if vendor specific objective evidence of the fair value of all undelivered elements exists. Vendor-specific
objective evidence of fair value is based on the price generally charged when the element is sold separately, or if not yet sold
separately, is established by authorized management. In situations where vendor-specific objective evidence of fair value for undelivered elements does not exist, the entire amount of revenue from the arrangement is deferred and recognized when
vendor-specific objective evidence of fair value can be established for all undelivered elements or when all such elements are
delivered. In situations where the only undelivered element is maintenance and vendor specific objective evidence of fair value
for maintenance does not exist, the entire amount of revenue from the arrangement is recognized ratably over the maintenance
period. As a general rule, license revenue from resellers is recognized when product has been sold through to an end user and such
sell-through has been reported to the Company. However, certain reseller agreements include time-based provisions on which the
Company bases revenue recognition, in these instances, there is no right of returns possible.

The timing of license revenue recognition is affected by whether the Company performs consulting services in the arrangement and
the nature of those services. In the majority of cases, the Company either performs no consulting services or the Company performs
services that are not essential to the functionality of the software. When the Company performs consulting and implementation
services that are essential to the functionality of the software, the Company recognizes both license and consulting revenue
utilizing contract accounting based on the percentage of the consulting services that have been completed. This calculation is
done in conformity with SOP 81-1, however judgment is required in determining the percentage of the project that has been
completed. Such contracts were significant for the three and nine months ended September 30, 2003 and 2002, respectively. The
Company has also explored the markets for complete speech solutions and delivering through combined product and services, where
the Company is required to use the contract accounting based upon percentage of completion. This method of accounting is subject
to certain judgments by the Company regarding amount of revenue allocated to percentage of work completed. Typically, the Company
would recognize revenue based upon the proportional level of effort expended, combined with the value of the technology delivered,
to complete certain milestones defined in the customer contract or statement of work.

Service revenue consists of revenue from providing implementation, consulting, training and other revenue. Other revenue consists
primarily of reimbursements for consulting out-of-pocket expenses incurred, in accordance with the Emerging Issues Task Force
("EITF") Issue No. 01-14, "Income Statement Characterization of Reimbursements Received for `Out-of-Pocket' Expenses Incurred." For
services revenue, we generally require a signed contract, Statement of Work and purchase order prior to recognizing any services
revenue. The Company's consulting service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. For a
fixed-fee contract, the Company recognizes revenue using the percentage of completion method. For time-and-materials contracts,
the Company recognizes revenue as services are performed. Training service revenue is recognized as services are performed. Losses
on service contracts, if any, are recognized as soon as such losses become known.

Maintenance revenue consists of fees for providing technical support and software upgrades and updates. The Company generally
requires a signed contract and purchase order prior to recognizing any maintenance revenue. The Company recognizes all maintenance
revenue ratably over the contract term for such maintenance. Customers have the option to purchase or decline maintenance
agreements at the time of the license purchase. If maintenance is declined, a reinstatement fee is generally required when the
customer decides to later activate maintenance. Customers generally have the option to renew or decline maintenance agreements
annually during the contract term.

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The Company's standard payment terms are generally net 30 to 90 days from the date of invoice.
Payment terms can be up to net 120 days at management discretion. Thus, a significant portion of our
accounts receivable balance at the end of a quarter is primarily comprised of revenue from that quarter.

The Company records deferred revenue primarily as a result of payments from customers received in advance of recognition of
revenue. As of September 30, 2003 and December 31, 2002, deferred revenue was $7.8 million and  $9.0 million, respectively. The
deferred revenue amount includes unearned license fees, which will be recognized as revenue when the appropriate criteria have
been met, or in some cases, when an identified time period has expired and the customer or resellers' right to certain licenses
has been forfeited, prepaid maintenance and prepaid or unearned professional services that will be recognized as revenue as the
services are performed.

Cost of license revenue consists primarily of license fees payable on third-party software products, amortization of software
costs, documentation and media costs. Cost of service revenue consists of compensation and related overhead costs for employees or
third parties engaged in consulting and training.  Cost of maintenance revenue consists of compensation and related overhead costs
for employees engaged in technical support.

Foreign Currency Translation

The functional currency of the Company's foreign subsidiaries is deemed to be the local country's currency. Consequently, assets
and liabilities recorded in foreign currencies are translated at period-end exchange rates; revenues and expenses are translated
at average exchange rates during the period. The effects of foreign currency translation adjustments are included in stockholders'
equity as a component of "Accumulated other comprehensive income" in the accompanying Condensed Consolidated Balance Sheets. The
effects of foreign currency transactions are included in "Interest and other income, net" in the accompanying condensed
consolidated statements of operations.

Accumulated Other Comprehensive Income

Comprehensive income includes net loss and all non-owner changes to stockholders' equity, which for the Company, is foreign
currency translation and changes in unrealized gains and losses on investments. As of September 30, 2003 and December 31, 2002,
the cumulative foreign currency translation gain (loss) is $267,000 and $(159,000), net of taxes $156,000 and $(93,000),
respectively. As of September 30, 2003 and December 31, 2002, the cumulative unrealized gains on investments are $27,000 and
$176,000, net of taxes $16,000 and $103,000, respectively. As of September 30, 2003 and December 31, 2002, the total cumulative
other comprehensive income are $294,000 and $17,000. For the three and nine months ended September 30, 2003, the total
comprehensive losses are $12.2 million and $18.8 million, respectively. For the three and nine months ended September 30, 2002,
the total comprehensive losses are $45.9 million and $65.8 million, respectively.

Stock-Based Compensation

We account for stock-based compensation in accordance with the provisions of APB No. 25, Accounting for Stock Issued to Employees,
and comply with the disclosure provisions of SFAS No. 123 as amended by SFAS No.148, Accounting for Stock-Based Compensation--
Transition and Disclosures. We adopted the disclosure-only provisions of SFAS No.123 and No.148, and accordingly, no expense has
been recognized for options granted to employees under the various Plans. We amortize deferred stock-based compensation on the
graded vesting method over the vesting periods of the applicable stock purchase rights and stock options, generally four years.
The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in greater vesting
in earlier years than the straight-line method. Had compensation expense been determined based on the fair value at the grant date
for awards, consistent with the provisions of SFAS 123, the Company's pro forma net loss and net loss per share would be as
follows (in thousands, except per share data):

|                                                                                                       | Three Months Ended | Nine Months Ended
|------------------------------------------------------------------------------------------------------ | ------------------ | -----------------
|                                                                                                       |                    |                  
|                                                                                                       |                    |                  
|Net loss, as reported                                                                                  |                    |                  
|Add: Stock-based employee compensation expense           included in net loss                          |                    |                  
|Less: Total stock-based employee compensation expense under           fair value method for all awards |                    |                  
|Pro forma net loss                                                                                     |                    |                  
|Basic and diluted net loss per share - as reported                                                     |                    |                  
|Basic and diluted net loss per share - pro forma                                                       |                    |                  

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# 3.    RECENT
ACCOUNTING PRONOUNCEMENTS

In December 2002, the FASB issued
SFAS 148, Accounting for Stock-Based Compensation  Transition and
Disclosure, an amendment to FASB Statement 123. SFAS 148 provides alternative
methods of transition for a voluntary change to the fair value based method of accounting
of stock-based employee compensation. In addition, SFAS 148 amends the disclosure
requirements of SFAS 123, Accounting for Stock-Based Compensation, to
require prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company adopted the disclosure provisions of SFAS 148
effective for the year ended December 31, 2002.

On January 1, 2003, the Company
adopted SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, (SFAS No. 146), which nullifies Emerging Issues Task
Force (EITF) 94-3,Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3). SFAS No. 146 requires that a liability
be recognized for restructuring costs only when the liability is incurred, that is, when
it meets the definition of a liability in the Financial Accounting Standards Boards
(FASBs) conceptual framework. SFAS No. 146 also establishes fair
value as the objective for initial measurement of liabilities related to exit or disposal
activities and is effective for exit or disposal activities that are initiated after
December 31, 2002. The adoption of SFAS No. 146 did not have a material impact
on our results of operations, financial position or cash flows.

On January 1, 2003, the Company
adopted Financial Interpretation 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others
(FIN 45). FIN 45 requires certain guarantees to be recorded at fair value
and requires a guarantor to make disclosures, even when the likelihood of making any
payments under the guarantee is remote. For those guarantees and indemnifications that do
not fall within initial recognition and measurement requirements of FIN 45, the
Company must continue to monitor the conditions that are subject to the guarantees and
indemnifications, as required under existing generally accepted accounting principles, to
identify if a loss has been incurred. If the Company determines that it is probable that a
loss has been incurred, any such estimable loss would be recognized. The initial
recognition and measurement requirements do not apply to the Companys product
warranties or to the provisions contained in the majority of the Companys software
license agreements that indemnify licensees of the Companys software from damages
and costs resulting from claims alleging that the Companys software infringes the
intellectual property rights of a third party. The Company has provided disclosures as
required by FIN 45 in Note 6 to its condensed consolidated financial statements. The
adoption of the liability recognition provisions did not have a material impact on its
financial position or results of operations.

In January 2003, the EITF published
EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, (EITF
00-21), which requires companies to determine whether an arrangement involving
multiple deliverables contains more than one unit of accounting. In applying EITF 00-21,
revenue arrangements with multiple deliverables should be divided into separate units of
accounting if the deliverables in the arrangement meet certain criteria. Arrangement
consideration should be allocated among the separate units of accounting based on their
relative fair values. This issue is effective for revenue arrangements entered into in
fiscal periods beginning after September 15, 2003. The Company adopted EITF 00-21 on
July 1, 2003 and adoption of EITF 00-21 did not have any material impact on its
consolidated financial position, results of operations or cash flows.

In January 2003, the FASB issued
Interpretation 46, Consolidation of Variable Interest Entities. In general, a
variable interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity investors with
voting rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. Interpretation 46 requires a variable
interest entity to be consolidated by a company if that company is subject to a majority
of the risk of loss from the variable interest entitys activities or entitled to
receive a majority of the entitys residual returns or both. The consolidation
requirements of Interpretation 46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements apply to older entities in the
first fiscal year or interim period beginning after December 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company does not
believe the adoption of the Interpretation will have a material impact on its financial
statements.

# 4. NET LOSS PER SHARE

Net loss per share is calculated
under SFAS No. 128, Earnings Per Share. Basic net loss per share is computed
using the weighted average number of shares of common stock outstanding. Diluted net loss
per share is equal to basic net loss per share for all periods presented since potential
common shares from stock options and warrants are anti-dilutive due to the reported net
loss. Shares subject to repurchase resulting from early exercises of options that have not
vested are excluded from the calculation of basic and diluted net loss per share. During
the three and nine months ended September 30, 2003 and 2002, the Company had securities
outstanding which could potentially dilute basic earnings per share in the future, but
were excluded in the computation of diluted loss per share in such periods, as their
effect would have been anti-dilutive due to the net loss reported in such periods. The
total number of shares excluded from diluted net loss per share was 9,558,000 shares and
9,449,000 shares, respectively, for the three months and nine months ended September 30,
2003. The total number of shares excluded from diluted net loss per share was 6,666,000
shares and 6,835,000 shares, respectively, for the three months and nine months ended
September 30, 2002.

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The following table presents the
calculation of basic and diluted net loss per share (in thousands, except per share data):

|                                                                             | Three Months Ended | Nine Months Ended
|---------------------------------------------------------------------------- | ------------------ | -----------------
|                                                                             |                    |                  
|                                                                             |                    |                  
|Net loss                                                                     |                    |                  
|                                                                             |                    |                  
|Basic and diluted shares:                                                    |                    |                  
|Weighted average shares of common stock outstanding                          |                    |                  
|Less: weighted average shares of common stock
subject to repurchase          |                    |                  
|Weighted average shares used to compute basic and diluted net loss per share |                    |                  
|Basic and diluted net loss per share                                         |                    |                  

# 5. INTANGIBLE ASSETS

Information
regarding the Companys intangible assets follows (in thousands):

|                     | As of September 30, 2003
|-------------------- | ------------------------
|                     |                         
|Purchased Technology |                         
|Patents Purchased    |                         
|Total                |                         

|                     | As of December 31, 2002
|-------------------- | -----------------------
|                     |                        
|Purchased Technology |                        
|Patents Purchased    |                        
|Warrant - Onstar GM  |                        
|Total                |                        

Purchased technology and patents purchased are amortized to cost of license revenue.  In total, for purchased technology, the
Company amortized $84,000 and $253,000 respectively, for the three and nine months ended September 30, 2003; for patents
purchased, the Company amortized $19,000 and $56,000 respectively, for the three and nine months ended September 30, 2003;
The warrant Onstar GM was fully amortized as of December 31, 2002.

As of September 30, 2003, total estimated amortization of the purchased technology and the patent for each of the five fiscal
years and thereafter is as follows (in thousands):

|Year Ended December 31,   |   | Amortization Expense
|------------------------- | - | --------------------
|2003 (remaining 3 months) | $ | 104                 
|2004                      |   | 413                 
|2005                      |   | 413                 
|2006                      |   | 116                 
|2007                      |   | 50                  
|Total                     | $ | 1,096               

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# 6.    GUARANTEES

Guarantee

As of September 30, 2003, our
financial guarantees consist of standby letters of credit outstanding and they include the
restricted cash requirements collateralizing our lease obligations. The maximum amount of
potential future payment under the arrangement at September 30, 2003 were $10.9 million
related to Pacific Shores lease in California and $198, 000 related to our Montreal lease,
totaling $11.1 million presented as Restricted cash on our Condensed Consolidated Balance
Sheet at September 30, 2003.

Warranty

The Company does not maintain a
general warranty reserve for estimated costs of product warranties at the time revenue is
recognized due to the effectiveness of our extensive product quality program and
processes.

Indemnifications to
Customers

We defend and indemnify our customers
for damages and reasonable costs incurred in any suit or claim brought against them
alleging that our products sold to our customers infringe any U.S. patent, copyright,
trade secret or similar right. If a product becomes the subject of an infringement claim,
we may, at our option: (i) replace the product with another non-infringing product
that provides substantially similar performance; (ii) modify the infringing product
so that it no longer infringes but remains functionally equivalent; (iii) obtain the
right for the customer to continue using the product at our expense and for the reseller
to continue selling the product; (iv) take back the infringing product and refund to
customer the purchase price paid less depreciation amortized on a straight line basis. We
have not been required to make material payments pursuant to these provisions
historically. We have not identified any losses that are probable under these provisions
and, accordingly, we have not recorded a liability related to these indemnification
provisions.

Indemnifications to
Officers and Directors

Our corporate by-laws require that we
indemnify our officers and directors, as well as those who act as directors and officers
of other entities at our request, against expenses, judgments, fines, settlements and
other amounts actually and reasonably incurred in connection with any proceedings arising
out of their services to Nuance. In addition, we have entered into separate
indemnification agreements with each director and each board-appointed officer of Nuance,
which provides for indemnification of these directors and officers under similar
circumstances and under additional circumstances. The indemnification obligations are more
fully described in the by-laws and the indemnification agreements. We purchase insurance
to cover claims or a portion of the claims made against our directors and officers. Since
a maximum obligation is not explicitly stated in our by-laws or in our indemnification
agreements and will depend on the facts and circumstances that arise out of any future
claims, the overall maximum amount of the obligations cannot be reasonably estimated.
Historically, we have not made payments related to these obligations, and the estimated
fair value for these obligations is zero on the Condensed Consolidated Balance Sheet as of
September 30, 2003.

Other Indemnifications

As is customary in our industry and
as provided for in local law in the U.S. and other jurisdictions, many of our standard
contracts provide remedies to others with whom we enter into contracts, such as defense,
settlement, or payment of judgment for intellectual property claims related to the use of
our products. From time to time, we indemnify our suppliers, contractors, lessors, lessees
and others with whom we enter into contracts, against combinations of loss, expense, or
liability arising from various trigger events related to the sale and the use of our
products and services, the use of their goods and services, the use of facilities, the
state of the assets and businesses that we sell and other matters covered by such
contracts, usually up to a specified maximum amount. In addition, from time to time we
also provide protection to these parties against claims related to undiscovered
liabilities, additional product liability or environmental obligations. In our experience,
claims made under such indemnifications are rare and the associated estimated fair value
of the liability is not material.

# 7.    RESTRUCTURING

Fiscal Year 2001

In April 2001, with Board of
Directors approval, the Company implemented a restructure plan to align our expenses with
revised anticipated demand and create a more efficient organization. In connection with
the restructuring plan, the Company recorded a restructuring charge of $34.1 million for
lease loss and severance costs and an asset impairment charge of $20.9 million on tenant
improvements during the quarter ended September 30, 2001. The Company decreased the asset
impairment charge by $0.5 million in the quarter ended December 31, 2001.

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In connection with the restructuring
plan, the Company decided not to occupy a new leased facility. This decision has resulted
in a lease loss of $32.6 million for the year ended December 31, 2001, comprised of a
sublease loss, broker commissions and other facility costs. To determine the sublease
loss, the loss after the Companys cost recovery efforts from subleasing the
building, certain assumptions were made related to the (1) time period over which the
building will remain vacant (2) sublease terms and (3) sublease rates. The Company
established the reserves at the low end of the range of estimable cost against outstanding
commitments, net of estimated future sublease income. These estimates were derived using
the guidance provided in SAB No. 100, Restructuring and Impairment Charges,
and EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)". The lease loss was increased in August 2002 and September 2003 as
described below and will continue to be adjusted in the future upon triggering events
(change in estimate of time to sublease, actual sublease rates, etc.).

The Company recorded $1.5 million in
costs for the year ended December 31, 2001 associated with severance and related benefits.
The Company reduced headcount by approximately 80 employees, with reductions ranging
between 10% and 20% across all functional areas and affecting several locations.

Fiscal Year 2002

In January 2002, with Board of
Directors approval, the Company implemented a restructuring plan to reduce the
Companys workforce by approximately 8%, or 33 employees. The restructuring was
primarily to realign the sales and professional services organizations. The Company
recorded a restructuring charge of $1.3 million for the three months ended March 31, 2002,
consisting primarily of payroll and related expenses associated with reducing headcount.
This amount was paid out as of December 31, 2002.

In August 2002, with Board of
Directors approval, the Company implemented a restructuring plan to reduce the
Companys worldwide workforce by approximately 21%, or 81 employees, to realign the
Companys expense structure with near term market opportunities. In connection with
the reduction of workforce, the Company recorded a charge of $2.6 million primarily for
severance and related employee termination costs. As of September 30, 2003, approximately
$2.3 million of this amount was paid out, with the remainder to be paid by the December
2003. As of September 30, 2003, the Company also reversed an excess accrual for this
restructuring plan, which resulted in recording of $0.2 million as a credit to the
Restructuring charge line in the Condensed Consolidated Statement of Operations.

The plan also included the
consolidation of facilities through the closing of certain international offices that
resulted in a charge of $1.6 million. In addition, the Company recorded an increase in the
Companys previously reported real estate restructuring accrual related to the new
leased facility the Company does not occupy and which has not been subleased as a result
of continued declines in the condition of the San Francisco Bay Area real estate market.
This additional charge of $31.8 million resulted from an analysis of the time period by
which the California property will remain vacant, sub-lease terms and sub-lease rates,
altogether reflecting continued softening of the local real estate market.

Fiscal Year 2003

In February 2003, the Company
received cash and recorded an asset impairment credit of $0.9 million related to a refund
of tenant improvement costs for the building the Company does not occupy, following the
landlords reconciliation of tenant improvement costs. This credit was recorded on
the Restructuring Charges (Credits) line of the Condensed Consolidated Statements of
Operation, where the original asset impairment charge of $20.4 million was recognized for
the year ended December 31, 2001.

For the three months ended September
30, 2003, the Company reviewed its earlier estimate for the lease loss for the unoccupied
leased facility and the condition of the San Francisco Bay Area real estate market. The
Company estimated that it might take an additional 18 months to sublease this unoccupied
facility. The Company also lowered the estimates for the expected sublease rates. This
evaluation resulted in recording an additional lease loss of $10.4 million and is recorded
as part of the Restructuring charges on the Condensed Consolidated Statement of
Operations.

For the three months ended September
30, 2003, the Company reduced the Companys general and administrative workforce by
9%, or net of 5 employees, to realign the organization to the Companys structure.
The Company recorded a restructuring charge of $0.2 million primarily for severance and
termination costs relating to the reduction in workforce. As of September 30, 2003, $0.1
million was paid out, with the remainder to be paid in the fourth quarter of 2003. In
addition, the Company reversed the excess accrual for the August 2002 restructuring plan,
which resulted in a $0.2 million credit to the Restructuring charge line in the Condensed
Consolidated Statement of Operations.

The restructuring charges and quarter
end balances for the quarter ended September 30, 2003 are as follows (in thousands):

|                                                        | Lease Loss | Severance & Related | Asset Write Down | Total Restructuring
|------------------------------------------------------- | ---------- | ------------------- | ---------------- | -------------------
|2001 Plan                                               |            |                     |                  |                    
|Total charges for the year ending December 31, 2001     |            |                     | $                | 32,615             
|Amount utilized in the year ending December 31, 2001    |            |                     |                  | (3,572             
|Accrual balance at December 31, 2001                    |            |                     | $                | 29,043             
|Total charges for the year ending December 31, 2002     |            |                     | $                | 31,829             
|Amount utilized in the year ended December 31, 2002     |            |                     |                  | (9,342             
|Balance at December 31, 2002                            |            |                     | $                | 51,530             
|Total charges for
the quarter ended March 31, 2003      |            |                     | $                | --                 
|Amount utilized
in the quarter ended March 31, 2003     |            |                     |                  | (2,320             
|Balance at March 31, 2003                               |            |                     | $                | 49,210             
|Total charges for
the quarter ended June 30, 2003       |            |                     | $                | --                 
|Amount utilized
in the quarter ended June 30, 2003      |            |                     |                  | (2,416             
|Balance at June 30, 2003                                |            |                     | $                | 46,794             
|Total charges for
the quarter ended September 30, 2003  |            |                     | $                | 10,373             
|Amount utilized
in the quarter ended September 30, 2003 |            |                     |                  | (2,392             
|Balance at September 30, 2003                           |            |                     | $                | 54,775             
|Current restructuring accrual                           |            |                     | $                | 9,603              
|Long-term restructuring accrual                         |            |                     | $                | 45,172             
|Q1 2002 Plan                                            |            |                     |                  |                    
|Total charges for the year ending December 31, 2002     |            |                     | $                | --                 
|Amount utilized in the year ending December 31, 2002    |            |                     |                  | --                 
|Balance at December 31, 2002                            |            |                     |                  | --                 
|Current restructuring accrual                           |            |                     |                  | --                 
|Long-term restructuring accrual                         |            |                     | $                | --                 
|Q3 2002 Plan                                            |            |                     |                  |                    
|Total charges for the year ending December 31, 2002     |            |                     | $                | 1,560              
|Amount utilized in the year ending December 31, 2002    |            |                     |                  | (1,046             
|Balance at December 31, 2002                            |            |                     |                  | 514                
|Total charges for the quarter ended March 31, 2003      |            |                     | $                | --                 
|Amount utilized in the quarter ended March 31, 2003     |            |                     |                  | (361               
|Balance at March 31, 2003                               |            |                     |                  | 153                
|Total charges for the quarter ended June 30, 2003       |            |                     | $                | --                 
|Amount utilized in the quarter ended June 30, 2003      |            |                     |                  | (36                
|Balance at June 30, 2003                                |            |                     | $                | 117                
|Total charges for the quarter ended September 30, 2003  |            |                     | $                | --                 
|Reclassed from severance to lease loss                  |            |                     | $                | (14                
|Amount utilized in the quarter ended September 30, 2003 |            |                     |                  | (37                
|Balance at September 30, 2003                           |            |                     | $                | 66                 
|Current restructuring accrual                           |            |                     | $                | 66                 
|Long-term restructuring accrual                         |            |                     | $                | --                 
|Q3 2003 Plan                                            |            |                     |                  |                    
|Total charges for the quarter ended September 30, 2003  |            |                     | $                | --                 
|Amount utilized in the quarter ended September 30, 2003 |            |                     |                  | --                 
|Balance at September 30, 2003                           |            |                     | $                | --                 
|Current restructuring accrual                           |            |                     | $                | --                 
|Long-term restructuring accrual                         |            |                     | $                | --                 
|Balance at September 30, 2003 (All restructuring plans) |            |                     |                  |                    
|Total restructuring accrual: Current                    |            |                     | $                | 9,669              
|Total restructuring accrual: Long-term                  |            |                     | $                | 45,172             

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The Company expects the total cash
outlay for the restructuring plans to be $81.8 million, of which $26.9 million was
paid through September 30, 2003 and $54.9 million remains accrued at September 30, 2003.
The Company expects $9.7 million of the lease loss to be paid out over the next twelve
months and remaining $45.2 million to be paid out over the remaining life of the lease of
approximately 9 years.

# 8. COMMITMENTS

Operating leases

The Company leases its facilities
under non-cancelable operating leases with various expiration dates through July 2012. As
of September 30, 2003, future minimum lease payments under these agreements (excluding
sublease income), including the Companys unoccupied facilities lease and lease loss
portion of the restructuring charges, are as follows (in thousands):

|Year Ended December 31,             |   | Operating leases
|----------------------------------- | - | ----------------
|2003 (remaining 3 months)           | $ | 2,433           
|2004                                |   | 9,142           
|2005                                |   | 8,319           
|2006                                |   | 8,610           
|2007                                |   | 8,871           
|Thereafter                          |   | 43,774          
|Total future minimum lease payments | $ | 81,149          

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In May 2000, the Company entered into a lease for a new headquarters facility. The lease has
an eleven-year term, which began in August 2001, and provides for monthly rent payments
starting at approximately $600,000. A $10.9 million certificate of deposit secures a
letter of credit required by the landlord for a rent deposit. In conjunction with the
April 2001 and August 2002 restructuring plans, the Company decided not to occupy this new
leased facility, as well as close certain international offices and have recorded a lease
loss of $65.8 million related to future lease commitments, net of expected sublease
income. For the three months ended September 30, 2003, the company reviewed its earlier
estimate for the sublease loss and estimated that there may be an additional 18 months
that the property will remain vacant. The Company also lowered the estimates for the
expected sublease rental rates. This evaluation resulted in recording an additional lease
loss of $10.4 million. The future minimum lease payments table referenced above does not
include estimated sublease income as there are no sublease commitments as of September 30,
2003.

Capital leases

In September 2002, the Companys
Canadian subsidiary entered into a lease for certain equipment for approximately $138,000,
which is accounted for as a capital lease. This lease bears interest at a rate of 11.2%,
and expires in August 2004. Future minimum lease payments under the agreement, as of
September 30, 2003, are as follows (in thousands):

|Year Ended December 31,                           |   | Capital leases
|------------------------------------------------- | - | --------------
|2003 (remaining 3 months)                         | $ | 12            
|2004                                              |   | 33            
|Total minimum lease payments                      | $ | 45            
|Amount representing interst (11.2%)               |   | (2)           
|Present value of minimum lease payments - current | $ | 43            

Asset under capital lease had a cost basis of $160,000 and accumulated depreciation of $62,000 as of September 30, 2003.

# 9. LITIGATION

On January 16, 2001,  Nuance filed an opposition  proceeding in the European  community  against a Community Trade Mark  application
for NUANCE,  owned by Nuance  Global  Traders,  Ltd. The  opposition  is still  pending.  The parties have agreed upon a settlement,
which will become final upon, among other things, completion of final settlement documents.

Beginning in March 2001, a number of putative  shareholder  class  actions were filed against the Company and certain of its present
and former  officers and  directors in the United  States  District  Court for the Northern  District of  California  (the  "Federal
Actions").  The  actions  have  been  consolidated  as In re Nuance  Communications  Inc.  Securities  Litigation,  Master  File No.
C-01-20320-JW.  Lead  plaintiffs  were  appointed and a consolidated  complaint was filed on behalf of a purported  class of persons
who  purchased  the  Company's  stock during the period  January 31, 2001  through  March 15, 2001,  alleging  false and  misleading
statements  and insider  trading in violation of the federal  securities  laws,  specifically  Section  10(b),  20(a) and 20A of the
Securities  Exchange  Act of 1934,  and seek  unspecified  damages.  In April  2003,  the court  granted  in part and denied in part
defendants'  most recent  motion to dismiss.  No trial date has been set. On August 18,  2003,  the parties  executed an agreement to
settle this  litigation for $11 million,  in which the settlement will become final, upon approval by the Court.  The settlement is to be covered by the Company's  insurance  policies and is
reflected in the accompanying  condensed  consolidated  balance sheet as of September 30, 2003 as an insurance claim  receivable and a
legal  settlement  payable.  In the event that final settlement does not occur,  and litigation  against the  Company continues, the
Company believes it has meritorious defenses and intends to defend the case vigorously.

In May and September 2001,  putative  shareholder  derivative  actions were filed in California  Superior  Court,  San Mateo County,
against various of the Company's present and former officers and the Company's  directors (the "Derivative  Actions").  The putative
derivative  complaints  contain  allegations  similar to the Federal Actions,  and claim that the defendants  engaged in breaches of
fiduciary  duty and insider  trading.  The Company  appears to be named as nominal  defendant,  against  whom no recovery is sought.
All proceedings in the putative  derivative  actions have been stayed by agreement of the parties.  An agreement has been reached to
settle these actions,  which  settlement  will become final upon,  among other things,  completion of formal  settlement  papers and
Court approval of the settlement.

In August 2001, the first of several  putative  shareholder  class actions were filed against  various of the  underwriters  for the
Company's  initial public offering  ("IPO"),  the Company and certain of its present and former officers and directors in the United
States District Court for the Southern  District of New York.  Those complaints have been  consolidated  and a consolidated  amended
complaint filed,  captioned In re Nuance  Communications  Inc. Initial Public Offering Sec. Litig.,  No.  01-CV-7344.  The complaint
generally alleges that various  investment bank underwriters  engaged in improper  activities related to the allocation of shares in
the Company's  IPO, that were not  disclosed in the  registration  statements  for the  Company's  IPO or secondary  offerings.  The
consolidated  action is part of a larger coordinated  proceeding,  In re Initial Public Offering  Securities  Litigation,  21 MC 92,
involving more than 40  underwriters  and 250 issuers.  In October 2002, the  individual  defendants  were dismissed from the action
without  prejudice  pursuant to  stipulation.  In February  2003, the court issued a ruling on an omnibus motion to dismiss filed by
defendants in the  coordinated  proceeding,  denying the motion as to the claims against the Company.  No trial date has been set. A
proposal has been made for the settlement and release of claims against the issuer  defendants in the case,  including the  Company.
The  settlement is contingent  upon a number of conditions,  including  completion of formal  settlement  papers and approval of the
Court.  In the event  that  settlement  does not  occur,  and  litigation  against Nuance  continues, the  Company  believes  it has
meritorious defenses and intends to defend the case vigorously.

Should the respective  settlements not proceed as anticipated,  an unfavorable resolution of these litigations could have a material
adverse effect on the Company's business, results of operations, or financial condition.

# 10. STOCK - BASED COMPENSATION

The Company  accounts for its  stock-based  awards to employees  using the  intrinsic  value method in  accordance  with APB No. 25.
Accordingly,  the Company records deferred stock  compensation equal to the difference between the grant price and fair value of the
Company's  common stock on the date of grant.  In connection  with the grant of stock options prior to our initial public  offering,
the Company  recorded  deferred stock  compensation of  approximately  $8.7 million within  stockholders'  equity,  representing the
difference  between the estimated  fair value of the common stock for  accounting  purposes and the option  exercise  price of these
options at the date of grant.  This amount is presented  as a reduction  of  stockholders'  equity and is being  amortized  over the
vesting period of the applicable options in a manner consistent with FASB Interpretation No. 28.

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Relating to  approximately  3,152,000  stock options  granted before initial  public offer at a weighted  average  exercise price of
$8.58,  for the three and nine months ended  September 30, 2003,  the Company  recorded  amortization  of deferred  compensation  of
$39,000 and $172,000.  During the same periods,  the Company  reversed  excess  amortization of deferred stock  compensation  due to
termination of employees of ($6,000) and ($153,000),  resulting in net expense of deferred  compensation of $33,000 and $19,000. For
the three and nine months ended  September  30, 2003,  the Company  reversed  approximately  $1,000 and $40,000,  of deferred  stock
compensation and additional paid-in capital,  representing  unamortized deferred stock compensation relating to forfeitures of stock
options by terminated  employees.  For the three and nine months ended  September 30, 2002,  the Company  recorded  amortization  of
deferred stock  compensation  of $221,000 and $790,000  respectively,  the Company  reversed  excess  amortization of deferred stock
compensation  due to termination  of ($188,000) and  ($374,000),  resulting in net expense of deferred  compensation  of $33,000 and
$416,000.  For the three and nine months  ended  September  30, 2002,  the Company  reversed  approximately  $77,000 and $139,000 of
deferred stock  compensation  and additional  paid-in-capital,  representing  unamortized  deferred stock  compensation  relating to
forfeitures of stock options by terminated employees.

In connection with the SpeechFront  acquisition,  the Company recorded  deferred  compensation  expense $387,000 for the nine months
ended September 30, 2002. SpeechFront related deferred compensation was fully amortized as of December 31, 2002.

The Company expects to amortize the remaining deferred stock compensation of $9,000 in the three months ended December 31, 2003.

# 11. SHORT-TERM INVESTMENTS

All our investments are classified as available for sale at September 30, 2003 and December 31, 2002. Available-for-sale
investments with original maturities of greater than three months are classified as short-term investments, as these investments
generally consist of highly marketable securities that are intended to be available to meet current cash requirements. Investment
securities classified as available-for-sale are reported at market value, and net unrealized gains or losses are recorded in
cumulative other comprehensive income (loss), a separate component of stockholders' equity, until realized. Realized gains and
losses on non-equity investments are computed based upon specific identification and are included in interest income and other,
net. For all periods presented, realized gains and losses on available-for-sale investments were not material. Management
evaluates investments on a regular basis to determine if an other-than-temporary impairment has occurred.

Our investments in publicly held companies are generally considered impaired when a decline in the fair value of an investment as
measured by quoted market prices is less than its carrying value, and such a decline is not considered temporary. For the nine
months ended September 30, 2003, the Company has incurred no such impairment.

# 12.    SEGMENT REPORTING

The Company has three  operating  segments:  licenses,  services and  maintenance.  Revenue and cost of revenue for the segments are
identical to those  presented on the  accompanying  condensed  consolidated  statements  of  operations.  The Company does not track
expenses nor derive profit or loss based on these segments. The Company also does not track assets by segments.

Sales of licenses,  as well as services and maintenance  through  September 30, 2003,  occurred  through  resellers and direct sales
representatives  located  in the  Company's  headquarters  in Menlo  Park,  California,  and in other  locations.  These  sales were
supported through the Menlo Park location. The Company does not separately report costs by region internally.

Revenues are based on the country in which the end-user is located.  The following is a summary of license,  service and maintenance
revenue by geographic region (in thousands):

14

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|                     | Three Months Ended | Nine Months Ended
|-------------------- | ------------------ | -----------------
|                     |                    |                  
|                     |                    |                  
|License Revenue:     |                    |                  
|United States        |                    |                  
|Canada               |                    |                  
|Europe               |                    |                  
|Asia                 |                    |                  
|Australia            |                    |                  
|Latin America        |                    |                  
|Total                |                    |                  
|Service Revenue:     |                    |                  
|United States        |                    |                  
|Canada               |                    |                  
|Europe               |                    |                  
|Asia                 |                    |                  
|Australia            |                    |                  
|Latin America        |                    |                  
|Total                |                    |                  
|Maintenance Revenue: |                    |                  
|United States        |                    |                  
|Canada               |                    |                  
|Europe               |                    |                  
|Asia                 |                    |                  
|Australia            |                    |                  
|Latin America        |                    |                  
|Total                |                    |                  
|Total revenue:       |                    |                  
|United States        |                    |                  
|Canada               |                    |                  
|Europe               |                    |                  
|Asia                 |                    |                  
|Australia            |                    |                  
|Latin America        |                    |                  
|Total revenue        |                    |                  

15

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# ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The following discussion should be
read in conjunction with the condensed consolidated financial statements and related notes
included elsewhere in this report. The results shown herein are not necessarily indicative
of the results to be expected for any future periods.

The section entitled
Managements Discussion and Analysis of Financial Condition and Results of
Operations set forth below contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act, including but not
limited to our expectations for results during the current fiscal year, statements
regarding revenue and expense trends and cash positions, statements regarding our sales
and marketing, hiring activities, product development and our outlook for the Company, as
well as our expectations, beliefs, intentions or strategies regarding the future. Words
such as anticipates, expects, intends,
may, will, plans, believes,
seeks and estimates and other similar expressions are intended to
identify forward-looking statements. These statements are not guarantees of future
performance and actual actions or results may differ materially. These statements are
based on information available to us on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. These statements involve risks
and uncertainties and actual results could differ materially from those anticipated in
these forward-looking statements as a result of a number of factors, including, but not
limited to, those set forth in Company Risk Factors and elsewhere in this
Report on Form 10-Q and in other reports or documents filed by us from time to time with
the Securities and Exchange Commission. For example, see Company Risk
FactorsOur ability to accurately forecast our quarterly sales is limited, our costs
are relatively fixed in the short term and we expect our business to be affected by
seasonality. As a result, our quarterly operating results may fluctuate, We
are exposed to general economic conditions, which may continue to harm our business,
If we are unable to effectively manage our operations and resources in accordance
with market and economic conditions, our business could be harmed, Our products can
have a long sales and implementation cycle and, as a result, our quarterly operating
results and revenues may fluctuate, We depend on a limited number of customer
orders for a substantial portion of our revenue during any given period. The loss or
delays in a key order could substantially reduce our revenue in any given period and harm
our business and We depend upon resellers for a significant portion of our
sales. The loss of key resellers or a decline in resellers sales of our products
could limit our ability to sustain and grow revenue. The following discussion should
be read in conjunction with the condensed consolidated financial statements and related
notes included elsewhere in this report. The results shown herein are not necessarily
indicative of the results to be expected for the full year or any future periods.

# OVERVIEW

We develop, market and support speech
software products for automating interactions over the telephone for a range of industries
and applications. Our products and services include: speech recognition software, which is
used to recognize what a person says, deliver responses and information and perform
transactions; text-to-speech synthesis software, which converts text, for example, from a
database, email or web page into an audio signal to deliver speech over the telephone;
voice authentication software, which can be used to verify the identity of speakers by the
unique qualities of their voices; grammars, which define the dictionary of possible caller
responses for use in applications; and a standards-based software platform designed as a
foundation for speech application deployment and management. In June 2003, we added our
Nuance Call Steering application, a packaged application designed to accurately and
cost-effectively route phone calls to the correct customer care destinations. We plan to
add additional applications for key industries which, like Nuance Call Steering, will be
designed to leverage the features inherent in our engines and platform while reducing
deployment time and cost.

We seek to actively support both
emerging industry standards as well as proprietary development environments. Our software
is designed to work with Voice Extensible Markup Language (VoiceXML), the
recognized industry standard language for the creation of voice-driven products and
services. We also offer a range of consulting, support and education services that enable
our customers and channel partners to develop and maintain voice-driven applications that
use our software products.

We sell our products both directly
through our sales force and indirectly through third-party resellers. We sell our products
to customers in the United States, Canada, the United Kingdom and other countries in
Europe, China and other countries in Asia, Australia, Central America and Latin America.
We anticipate that markets outside of the United States will continue to represent a
meaningful portion of total future revenue.

# OVERVIEW OF OPERATION

Our growth and profitability are
heavily dependent upon general economic conditions and demand for information technology.
Our growth has traditionally been fueled by the telecommunications and financial services
industries. Both industries have sustained dramatic slowdowns over the past several years.
Information technology spending remains sluggish and may continue to lag for the
foreseeable future.

In response to the challenging
business environment, we have evolved and continue to evolve our strategic direction in a
way that we believe will improve our business performance. Our strategic objectives
include

|. | focusing resources on geographic and industry targets believed to have the highest
potential for revenue,                                                                                          
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                    
|. | evolving  our voice  platform  and  developing supporting  applications  designed to  increase  the speed and ease of
         deployment and reduce the total cost of ownership of speech systems,
|  |                                                                                                                                                                                                    
|. | developing and strengthening a multi-channel selling model,                                                                                                                                        
|  |                                                                                                                                                                                                    
|. | developing  advanced speech  technologies  that deliver  customer value and maintain our leadership  position in the speech
         industry.                                                     

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Some specific operating changes have
already been accomplished, such as the restructuring actions taken in the first and third
quarters of 2002, the release of the Nuance Voice Platform product in the first quarter of
2003 and the release of our first application product, Nuance Call Steering in the second
quarter of 2003 and our focus on driving complete speech solutions into the large telecom
and enterprise call center markets. We plan to introduce certain new applications in the
future. Other operating activities, including new products and changes to selling and
delivery channels, will continue to evolve over the remainder of this and next fiscal
year. We are making these strategic shifts because we believe that they will enhance our
business performance, however, some of the actions we are taking, such as the introduction
of new products, present inherent risks. We believe that these new products will make
speech systems faster and easier to deploy, and will create value for our customers. The
success of these products depends upon certain market factors such as information
technology spending generally, market acceptance of packaged software applications and
industry adoption of VoiceXML and related standards.

In addition, we are responding to
customers requests to work more directly with them and provide them greater access
to Nuances speech expertise across all levels of their speech solutions. We believe
that increasing our direct relationships with end users and delivering more complete
solutions will allow us to reap greater value from these sales transactions. However, this
new sales and delivery model may also present increased costs and risks such as increased
liability for complete solution delivery, costs and risks of subcontractors, and delays in
recognition of revenue due to project timelines for solutions deployment. Further, we may
experience periodic variation in our consulting services revenues when long-term
consulting projects come to completion. In addition, while we are actively working to
manage potential channel conflicts and maintain strong reseller relationships, certain
reseller relationships may be adversely affected by our introduction of our own platform
product and application product and/or our direct sales activities, which may have an
unfavorable impact on revenue from certain resellers.

We are committed to a multi-channel
sales approach and reseller partners have been and will continue to be instrumental in
delivering speech engines, applications and services to our end customers. We are actively
working to maintain and build strong relationships with existing resellers as well as new
resellers. We will continue to focus efforts on fostering a strong reseller channel,
particularly to leverage complementary capabilities in order to speed and ease deployment
of speech solutions. We may encounter difficulties or delays in finding reseller partners
having such complementary capabilities and/or establishing reseller partner relationships
with such entities.

In addition, competition exists in
the speech technology market. We believe that our business and technology has the ability
to compete effectively, however, the speech market is relatively new and susceptible to
change. Our competitors may be able to develop superior technologies or may combine with
each other to leverage complimentary technologies or relationships. Current and potential
competitors may be larger than Nuance and may be able to invest greater resources in
competitive efforts and/or may establish relationships among themselves or with third
parties to increase their technological and/or selling and marketing abilities.

# CODE OF BUSINESS CONDUCT
AND ETHICS

We maintain a code of business
conduct and ethics for directors, officers and employees, and will promptly disclose any
waivers of the code for directors or executive officers. Our code of business practices
addresses conflicts of interest; confidentiality; compliance with laws, rules and
regulations (including insider trading laws); and related matters.

# RESULTS OF OPERATIONS

The following table sets forth, for
the periods indicated, the percentage of net revenue represented by certain items in our
statements of operations for the three and nine months ended September 30, 2003 and 2002.

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|                                      | Three Months Ended | Nine Months Ended
|------------------------------------- | ------------------ | -----------------
|                                      |                    |                  
|                                      |                    |                  
|Revenue:                              |                    |                  
|License                               |                    |                  
|Service                               |                    |                  
|Maintenance                           |                    |                  
|Total revenue                         |                    |                  
|Cost of revenue:                      |                    |                  
|License                               |                    |                  
|Service                               |                    |                  
|Maintenance                           |                    |                  
|Total cost of revenue                 |                    |                  
|Gross profit                          |                    |                  
|Operating expenses:                   |                    |                  
|Sales and marketing                   |                    |                  
|Research and development              |                    |                  
|General and administrative            |                    |                  
|Non-cash stock-based compensation     |                    |                  
|Restructuring charges                 |                    |                  
|Asset impairments                     |                    |                  
|Total operating expenses              |                    |                  
|Loss from operations                  |                    |                  
|Interest and other income, net        |                    |                  
|Loss before income taxes              |                    |                  
|Provision (benefits)from income taxes |                    |                  
|Net loss                              |                    |                  

# COMPARISON OF THREE AND
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

# Revenue

Total revenue for the three months ended September 30, 2003 was $13.8 million, compared with $10.5 million in the three months
     ended September 30, 2002, an increase of 32%. This increase was attributable to increases in each of our three revenue
     categories, and from a regional standpoint, reflected U.S. growth of 27% and international growth of 40%.  Total revenue for
     the nine months ended September 30, 2003 was $38.3 million, compared with $30.9 million in the nine months ended September 30,
     2002, an increase of 24%.  This increase was primarily attributable to the increase in service revenues, and to a lesser
     extent maintenance revenues, and from a regional standpoint, reflected U.S. growth of 22% and international growth of 27%.

License revenue for the three months ended September 30, 2003 was $7.1 million, compared with $5.7 million in the three months
ended September 30, 2002, an increase of 24%. This increase was primarily attributable to revenues generated from several large
scale solutions projects in the U.S. and Canada. License revenue for the nine months ended September 30, 2003 was $19.4 million,
compared with $19.2 million in the nine months ended September 30, 2002, an increase of 1%. License revenue represented 51% of
total revenue both for the three and nine months ended September 30, 2003, respectively, and 55% and 62% of total revenue for the
three and nine months ended September 30, 2002, respectively. Our license revenue
represented 51% of total revenue both for the three and nine months ended September 30,
2003, respectively, and 55% and 62% of total revenue for the three and nine months ended
September 30, 2002, respectively. License revenue as a percentage of total revenue
decreased from the nine months ended September 30, 2002 to the nine months ended September
30, 2002, due primarily to that service revenue as a percentage of total revenue increases
during these periods. This increase in service revenue was a result of a few large
multi-quarter service contracts in the U.S. and Canada.

Service revenue for the three months
ended September 30, 2003 was $3.6 million, compared with $2.4 million for the three months
ended September 30, 2002, an increase of 52%. Service revenue for the nine months ended
September 30, 2003 was $10.1 million, compared with $5.2 million for the nine months ended
September 30, 2002, an increase of 92%. Service revenues grew primarily from a few large
multi-quarter services contracts in the U.S and Canada. Service revenue represented 27%
and 26% of total revenue for the three and nine months ended September 30, 2003,
respectively, and 23% and 17% of total revenue both for the three and nine months ended
September 30, 2002, respectively.

Maintenance revenue for the three
months ended September 30, 2003 was $3.1 million, compared with $2.4 million for the three
months ended September 30, 2002, representing an increase of 31%. Maintenance revenue for
the nine months ended September 30, 2002 was $8.8 million, compared with $6.5 million for
the nine months ended September 30, 2002, an increase of 36%. The increased maintenance
revenue during these periods was due primarily to an increase in the support contract
renewal rate and a one-time benefit from some retroactive back support revenue for which
the services had already been delivered. Maintenance revenue represented 22% and 23% of
total revenue for the three and nine months ended September 30, 2003, respectively, and
22% and 21% of total revenue for the three and nine months ended September 30, 2002,
respectively.

# Cost of Revenue

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Cost of license revenue consists
primarily of third-party royalties, media and documentation costs. Cost of license
revenues for the three months ended September 30, 2003 was $0.1 million, compared with
$0.2 million in the three months ended September 30, 2002, representing a decrease of 48%.
Cost of license revenues was $0.3 million for the nine months ended September 30, 2003,
compared with $0.5 million for the nine months ended September 30, 2002, representing a
decrease of 43%. The decrease was primarily due to the write off of purchased software for
the nine months ended September 30, 2002. During 2001, we purchased $550,000 of
third-party software to complement our core platform product line. At December 31, 2001,
we assessed the remaining carrying value of this software in relation to recovery of
future revenues and wrote off $275,000. We wrote off the remaining amount of $275,000 in
the nine months ended September 30, 2002. Cost of license revenue as a percentage of
license revenue was 1% both for the three and nine months ended September 30, 2003,
respectively, compared with 3% both for the three and nine months ended September 30,
2002, respectively.

Cost of service revenue for the three
months ended September 30, 2003 was $2.3 million, compared with $2.1 million in the
quarter ended September 30, 2002, representing an increase of 10%. Cost of service revenue
for the nine months ended September 30, 2003 was $6.7 million, compared with $5.5 million
in the nine months ended September 30, 2002, an increase of 23%. The increase was due to
the temporary employment of third party services, to fulfill a few large multi-quarter
services contracts. Cost of service revenue as a percentage of service revenue decreased
to 62% and 67% in the three and nine months ended September 30, 2003, respectively,
compared with 85% and 104% for the three and nine months ended September 30, 2002,
respectively, due to the increase in service revenues, partially offset by the cost of
third party services referred to above. We provide consulting services both through the
use of our own employees as well as through the use of contracted third party services.
Cost of service revenue may fluctuate and may vary based on the need to add additional
employees or contract with third party services.

Cost of maintenance revenue was $0.9
million both for the three months ended September 30, 2003 and 2002. Cost of maintenance
revenue was $2.6 million both for the nine months ended September 30, 2003 and 2002. This
cost typically remains flat period over period. Cost of maintenance revenue as a
percentage of maintenance revenue was 28% and 30% in the three and nine months ended
September 30, 2003, respectively, compared with 37% and 41% for the three and nine months
ended September 30, 2002, respectively. Cost of maintenance revenue run rates are expected
to remain constant in absolute dollars but are expected to vary slightly as a percentage
of total revenue in the next several quarters. However, this will depend upon our ability
to grow revenue, among other factors. Accordingly, there can be no assurance that we will
be successful in maintaining our cost of maintenance revenues as a percentage of
maintenance revenue.

# Operating Expenses

We have reduced costs and expenses to
better align resources with revenue opportunities anticipated in the current information
technology market. In January 2002 and August 2002, we announced restructuring plans to
reduce our workforce by approximately 8% and 21%, respectively. Most of the savings
resulting from the workforce reduction is reflected in sales and marketing expense. We
have also reduced the use of outside professional services and lowered capital
expenditures.

Sales and Marketing  Sales and
marketing expenses primarily consist of compensation and related costs for sales,
marketing and business development personnel and promotional expenditures, including
public relations, advertising, trade shows and marketing collateral materials. Sales and
marketing expenses for the three months ended September 30, 2003 were $6.6 million,
compared with $11.0 million in the three months ended September 30, 2002, representing a
decrease of 40%. Sales and marketing expenses for the nine months ended September 30, 2003
were $20.9 million, compared with $32.3 million in the nine months ended September 30,
2002, a decrease of 35%. The decreases during these periods were primarily attributable to
the lower payroll and related overhead costs resulting from reduction of sales and
marketing personnel. Sales and marketing decreased by 36 employees, approximately 33%,
from 109 employees at September 30, 2002 to 73 employees at September 30, 2003. As a
percentage of total revenue, sales and marketing expenses were 48% and 55% for the three
and nine month periods ended September 30, 2003, respectively, and 104% for both the three
and nine month periods ended September 30, 2002, respectively.

Research and Development 
Research and development expenses primarily consist of compensation and related costs for
research and development personnel and contractors. Research and development expenses for
the three months ended September 30, 2003 were $3.7 million, compared with $3.9 million in
the three months ended September 30, 2002, representing a decrease of 6%. Research and
development expenses for the nine months ended September 30, 2003 were $11.5 million,
compared with $11.1 million in the nine months ended September 30, 2002, an increase of
4%. This increase reflects our continuing efforts and investment to develop and deliver
enhancements to our core speech engine products, to develop and deliver our new Nuance
Voice Platform product and Nuance Call Steering Application product. As a percentage of
total revenue, research and development expenses were 26% and 30% in the three and nine
months ended September 30, 2003 respectively, and 37% and 36% in the three and nine months
ended September 30, 2002, respectively. We anticipate that research and development
expenses will increase nominally in absolute dollars and will vary as a percentage of
total revenue from period to period.

General and Administrative 
General and administrative expenses primarily consist of compensation and related costs
for administrative personnel, legal services, accounting services, insurance and other
general corporate expenses. General and administrative expenses for the three months ended
September 30, 2003 were $2.8 million, compared with $3.2 million in the three months ended
September 30, 2002, representing a decrease of 13%. General and administrative expenses
for the nine months ended September 30, 2003 were $8.9 million, compared with $10.1
million in the nine months ended September 30, 2002, a decrease of 12%. The decreases
during these periods were primarily due to the reduction in professional services and
lower payroll and related overhead costs as a result of the head count reduction
in the Q3 2002 and Q3 2003 restructuring plans. Headcount for general and administrative
personnel decreased by approximately net of 5 employees, a reduction of approximately 9%,
from 56 employees at September 30, 2002 to 51 employees at September 30, 2003. As a
percentage of total revenue, general and administrative expenses were 20% and 23% in the
three and nine months ended September 30, 2003, respectively, and 30% and 32% in the three
and nine months ended September 30, 2002. We anticipate that general and administrative
expenses will remain relatively constant in absolute dollars and will vary as a percentage
of total revenue from period to period.

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Non-Cash Compensation Expense 
In connection with the grant of stock options prior to our initial public offering, we
recorded deferred stock compensation of approximately $8.7 million within
stockholders equity, representing the difference between the estimated fair value of
the common stock for accounting purposes and the option exercise price of these options at
the date of grant. This amount is presented as a reduction of stockholders equity
and is amortized over the vesting period of the applicable options in a manner consistent
with FASB Interpretation No. 28. For the three and nine months ended September 30, 2003,
we recorded amortization of deferred compensation of $39,000 and $172,000. During the same
periods, we reversed excess amortization of deferred stock compensation due to termination
of employees of ($6,000) and ($153,000), resulting in net expense of deferred compensation
of $33,000 and $19,000. For the three and nine months ended September 30, 2003, we
reversed approximately $1,000 and $40,000, of deferred stock compensation and additional
paid-in capital, representing unamortized deferred stock compensation relating to
forfeitures of stock options by terminated employees. For the three and nine months ended
September 30, 2002, we recorded amortization of deferred stock compensation of $221,000
and $790,000 and reversed excess amortization of deferred stock compensation due to
termination of employees of ($188,000) and ($374,000), resulting in net expense of
deferred compensation of $33,000 and $416,000. For the three and nine months ended
September 30, 2002, we reversed approximately $77,000 and $139,000 of deferred stock
compensation and additional paid-in-capital, representing unamortized deferred stock
compensation relating to forfeitures of stock options by terminated employees.

In December 2000, we issued a warrant
to a customer to purchase 100,000 shares of common stock at an exercise price of $138.50
per share subject to certain anti-dilution adjustments. The warrant was exercisable at the
option of the holder, in whole or part, at any time between January 17, 2001 and August
2002. In January 2001, we valued the warrant at $526,000, utilizing the Black-Scholes
valuation model using the following assumptions: risk-free interest rate of 5.5%, expected
dividend yields of zero, expected life of 1.5 years and expected volatility of 80%. We
amortized $321,000 for the year ended December 31, 2001. Out of remaining $205,000
balance, we amortized $187,000 for the nine months ended September 30, 2002 related to
this warrant and reduced the warrant expense by $18,000 for the performance we delivered
to this customer. The warrant expired unexercised in August 2002.

In connection with the SpeechFront
acquisition, we recorded deferred compensation expense of $387,000 for the nine months
ended September 30, 2002. SpeechFront related deferred compensation was fully amortized as
of December 31, 2002.

We expect to amortize the remaining
deferred stock compensation of $9,000 in the three months ended December 31, 2003.

Restructuring charges

Fiscal Year 2001

In April 2001, with Board of
Directors approval, we implemented a restructure plan to align our expenses with revised
anticipated demand and create a more efficient organization. In connection with the
restructuring plan, we recorded a restructuring charge of $34.1 million for lease loss and
severance costs and an asset impairment charge of $20.9 million on tenant improvements
during the quarter ended September 30, 2001. We decreased the asset impairment charge by
$0.5 million in the quarter ended December 31, 2001.

In connection with the restructuring
plan, we decided not to occupy a new leased facility. This decision has resulted in a
lease loss of $32.6 million for the year ended December 31, 2001, comprised of a sublease
loss, broker commissions and other facility costs. To determine the sublease loss, the
loss after our cost recovery efforts from subleasing the building, certain assumptions
were made related to the (1) time period over which the building will remain vacant
(2) sublease terms and (3) sublease rates. We established the reserves at the low end of
the range of estimable cost against outstanding commitments, net of estimated future
sublease income. These estimates were derived using the guidance provided in SAB No. 100,
Restructuring and Impairment Charges, and EITF No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)". The lease loss was increased
in August 2002 and September 2003 as described below and will continue to be adjusted in
the future upon triggering events (change in estimate of time to sublease, actual sublease
rates, etc.).

We recorded $1.5 million in costs for
the year ended December 31, 2001 associated with severance and related benefits. We
reduced headcount by approximately 80 employees, with reductions ranging between 10% and
20% across all functional areas and affecting several locations.

Fiscal Year 2002

In January 2002, with Board of
Directors approval, we implemented a restructuring plan to reduce our workforce by
approximately 8%, or 33 employees. The restructuring was primarily to realign the sales
and professional services organizations. We recorded a restructuring charge of $1.3
million for the three months ended March 31, 2002, consisting primarily of payroll and
related expenses associated with reducing headcount. This amount was paid out as of
December 31, 2002.

In August 2002, with Board of
Directors approval, we implemented a restructuring plan to reduce our worldwide workforce
by approximately 21%, or 81 employees, to realign our expense structure with near term
market opportunities. In connection with the reduction of workforce, we recorded a charge
of $2.6 million primarily for severance and related employee termination costs. As of
September 30, 2003, approximately $2.3 million of this amount was paid out, with the
remainder to be paid by the December 2003. As of September 30, 2003, we also reversed an
excess accrual for this restructuring plan, which resulted in recording of $0.2 million as
a credit to the Restructuring charge line in the Condensed Consolidated Statement of
Operations.

The plan also included the
consolidation of facilities through the closing of certain international offices that
resulted in a charge of $1.6 million. In addition, we recorded an increase in our
previously reported real estate restructuring accrual related to the new leased facility
we do not occupy and which has not been subleased as a result of continued declines in the
condition of the San Francisco Bay Area real estate market. This additional charge of
$31.8 million resulted from an analysis of the time period by which the California
property will remain vacant, sub-lease terms and sub-lease rates, altogether reflecting
continued softening of the local real estate market.

Fiscal Year 2003

In February 2003, we received cash
and recorded an asset impairment credit of $0.9 million related to a refund of tenant
improvement costs for the building we do not occupy, following the landlords
reconciliation of tenant improvement costs. This credit was recorded on the Restructuring
Charges (Credits) line of the Condensed Consolidated Statements of Operation, where the
original asset impairment charge of $20.4 million was recognized for the year ended
December 31, 2001.

For the three months ended September
30, 2003, we reviewed its earlier estimate for the lease loss for the unoccupied leased
facility and the condition of the San Francisco Bay Area real estate market. We estimated
that it might take an additional 18 months to sublease this unoccupied facility. We also
lowered the estimates for the expected sublease rates. This evaluation resulted in
recording an additional lease loss of $10.4 million and is recorded as part of the
Restructuring charges on the Condensed Consolidated Statement of Operations.

For the three months ended September
30, 2003, we reduced our general and administrative workforce by 9%, or net of 5
employees, to realign the organization to the Companys structure. We recorded a
restructuring charge of $0.2 million primarily for severance and termination costs
relating to the reduction in workforce. As of September 30, 2003, $0.1 million was paid
out, with the remainder to be paid in the fourth quarter of 2003. In addition, we reversed
the excess accrual for the August 2002 restructuring plan, which resulted in a $0.2
million credit to the Restructuring charge line in the Condensed Consolidated Statement of
Operations.

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The restructuring charges and quarter
end balances for the quarter ended September 30, 2003 are as follows (in thousands):

|                                                        | Lease Loss | Severance & Related | Asset Write Down | Total Restructuring
|------------------------------------------------------- | ---------- | ------------------- | ---------------- | -------------------
|2001 Plan                                               |            |                     |                  |                    
|Total charges for the year ending December 31, 2001     |            |                     | $                | 32,615             
|Amount utilized in the year ending December 31, 2001    |            |                     |                  | (3,572             
|Accrual balance at December 31, 2001                    |            |                     | $                | 29,043             
|Total charges for the year ending December 31, 2002     |            |                     | $                | 31,829             
|Amount utilized in the year ended December 31, 2002     |            |                     |                  | (9,342             
|Balance at December 31, 2002                            |            |                     | $                | 51,530             
|Total charges for
the quarter ended March 31, 2003      |            |                     | $                | --                 
|Amount utilized
in the quarter ended March 31, 2003     |            |                     |                  | (2,320             
|Balance at March 31, 2003                               |            |                     | $                | 49,210             
|Total charges for
the quarter ended June 30, 2003       |            |                     | $                | --                 
|Amount utilized
in the quarter ended June 30, 2003      |            |                     |                  | (2,416             
|Balance at June 30, 2003                                |            |                     | $                | 46,794             
|Total charges for
the quarter ended September 30, 2003  |            |                     | $                | 10,373             
|Amount utilized
in the quarter ended September 30, 2003 |            |                     |                  | (2,392             
|Balance at September 30, 2003                           |            |                     | $                | 54,775             
|Current restructuring accrual                           |            |                     | $                | 9,603              
|Long-term restructuring accrual                         |            |                     | $                | 45,172             
|Q1 2002 Plan                                            |            |                     |                  |                    
|Total charges for the year ending December 31, 2002     |            |                     | $                | --                 
|Amount utilized in the year ending December 31, 2002    |            |                     |                  | --                 
|Balance at December 31, 2002                            |            |                     |                  | --                 
|Current restructuring accrual                           |            |                     |                  | --                 
|Long-term restructuring accrual                         |            |                     | $                | --                 
|Q3 2002 Plan                                            |            |                     |                  |                    
|Total charges for the year ending December 31, 2002     |            |                     | $                | 1,560              
|Amount utilized in the year ending December 31, 2002    |            |                     |                  | (1,046             
|Balance at December 31, 2002                            |            |                     |                  | 514                
|Total charges for the quarter ended March 31, 2003      |            |                     | $                | --                 
|Amount utilized in the quarter ended March 31, 2003     |            |                     |                  | (361               
|Balance at March 31, 2003                               |            |                     |                  | 153                
|Total charges for the quarter ended June 30, 2003       |            |                     | $                | --                 
|Amount utilized in the quarter ended June 30, 2003      |            |                     |                  | (36                
|Balance at June 30, 2003                                |            |                     | $                | 117                
|Total charges for the quarter ended September 30, 2003  |            |                     | $                | --                 
|Reclassed from severance to lease loss                  |            |                     | $                | (14                
|Amount utilized in the quarter ended September 30, 2003 |            |                     |                  | (37                
|Balance at September 30, 2003                           |            |                     | $                | 66                 
|Current restructuring accrual                           |            |                     | $                | 66                 
|Long-term restructuring accrual                         |            |                     | $                | --                 
|Q3 2003 Plan                                            |            |                     |                  |                    
|Total charges for the quarter ended September 30, 2003  |            |                     | $                | --                 
|Amount utilized in the quarter ended September 30, 2003 |            |                     |                  | --                 
|Balance at September 30, 2003                           |            |                     | $                | --                 
|Current restructuring accrual                           |            |                     | $                | --                 
|Long-term restructuring accrual                         |            |                     | $                | --                 
|Balance at September 30, 2003 (All restructuring plans) |            |                     |                  |                    
|Total restructuring accrual: Current                    |            |                     | $                | 9,669              
|Total restructuring accrual: Long-term                  |            |                     | $                | 45,172             

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We expect the total cash outlay for
the restructuring plans to be $81.8 million, of which $26.9 million was paid through
September 30, 2003 and $54.9 million remains accrued at September 30, 2003. We expect $9.7
million of the lease loss to be paid out over the next twelve months and remaining $45.2
million to be paid out over the remaining life of the lease of approximately 9 years.

# Interest and Other
Income, Net

Interest and other income, net,
consists primarily of interest earned on cash and cash equivalents and short-term and
long-term investments. Interest and other income, net was $325,000 and $1,044,000 in the
three and nine months ended September 30, 2003, respectively; $694,000 and $2,215,000 in
the three and nine months ended September 30, 2002, respectively, a decrease of 53% both
for the three and nine month period. This decrease was due to a reduction in interest
income, resulting from lower cash and investment balances and a decline in interest rates.

# Provision for Income
Taxes

We have incurred operating losses for
all periods from inception through September 30, 2003 and therefore have not recorded a
provision for U.S. federal income taxes for any period through September 30, 2003. We
recorded income tax expense relating to foreign royalties taxes of $65,000 and $7,000 for
the three months ended September 30, 2003 and 2002, respectively, and $128,000 and $99,000
for the nine months ended September 30, 2003 and 2002, respectively. The income tax
expense has been reduced by foreign tax credits. For the three months ended September 30,
2003, income taxes included a credit of $0.2 million due primarily to technology tax
credits from our Canadian operations. We do not expect the tax credits to be substantial
in future quarters.

# LIQUIDITY AND CAPITAL
RESOURCES

From inception to our initial public
offering, we financed our operations primarily from private sales of convertible preferred
stock totaling $70.0 million through March 31, 2000 and, to a lesser extent, from bank
financing. On April 18, 2000, we raised approximately $80 million through the completion
of our initial public offering of common stock. On October 2, 2000, we raised
approximately $144 million through the completion of our follow-on public offering.

As of September 30, 2003, we had
cash, cash equivalents and short-term investments totaling $107.6 million.   Our
operating activities used cash of $19.8 million and $38.8 million for the nine months
ended September 30, 2003 and 2002, respectively. The negative operating cash flows in the
nine months ended September 30, 2003 and 2002 both resulted principally from our net
losses. In 2002, restructuring accrual offset the net loss.

Our investing activities generated
(used) cash of $5.0 million and $(31.4) million for the nine months ended September 30,
2003 and 2002, respectively. The generation of cash from investing activities during the
nine months ended September 30, 2003 resulted primarily from maturities of investments.
The use of cash in investing activities during the corresponding period in 2002 consisted
primarily of purchases of investments, property and equipments.

Our financing activities generated
cash of $687,000 and $2.0 million for the nine months ended September 30, 2003 and 2002,
respectively. Net cash provided by financing activities related primarily to the proceeds
from the sale of common stock through the exercise of stock options and through the
employee stock purchase plan.

Contractual obligations

The following table summarizes our
obligations and commercial commitments to make future payments under contracts as of
September 30, 2003 (in thousands):

|Contractual Obligations       | Total    | 2003 (remaining 3 months) | 2004    | 2005    | 2006    | 2007    | Thereafter
|----------------------------- | -------- | ------------------------- | ------- | ------- | ------- | ------- | ----------
|Operating leases              | $ 81,149 | $ 2,433                   | $ 9,142 | $ 8,319 | $ 8,610 | $ 8,871 | $ 43,774  
|Capital lease                 | 45       | 12                        | 33      | --      | --      | --      | --        
|Total Contractual Obligations | $ 81,194 | $ 2,445                   | $ 9,175 | $ 8,319 | $ 8,610 | $ 8,871 | $ 43,774  

|Other Commercial Commitments                                | Total    | Less than 1 year | 1-3 years | 4-5 years | After 5 years |  | 
|----------------------------------------------------------- | -------- | ---------------- | --------- | --------- | ------------- |  | 
|Standby Letter of Credit (California, Pacific Shores lease) | $ 10,908 | $      --        | $      -- | $      -- | $ 10,908      |  | 
|Standby Letter of Credit (Montreal lease)                   | $ 198    | $      --        | $      -- | $      -- | $ 198         |  | 
|Total Other Commercial Commitments                          | $ 11,106 | --               | --        | --        | 11,106       

Our balance sheet as of September 30,
2003 includes $11.1 million of restricted cash. This amount consists of $10.9 million
related to our Pacific Shores lease in California and $198, 000 related to our Montreal
lease.

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Our capital requirements depend on
numerous factors. We may continue to report significant quarterly operating losses
resulting in future negative operating cash flows. We do not plan to spend more than
$500,000 on capital expenditures in the remaining 3 months of 2003. We believe that our
cash, cash equivalents and our short-term investments will be sufficient to fund our
activities for at least the next 12 months. Thereafter, we may need to raise additional
funds in order to fund more rapid expansion, including increases in employees and office
facilities; to develop new or enhance existing products or services; to respond to
competitive pressures; or to acquire or invest in complementary businesses, technologies,
services or products. Additional funding may not be available on favorable terms or at
all. In addition, we may, from time to time, evaluate potential acquisitions of other
businesses, products and technologies. We may also consider additional equity or debt
financing, which could be dilutive to existing investors.

# CRITICAL ACCOUNTING
POLICIES AND ESTIMATES

The preparation of financial
statements in accordance with accounting principles generally accepted in the United
States of America requires that management make a number of assumptions and estimates that
affect the reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the periods presented
in our consolidated financial statements and accompanying notes. Management bases its
estimates on historical experience and various other assumptions believed to be
reasonable. Such estimates include uncollectible accounts receivable, restructuring
accrual for leases, taxes and contingencies. Although these estimates are based on
managements best knowledge of current events and actions that may impact us in the
future, actual results may differ from these estimates and assumptions.

Our critical accounting policies are
those that affect our financial statements materially and involve a significant level of
judgment by management. Those policies are as follows:

|. | revenue recognition;                 
|- | -------------------------------------
|  |                                      
|. | restructuring and impairment charges;
|  |                                      
|. | allowance for doubtful accounts;     
|  |                                      
|. | income taxes;                        
|  |                                      
|. | valuation of long-lived assets.      

Revenue Recognition

Revenues are generated from licenses,
services and maintenance. All revenues generated from our worldwide operations are
reviewed at our corporate headquarters, located in the United States. We apply the
provisions of Statement of Position (SOP) 97-2, Software Revenue
Recognition, as amended by SOP 98-9 Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions to all transactions involving the
sale of software products. We also recognize some revenue based on SOP 81-1
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts.

Our license revenue consists of
license fees for the software products. The license fees for our software products are
calculated using two variables, one of which is the estimated maximum number of
simultaneous end-user connections or ports to an application running on our
software and the other of which is the value attributed to the functional use of the
software.

For licensed products requiring
significant customization, we generally recognize license revenue using the
percentage-of-completion method of accounting over the period that services are performed.
For all license and service agreements accounted for under the percentage-of-completion
method, we determine progress to completion based on actual direct labor hours incurred to
date as a percentage of the estimated total direct labor hours required to complete the
project. We periodically evaluate the actual status of each project to ensure that the
estimates to complete each contract remain accurate. A provision for estimated losses on
contracts is made in the period in which the loss becomes probable and can be reasonably
estimated. To date, these losses have not been significant. Costs incurred in advance of
billings are recorded as costs in excess of related billings on uncompleted contracts. If
the amount of revenue recognized exceeds the amounts billed to customers, the excess
amount is recorded as unbilled accounts receivable. If the amount billed exceeds the
amount of revenue recognized, the excess amount is recorded as deferred revenue. Revenue
recognized in any period is dependent on our progress toward completion of projects in
progress. Significant management judgment and discretion are used to estimate total direct
labor hours. Any changes in or deviation from these estimates could have a material effect
on the amount of revenue we recognize in any period.

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For licensed products which do not
require significant customization of components, we recognize revenue from the sale of
software licenses when:

|. | persuasive evidence of an arrangement exists;                          
|- | -----------------------------------------------------------------------
|  |                                                                        
|. | the software and corresponding authorization codes have been delivered;
|  |                                                                        
|. | the fee is fixed and determinable;                                     
|  |                                                                        
|. | collection of the resulting receivable is probable.                    

We use a signed contract and purchase
order or royalty report as evidence of an arrangement for license orders.

Products delivered with acceptance
criteria or return rights are not recognized as revenue until all criteria are achieved.
If undelivered products or services exist that are essential to the functionality of the
delivered product in an arrangement, delivery is not considered to have occurred. Delivery
is accomplished through electronic distribution of the authorization codes or
keys. The software was previously delivered to the customer either
electronically or on a CD-ROM. Occasionally the customer will require that we secure their
acceptance of the system in addition to the delivery of the keys. Such acceptance, when
required, typically consists of a demonstration to the customer that, upon implementation,
the software performs in accordance with specified system parameters, such as recognition
accuracy or task completion rates. In cases of absence of such required acceptance, we
will wait and not recognize revenue until signed acceptance is obtained.

We assess whether the fee is fixed
and determinable based on the payment terms associated with the transaction. We assess
collectibility of the transaction based on a number of factors, including the
customers past payment history and its current financial position. If we determine
that collection of a fee is not probable, we defer recognition of the revenue until the
time collection becomes reasonably assured, which is generally upon receipt of the cash
payment.

We use the residual method to
recognize revenue when a license agreement includes one or more elements to be delivered
at a future date if vendor specific objective evidence of the fair value of all
undelivered elements exists. Vendor-specific objective evidence of fair value is based on
the price generally charged when the element is sold separately, or if not yet sold
separately, is established by authorized management. In situations where vendor-specific
objective evidence of fair value for undelivered elements does not exist, the entire
amount of revenue from the arrangement is deferred and recognized when vendor-specific
objective evidence of fair value can be established for all undelivered elements or when
all such elements are delivered. In situations where the only undelivered element is
maintenance and vendor specific objective evidence of fair value for maintenance does not
exist, the entire amount of revenue from the arrangement is recognized ratably over the
maintenance period. As a general rule, license revenue from resellers is recognized when
product has been sold through to an end user and such sell-through has been reported to
us. However, certain reseller agreements include time-based provisions on which we base
revenue recognition, in these instances, there is no right of returns possible.

The timing of license revenue
recognition is affected by whether we perform consulting services in the arrangement and
the nature of those services. In the majority of cases, we either perform no consulting
services or we perform services that are not essential to the functionality of the
software. When we perform consulting and implementation services that are essential to the
functionality of the software, we recognize both license and consulting revenue utilizing
contract accounting based on the percentage of the consulting services that have been
completed. This calculation is done in conformity with SOP 81-1, however judgment is
required in determining the percentage of the project that has been completed. Such
contracts were significant for the three and nine months ended September 30, 2003 and
2002, respectively. We have also explored the markets for complete speech solutions and
delivering through combined product and services, where we are required to use the
contract accounting based upon percentage of completion. This method of accounting is
subject to certain judgments by us regarding amount of revenue allocated to percentage of
work completed. Typically, we would recognize revenue based upon the proportional level of
effort expended, combined with the value of the technology delivered, to complete certain
milestones defined in the customer contract or statement of work.

Service revenue consists of revenue
from providing implementation, consulting, training and other revenue. Other revenue
consists primarily of reimbursements for consulting out-of-pocket expenses incurred, in
accordance with the Emerging Issues Task Force (EITF) Issue No. 01-14,
Income Statement Characterization of Reimbursements Received for
Out-of-Pocket Expenses Incurred. For services revenue, we generally
require a signed contract, Statement of Work and purchase order prior to recognizing any
services revenue. Our consulting service contracts are bid either on a fixed-fee basis or
on a time-and-materials basis. For a fixed-fee contract, we recognize revenue using the
percentage of completion method. For time-and-materials contracts, we recognize revenue as
services are performed. Training service revenue is recognized as services are performed.
Losses on service contracts, if any, are recognized as soon as such losses become known.

Maintenance revenue consists of fees
for providing technical support and software upgrades and updates. We generally require a
signed contract and purchase order prior to recognizing any maintenance revenue. We
recognize all maintenance revenue ratably over the contract term for such maintenance.
Customers have the option to purchase or decline maintenance agreements at the time of the
license purchase. If maintenance is declined, a reinstatement fee is generally required
when the customer decides to later activate maintenance. Customers generally have the
option to renew or decline maintenance agreements annually during the contract term.

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Our standard payment terms are
generally net 30 to 90 days from the date of invoice.Payment terms can be up to net 120 days at management discretion. Thus, a significant portion of our
accounts receivable balance at the end of a quarter is primarily comprised of revenue from
that quarter.

We record deferred revenue primarily
as a result of payments from customers received in advance of recognition of revenue. As
of September 30, 2003 and December 31, 2002, deferred revenue was $7.8 million and $9.0
million, respectively. The deferred revenue amount includes unearned license fees, which
will be recognized as revenue when the appropriate criteria have been met, or in some
cases, when an identified time period has expired and the customer or resellers
right to certain licenses has been forfeited, prepaid maintenance and prepaid or unearned
professional services that will be recognized as revenue as the services are performed.

Cost of license revenue consists
primarily of license fees payable on third-party software products, amortization of
software costs, documentation and media costs. Cost of service revenue consists of
compensation and related overhead costs for employees or third parties engaged in
consulting and training. Cost of maintenance revenue consists of compensation and related
overhead costs for employees engaged in technical support.

Restructuring and
Impairment Charges

Through September 30, 2003, we have
accrued for restructuring costs when management approved and committed to a firm plan.
Historically the main components of our restructuring plans have been related to workforce
reductions, lease losses as a result of a decision not to occupy certain leased property
and asset impairments. Workforce-related charges were accrued based on an estimate of
expected benefits that would be paid out to the employees. To determine the sublease loss,
after our cost recovery efforts from subleasing the building, certain assumptions were
made related to the (1) time period over which the building would remain vacant (2)
sublease terms and (3) sublease rates. We established the reserves at the low end of the
range of estimable cost against outstanding commitments, net of estimated future sublease
income. These estimates were derived using the guidance provided in SAB No. 100,
Restructuring and Impairment Charges, EITF No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)", and SFAS No.146 
Accounting for Costs Associated with Exit or disposal Activities. SFAS No.146
governs all the exit or disposal activities initiated after December 31, 2002. These
reserves were based upon managements estimate of the time required to sublet the
property and the amount of sublet income that might be generated between the date the
property was not occupied and expiration of the lease for each of the unoccupied property.
These estimates were reviewed and revised quarterly and may result in a substantial
increase or decrease to restructuring expense should different conditions prevail than
were anticipated in original management estimates. As of September 30, 2003, and the date
of this filing, we believe our estimates remain materially correct. Asset impairments
primarily reflected write-offs of tenant improvements and fixtures associated with
abandoned lease space. SFAS No.146 requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred and was effective
for exit or disposal activities initiated after January 1, 2003.

Allowance for Doubtful
Accounts

We perform ongoing credit evaluations
of our customers and adjust credit limits based upon payment history and the
customers current creditworthiness, as determined by our review of their current
credit information. We continuously monitor collections and payments from our customers
and maintain a provision for estimated credit losses based on a percentage of our accounts
receivable, our historical experience and any specific customer collection issues that we
have identified. While such credit losses have historically been within our expectations
and appropriate reserves have been established, we cannot guarantee that we will continue
to experience the same credit loss rates that we have experienced in the past. Material
differences may result in the amount and timing of revenue and or expenses for any period
if management made different judgments or utilized different estimates.

Income Taxes

In preparing our condensed
consolidated financial statements, we are required to estimate our income taxes in each of
the jurisdictions in which we operate. This process involves estimating actual current tax
exposures together with assessing tax credits and with assessing temporary differences
resulting from differing treatment of items, such as deferred revenue, for tax and
accounting purposes. These differences result in deferred tax assets and liabilities,
which are included within the Condensed Consolidated Balance Sheet. We then assess the
likelihood that deferred tax assets will be recovered from future taxable income, and to
the extent we believe that recovery is not likely, we must establish a valuation
allowance. To the extent we establish a valuation allowance or increase this allowance in
a period, we include an expense within the tax provision in our Condensed Consolidated
Statement of Operations.

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Significant management judgment is
required in determining our provision for income taxes, income tax credits, our deferred
tax assets and liabilities and any valuation allowance recorded against our net deferred
tax assets. We have recorded a valuation allowance due to uncertainties related to our
ability to utilize some of our deferred tax assets, primarily consisting of the
utilization of certain net operating loss carry forwards and foreign tax credits before
they expire. The valuation allowance is based on estimates of taxable income by the
jurisdictions in which we operate and the period over which deferred tax assets will be
recoverable. In the event that actual results differ from these estimates or we adjust
these estimates in future periods, we may need to establish an additional valuation
allowance, which could impact our financial position and results of operations.

Valuation of Long-lived
Assets

We have assessed the recoverability
of long-lived assets, including intangible assets other than goodwill, by determining
whether the carrying value of such assets will be recovered through undiscounted future
cash flows according to the guidance of SFAS No. 144 Accounting for the Impairment
or Disposal of Long Lived Assets. SFAS No. 144 supercedes SFAS No. 121
Accounting for the Impairment or Disposal of Long-lived Assets in 2002. We
assess the realizability of long-lived assets, including intangibles in accordance with
the provisions of SFAS No. 144. We assess the impairment of goodwill in accordance with
SFAS No. 142 Goodwill and Other Intangible Assets, which became effective for
the year ended December 31, 2002. For assets to be held and used, including acquired
intangibles, we initiate our review annually or whenever events or changes in
circumstances indicate that the carrying amount of a long-lived asset may not be
recoverable. Recoverability of an asset is measured by comparison of its carrying amount
to the expected future undiscounted cash flows (without interest charges) that the asset
is expected to generate. Any impairment to be recognized is measured by the amount by
which the carrying amount of the asset exceeds its fair value. Significant management
judgment is required in the forecasting of future operating results which are used in the
preparation of projected discounted cash flows and should different conditions prevail,
material write downs of net intangible assets and/or goodwill could occur.

It is reasonably possible that the
estimates of anticipated future gross revenue, the remaining estimated economic life of
the products and technologies, or both, could differ from those used to assess the
recoverability of these costs and result in a write-down of the carrying amount or a
shortened life of acquired intangibles in the future. As of September 30, 2003, we have no
goodwill balance and no impairment of intangibles was recorded.

# FACTORS THAT AFFECT
FUTURE RESULTS

OUR ABILITY TO ACCURATELY FORECAST
OUR QUARTERLY SALES IS LIMITED, OUR SHORT TERM COSTS ARE RELATIVELY FIXED, AND WE EXPECT
OUR BUSINESS TO BE AFFECTED BY SEASONALITY. AS A RESULT, OUR QUARTERLY OPERATING RESULTS
MAY FLUCTUATE.

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Our quarterly operating results have
varied significantly in the past and we expect that they will vary significantly from
quarter to quarter in the future. As a result, our quarterly operating results are
difficult to predict. These quarterly variations are caused by a number of factors,
including:

 general economic downturn and
global economic and political conditions;

 delays or cancellations in expected orders
by customers who are reducing spending or adjusting project plans;

 delays in customer orders due
to the complex nature of large telephony systems and the associated implementation
projects;

 timing of product deployments
and completion of project phases, particularly for large orders and large solution
projects;

 delays in recognition of
software license revenue in accordance with applicable accounting principles;

 our ability to develop,
introduce, ship and support new and/or enhanced products, such as new versions of our
software platform and application(s), that respond to changing technology trends in a
timely manner and our ability to manage product transitions;

 rate of market adoption for
speech technology generally and our products in particular, such as our new software
platform and applications;

 changes in our selling model
including focus of certain sales representatives on direct sales to end user customers and
resulting potential for channel conflict;

 unexpected customer
non-renewal of maintenance contracts, or renewal at lower rates than anticipated;

 the amount and
timing of our expenses; and

 the utilization rate of our
professional services personnel, which is dependent upon acquisition of new projects as large scale, multi-quarter projects come to completion.

Due to these factors, because the
market for our software is relatively new and rapidly changing, and because our business
model is evolving, our ability to accurately forecast our quarterly sales is limited. In
addition, most of our costs are relatively fixed in the short term, even as we endeavor to
manage these costs. If we have a shortfall in revenue in relation to our expenses, we may
be unable to reduce our expenses quickly enough to avoid lower quarterly operating
results. We do not know whether our business will grow rapidly enough to absorb our
expenses, even as we endeavor to manage these costs. As a result, our quarterly operating
results could fluctuate significantly and unexpectedly from quarter to quarter.

We also expect to experience
seasonality in the sales of our products. For example, we anticipate that sales may be
lower in the first and third quarters of each year due to patterns in the capital
budgeting and purchasing cycles of our current and prospective customers. We also expect
that sales may decline during summer months. These seasonal variations in our sales may
lead to fluctuations in our quarterly operating results. It is difficult for us to
evaluate the degree to which this seasonality may affect our business.

WE DEPEND ON A LIMITED NUMBER OF
CUSTOMER ORDERS FOR A SUBSTANTIAL PORTION OF OUR REVENUE DURING ANY GIVEN PERIOD. THE LOSS
OF, OR DELAYS IN, A KEY ORDER COULD SUBSTANTIALLY REDUCE OUR REVENUE IN ANY GIVEN PERIOD
AND HARM OUR BUSINESS.

We derive a significant portion of
our revenue in each period from a limited number of customers. For example, for the three
months ended September 30, 2003, our top five customers accounted for 37% of our total
revenue.One customer accounted for more than 10% of our total revenue.

We expect that a limited number of
customers and customer orders will continue to account for a substantial portion of our
revenue in any given period. Generally, customers who make large purchases from us are not
expected to make subsequent, equally large purchases in the short term, and therefore we
must attract new customers in order to maintain or increase our revenues. If we experience
delays or cancellations in orders from a major customer, if an anticipated sale is not
made or is deferred, or if we fail to acquire a major new customer, our revenue in a given
period could be impacted negatively and our business could be harmed.

WE DEPEND UPON RESELLERS FOR A
SIGNIFICANT PORTION OF OUR SALES. THE LOSS OF KEY RESELLERS, OR A DECLINE IN
RESELLERS RESALE OF OUR PRODUCTS AND SERVICES, COULD LIMIT OUR ABILITY TO SUSTAIN
AND GROW OUR REVENUE.

In 2000, 72% of our revenue was
achieved by indirect sales through resellers. The percentage of revenue through indirect
sales increased to 75% in 2001, then decreased to 74% in 2002 and 60% for the nine months
ended September 30, 2003. Though this percentage may vary or decrease in the future, we
intend to continue to rely on resellers for a substantial portion of our sales in the
future. As a result, we are dependent upon the viability and financial stability of our
resellers, as well as upon their continued interest and success in selling our products.
In addition, some of our resellers are thinly capitalized or otherwise experiencing
financial difficulties. The loss of a key reseller or our failure to develop new and
viable reseller relationships could limit our ability to sustain and grow our revenue.
Significant expansion of our internal sales force to replace the loss of a key reseller
would require increased management attention and higher expenditures.

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Our contracts with resellers
generally do not require a reseller to purchase our products or services. We cannot
guarantee that any of our resellers will continue to market our products or devote
significant resources to doing so. In addition, while we are actively working to manage
potential channel conflicts and maintain strong reseller relationships, certain reseller
relationships may be adversely affected by our introduction of our own platform product
and /or our direct sales activities, which may have an unfavorable impact on revenue from
certain resellers. In addition, we will, from time to time, terminate or adjust some of
our relationships with resellers in order to address changing market conditions, improve
our business, adapt to our business strategy, resolve disputes, or for other reasons. Any
such termination or adjustment could have a negative impact on our relationships with
resellers and our business and result decreased sales through resellers or threatened or
actual litigation. Finally, our resellers possess confidential information concerning our
products and services, product release schedules and sales, marketing and reseller
operations. Although we have nondisclosure agreements with our resellers, we cannot
guarantee that any reseller would not use our confidential information in competition with
us or otherwise. If our resellers do not successfully market and sell our products or
services for these or any other reasons, our sales could be adversely affected and our
revenue could decline.

SPEECH SOFTWARE PRODUCTS
GENERALLY, AND OUR PRODUCTS AND SERVICES IN PARTICULAR, MAY NOT ACHIEVE WIDESPREAD
ACCEPTANCE, WHICH COULD REQUIRE US TO MODIFY OUR SALES AND MARKETING EFFORTS AND COULD
LIMIT OUR ABILITY TO SUCCESSFULLY GROW OUR BUSINESS.

The market for speech software
products is relatively new and rapidly changing. In addition, some of our products are new
to the market or will be new to the market once released. Our ability to increase revenue
in the future depends on the acceptance by our customers, resellers and end users of
speech software solutions generally and our products and services in particular. The
adoption of speech software products could be hindered by the perceived costs and
deployment risks of this relatively new technology, as well as the reluctance of
enterprises that have invested substantial resources in existing call centers or
touch-tone-based systems to replace their current systems with this new technology.
Accordingly, in order to achieve commercial acceptance, we may have to educate prospective
customers, including large, established enterprises and telecommunications companies,
about the uses and benefits of voice interface software in general and our products in
particular. This may require shifts in our sales and marketing efforts and strategies to
achieve such education. If these efforts fail or prove excessively costly or otherwise
unmanageable, or if speech software generally do not achieve commercial acceptance, our
business could be harmed.

The continued development of the
market for our products will depend upon the following factors, among others:

 widespread and successful deployment
of speech software applications;

 customer demand for services
and solutions having a voice user interface;

 acceptance by businesses of
the benefits of speech technology;

 demand for new uses and
applications of speech software technology, including adoption of voice user interfaces by
companies that operate web-based and touch tone IVR self service solutions;

 adoption of industry standards
for speech software and related technologies; and

 continuing improvements in
hardware and telephony technology that may reduce the costs of speech software solutions.

OUR PRODUCTS CAN HAVE A LONG SALES
AND IMPLEMENTATION CYCLE AND, AS A RESULT, OUR QUARTERLY REVENUES AND OPERATING RESULTS
MAY FLUCTUATE.

The sales cycles for our products
have typically ranged from three to twelve months, depending on the size and complexity of
the order, the amount of services to be provided by us and whether the sale is made
directly by us or indirectly through a reseller, a voice application service provider or a
systems integrator.

Purchase of our products requires a
significant expenditure by a customer. Accordingly, the decision to purchase our products
typically requires significant pre-purchase evaluation. We may spend significant time
educating and providing information to prospective customers regarding the use and
benefits of our products. During this evaluation period, we may expend substantial sales,
technical, marketing and management resources. Because of this lengthy evaluation cycle,
we may experience a delay between the time we incur these expenditures and the time we
generate revenues, if any, from such expenditures.

After purchase, it may take
substantial time and resources to implement our software and to integrate it with our
customers existing systems. If we are performing services that are essential to the
functionality of the software, in connection with its implementation, we recognize
licenses and services revenue based on the percentage of services completed using contract
accounting. In cases where the contract specifies milestones or acceptance criteria, we
may not be able to recognize either license or service revenue until these conditions are
met. We have in the past and may in the future experience unexpected delays in recognizing
revenue. Consequently, the length of our sales and implementation cycles and the varying
order amounts for our products make it difficult to predict the quarter in which revenue
recognition may occur and may cause license and services revenue and operating results to
vary significantly from period to period.

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OUR CURRENT AND POTENTIAL
COMPETITORS, SOME OF WHOM HAVE GREATER RESOURCES AND EXPERIENCE THAN WE DO, MAY MARKET OR
DEVELOP PRODUCTS, SERVICES AND TECHNOLOGIES THAT MAY CAUSE DEMAND FOR, AND THE PRICES OF,
OUR PRODUCTS TO DECLINE.

A number of companies have developed,
or are expected to develop, products that compete with our products. Competitors with
respect to speech technologies include SpeechWorks International and Scansoft, which have
merged IBM, Microsoft and others. With respect to our software platform, there are many
vendors, including some of our reseller partners, who market and sell platforms for voice
systems. We expect additional competition from other companies, our competitors may
combine with each other, and other companies may enter our markets by acquiring or
entering into strategic relationships with our competitors. Current and potential
competitors may have established, or may establish, cooperative relationships among
themselves or with third parties to increase the abilities of their advanced speech and
language technology products, platforms and applications to address the needs of our
prospective customers.

Many of our current and potential
competitors have longer operating histories, significantly greater financial, technical,
product development and marketing resources, greater name recognition and larger customer
bases than we do. Our present or future competitors may be able to develop products
comparable or superior to those we offer, adapt more quickly than we do to new
technologies, evolving industry trends and standards or customer requirements, or devote
greater resources to the development, promotion and sale of their products than we do.
Accordingly, we may not be able to compete effectively in our markets, competition may
intensify and future competition may cause us to reduce prices and/or otherwise harm our
business.

USE OF OUR PRODUCTS MAY INFRINGE
THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS. INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS
AGAINST OUR CUSTOMERS, OR US WHETHER OR NOT MERITORIOUS, COULD BE COSTLY AND COULD REQUIRE
OUR CUSTOMERS OR US TO ENTER INTO DISADVANTAGEOUS LICENSE OR ROYALTY ARRANGEMENTS. IN
ADDITION, SUCH CLAIMS AND LICENSE OR ROYALTY ARRANGEMENTS COULD SLOW OUR SALES CYCLE
AND/OR MARKET ADOPTION GENERALLY.

The software industry and the field
of speech and voice technologies are characterized by the existence of a large number of
patents and frequent litigation based on allegations of patent infringement and the
violation of intellectual property rights. Although we attempt to avoid infringing known
proprietary rights of third parties we may be subject to legal proceedings and claims for
alleged infringement by us or our licensees of third-party proprietary rights, such as
patents, trade secrets, trademarks or copyrights, from time to time in the ordinary course
of business. Any claims relating to the infringement of third-party proprietary rights,
even if not successful or meritorious, could result in costly litigation, divert resources
and managements attention or require us and/or our customers to enter into royalty
or license agreements which are not advantageous to us. Further, parties making these
claims may be able to obtain injunctions, which could prevent us from selling our
products. In addition, former employers of our employees may assert that these employees
have improperly disclosed confidential or proprietary information to us. Any of these
types of claims against our customers, or us whether or not meritorious, could be costly
and time consuming and could slow our sales cycle and/or market adoption generally, any of
which results could harm our business. We may be increasingly subject to infringement
claims as the number and features of our products grow and/or as the speech market grows.

WE HAVE A HISTORY OF LOSSES. WE
EXPECT TO CONTINUE TO INCUR LOSSES AND WE MAY NOT ACHIEVE OR MAINTAIN PROFITABILITY.

We have incurred losses since our
inception, including a net loss of approximately $19.1 million for the nine months ended
September 30, 2003. As of September 30, 2003, we had an accumulated deficit of
approximately $258.0 million. We expect we could have net losses and negative cash flow
for at least the next 12 months. We expect to spend significant amounts to develop or
enhance our products, services and technologies and to enhance delivery capabilities. As a
result, we will need to generate significant increases in revenue to achieve
profitability. Even if we achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis.

SALES TO CUSTOMERS OUTSIDE THE
UNITED STATES ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUE, WHICH EXPOSES US TO RISKS
INHERENT IN INTERNATIONAL OPERATIONS.

International sales represented
approximately 35%, 42% and 47% of our total revenue in 2002, 2001 and 2000, respectively
and represented 39% of our total revenue for the nine months ended September 30, 2003. We
anticipate that revenue from markets outside the United States will continue to represent
a meaningful portion of our total revenue. We are subject to a variety of risks associated
with conducting business internationally, any of which could harm our business. These
risks include:

 difficulties and costs of
staffing and managing foreign operations;

 the difficulty in establishing
and maintaining an effective international reseller network;

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 the burden of complying with a wide
variety of foreign laws, particularly with respect to tax, intellectual property and
license requirements;

 longer sales
cycles;

 political and economic
instability outside the United States;

 import or export licensing and
product certification requirements;

 tariffs, duties, price
controls or other restrictions on foreign currencies or trade barriers imposed by foreign
countries;

 potential adverse tax
consequences, including higher marginal rates;

 unfavorable fluctuations in
currency exchange rates; and

 limited ability to enforce
agreements, intellectual property rights and other rights in some foreign countries.

# WE ARE EXPOSED TO
GENERAL ECONOMIC CONDITIONS, WHICH MAY CONTINUE TO HARM OUR BUSINESS.

As a result of recent unfavorable
economic conditions and reduced capital spending, it is possible that our sales will
decline. There has been a global economic downturn over the past several years. We
experienced a decline in revenues during this time due in part to delays in purchases by
our customers and to prevailing economic conditions. If unfavorable economic conditions
continue or worsen in the United States or internationally, we may experience a material
adverse impact on our business, operating results and financial condition.

# OUR STOCK PRICE MAY BE
VOLATILE DUE TO FACTORS OUTSIDE OF OUR CONTROL.

Since our initial public offering on
April 13, 2000, our stock price has been extremely volatile. During that time, the stock
market in general, The Nasdaq National Market and the securities of technology companies
in particular have experienced extreme price and trading volume fluctuations. These
fluctuations have often been unrelated or disproportionate to the operating performance of
individual companies. The following factors, among others, could cause our stock price to
fluctuate:

 actual or anticipated
variations in operating results;

 announcements of operating
results and business conditions by our customers and suppliers;

 announcements by our
competitors relating to new customers, technological innovation or new services;

 announcements of new product
lines and/or shifts in business focus of sales and distribution models;

 increases in our plans for, or
rate of, capital expenditures for infrastructure, information technology and other similar
capital expenditures

 economic developments in our
industry as a whole;

 general market and economic
conditions;

 general decline in information
technology and capital spending plans.

These broad market fluctuations may
materially adversely affect our stock price, regardless of our operating results. Our
stock price may fluctuate due to variations in our operating results. For example, our
stock price steadily declined throughout 2002.

# ANY SOFTWARE DEFECTS IN
OUR PRODUCTS COULD HARM OUR BUSINESS AND RESULT IN LITIGATION.

Complex software products such as
ours may contain errors, defects and bugs. With the planned release of any product, we may
discover these errors, defects and bugs and, as a result, our products may take longer
than expected to develop. In addition, we may discover that remedies for errors or bugs
may be technologically unfeasible. Delivery of products with undetected production defects
or reliability, quality, or compatibility problems could damage our reputation. Errors,
defects or bugs could also cause interruptions, delays or a cessation of sales to our
customers. We could be required to expend significant capital and other resources to
remedy these problems. In addition, customers whose businesses are disrupted by these
errors, defects and bugs could bring claims against us, which, even if unsuccessful, would
likely be time-consuming and could result in costly litigation and payment of damages.

IF WE ARE UNABLE TO EFFECTIVELY
MANAGE OUR OPERATIONS AND RESOURCES IN ACCORDANCE WITH MARKET AND ECONOMIC CONDITIONS, OUR
BUSINESS COULD BE HARMED.

Our operations have changed
significantly due to volatility in our business and may continue to change in the future.
We experienced significant growth in the past; however, in April 2001, we reduced our
workforce by approximately 20%. Additionally, during the quarter ended March 31, 2002, we
implemented a restructuring plan to reduce our workforce by approximately another 8% and
in August 2002 we reduced our work force by approximately 21%. We may be required to
expand or contract our business operations and workforce in the future to adapt to the
market environment, and as a result may need to expand or contract our management,
operational, sales, marketing, financial and human resources, as well as management
information systems and controls, to align and support any such growth or contraction. Our
failure to successfully manage these types of changes would place a burden on our
business, our operations and our management team, and could negatively impact sales,
customer relationships and other aspects of our business performance and could cause our
business to suffer. In addition, a significant portion of our restructuring accrual is
represented by a lease loss created by our decision to not occupy our Pacific Shores
facility. The accrual assumptions are based upon estimates of real estate market
conditions, which are subject to wide fluctuations and could decline further, which may
result in additional restructuring accrual.

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WE RELY ON THE SERVICES OF OUR KEY
PERSONNEL, WHOSE KNOWLEDGE OF OUR BUSINESS AND TECHNICAL EXPERTISE WOULD BE DIFFICULT TO
REPLACE.

We rely upon the continued service
and performance of a relatively small number of key technical and senior management
personnel. Our future success will be impacted by our ability to retain these key
employees. We cannot guarantee that we will be able to retain all key personnel. For
example, in April 2003, our President, Chief Executive Officer and Chairman, Ronald Croen,
exited his position as President and CEO. In addition, in January 2002 Graham Smith
resigned from his position with Nuance as Chief Financial Officer. Other than Charles
Berger, none of our key technical or senior management personnel are bound by employment
agreements to remain at the Company, and, as a result, any of these employees could leave
with little or no prior notice. If we lose any of our key technical and senior management
personnel, replacement of such personnel could be difficult and costly, and if we are
unable to successfully and swiftly replace such personnel and effectively transition to
new management personnel, our business could be harmed. We do not have key personnel life
insurance policies covering any of our employees.

OUR FAILURE TO RESPOND TO AND
SUCCESSFULLY MANAGE RAPID CHANGE IN THE MARKET FOR SPEECH SOFTWARE COULD CAUSE US TO LOSE
REVENUE AND HARM OUR BUSINESS.

The speech software industry is
relatively new and rapidly changing. Our success will depend substantially upon our
ability to enhance our existing products and to develop and introduce, on a timely and
cost-effective basis, new products and features that meet changing end-user requirements,
gain commercial acceptance and incorporate technological advancements such as products
that speed deployment and accelerate customers return on investment. If we are
unable to develop new products and enhanced functionalities or technologies to adapt to
these changes, we may be unable to retain existing customers or attract new customers,
which could harm our business. In addition, as we develop new products, sales of existing
products may decrease. If we cannot offset a decline in revenue from existing products
with sales of new products, our business would suffer.

Commercial acceptance of any new
products and technologies we may introduce will depend, among other things, on:

 the ability of our services,
products and technologies to meet and adapt to the needs of our target markets;

 the performance and price of our
products and services and our competitors products and services; and

 our ability to deliver speech
solutions, customer service and professional services directly and through our resellers.

OUR PRODUCTS ARE NOT 100% ACCURATE
AND WE COULD BE SUBJECT TO CLAIMS RELATED TO THE PERFORMANCE OF OUR PRODUCTS. ANY CLAIMS,
WHETHER SUCCESSFUL OR UNSUCCESSFUL, COULD RESULT IN SIGNIFICANT COSTS AND COULD DAMAGE OUR
REPUTATION.

Speech recognition, natural language
understanding and authentication technologies, including our own, are not 100% accurate.
Our customers, including several financial institutions, use our products to provide
important services to their customers, including transferring funds to accounts and buying
and selling securities. Any misrecognition of voice commands or incorrect authentication
of a users voice in connection with these financial or other transactions could
result in claims against our customers or us for losses incurred. Although our contracts
typically contain provisions designed to limit our exposure to liability claims, a claim
brought against us for misrecognition or incorrect authentication, even if unsuccessful,
could be time-consuming, divert managements attention, result in costly litigation
and harm our reputation. Moreover, existing or future laws or unfavorable judicial
decisions could limit the enforceability of the limitation of liability, disclaimer of
warranty or other protective provisions contained in our contracts.

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WE MAY INCUR A VARIETY OF COSTS TO
ENGAGE IN FUTURE ACQUISITIONS OF COMPANIES, PRODUCTS OR TECHNOLOGIES, AND THE ANTICIPATED
BENEFITS OF THOSE ACQUISITIONS MAY NEVER BE REALIZED.

As a part of our business strategy,
we may make acquisitions of, or significant investments in, complementary companies,
products or technologies. For instance, in November 2000 we acquired SpeechFront, a
Canadian company. For the year ended December 31, 2001, the Company evaluated the carrying
value of the assets related to the SpeechFront acquisition and recorded an asset
impairment. In February 2001, we acquired non-exclusive intellectual property rights from
a third-party. For the year ended December 31, 2001, the Company performed an impairment
analysis and determined that asset was impaired and was subsequently written down to its
estimated fair value. Any future acquisitions of companies or technologies would be
accompanied by risks such as:

 difficulties in assimilating
the operations and personnel of acquired companies;

 diversion of our
managements attention from ongoing business concerns;

 our potential inability to
maximize our financial and strategic position through the successful incorporation of
acquired technology and rights into our products and services;

 additional expense associated
with impairments of acquired assets such as, goodwill or acquired workforce;

 maintenance of uniform
standards, controls, procedures and policies; and

 impairment of existing relationships
with employees, suppliers and customers as a result of the integration of new management
personnel.

We cannot guarantee that we will be
able to successfully integrate any business, products, technologies or personnel that we
might acquire in the future. For example, the SpeechFront assets and text to speech
technology we acquired have been impaired (see notes to the consolidated financial
statements). Our inability to integrate successfully any business products, technologies
or personnel we may acquire in the future could harm our business.

# WE ARE CURRENTLY ENGAGED
IN VARIOUS SECURITIES LITIGATIONS, WHICH, IF RESOLVED UNFAVORABLY, COULD ADVERSELY AFFECT
OUR BUSINESS,RESULTS OF OPERATIONS OR FINANCIAL OPERATIONS.

We have been sued in various
shareholder lawsuits in state court in California and federal district court in California
and New York (See  Part II  Item 1  Legal Proceedings). If the
respective settlements to not proceed as anticipated, an unfavorable resolution of these
lawsuits could have a material adverse effect on our business, results of operations,
and/or financial condition.

# WE MAY HAVE DIFFICULTY COLLECTING AMOUNTS OWED TO US.

Certain of our customers and resellers have experienced and may in the future experience credit-related issues.   We perform
ongoing credit evaluations of customers, but do not generally require collateral. We grant payment terms to most customers ranging
from 30 to 90 days, however in some instances we may provide longer payment terms. Should more customers than we anticipate
experience liquidity issues, or if payment is not received on a timely basis, our business, operating results and general
financial condition could be adversely impacted.

# IF REQUIREMENTS RELATING TO ACCOUNTING TREATMENT FOR
EMPLOYEE STOCK OPTIONS ARE CHANGED, WE MAY BE FORCED TO CHANGE OUR BUSINESS PRACTICES.

We currently account for the issuance of stock options under APB Opinion No. 25, Accounting for Stock Issued to Employees. The
accounting industry has recently determined that corporations will include a compensation expense in their statement of operations
relating to the issuance of employee stock options. This is anticipated to  become effective in April 2005. As a result, we could
decide to decrease the number of employee stock options that we would grant. This could affect our ability to retain existing
employees and attract qualified candidates, and increase the cash compensation we would have to pay to them. Conversely, issuing a
comparable number of stock options could adversely impact our results of operations under the new accounting requirements once
they take effect.

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INTERNATIONAL SALES OPPORTUNITIES
MAY REQUIRE US TO DEVELOP LOCALIZED VERSIONS OF OUR PRODUCTS. IF WE ARE UNABLE TO DO SO,
WE MAY BE UNABLE TO GROW OUR REVENUE AND EXECUTE OUR BUSINESS STRATEGY.

International sales opportunities may
require investing significant resources in creating and refining different language models
for each particular language or dialect. These language models are required to create
versions of our products that allow end users to speak the local language or dialect and
be understood and authenticated. If we fail to develop localized versions of our products,
our ability to address international market opportunities and to grow our business will be
limited. We must also expend resources to develop localized versions of our products, and
we may not be able to recognize adequate revenues from these localized versions of our
products to make them profitable.

IF THE STANDARDS WE HAVE SELECTED
TO SUPPORT ARE NOT ADOPTED AS THE STANDARDS FOR SPEECH SOFTWARE, CUSTOMERS MIGHT NOT USE
OUR SPEECH SOFTWARE PRODUCTS FOR DELIVERY OF APPLICATIONS AND SERVICES.

The market for speech software is
relatively new and emerging and industry standards are still being established. We may not
be competitive unless our products support changing industry standards. The emergence of
industry standards, whether through adoption by official standards committees or
widespread usage, could require costly and time-consuming redesign of our products. If
these standards become widespread and our products do not support them, our customers and
potential customers may not purchase our products. Multiple standards in the marketplace
could also make it difficult for us to ensure that our products will support all
applicable standards, which could in turn result in decreased sales of our products.

Our V-Builder applications-building
tool and our Nuance Voice Platform software are each designed to work with the recently
emerged VoiceXML standard. There are currently other, similar standards in development,
some of which may become more widely adopted than VoiceXML. If VoiceXML is not widely
accepted by our target customers or if another competing standard were to become widely
adopted, then sales of our products could decline and our business would be harmed. In
that case, we may find it necessary to redesign our existing products or design new
products that are compatible with alternative standards that are widely adopted or that
replace VoiceXML. This design or redesign could be costly and time-consuming.

# ANY INABILITY TO
ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY COULD HARM OUR ABILITY TO COMPETE.

Our future success and ability to
compete depends in part upon our proprietary technology and our trademarks, which we
attempt to protect with a combination of patent, copyright, trademark and trade secret
laws, as well as with our confidentiality procedures and contractual provisions. These
legal protections afford only limited protection and may be time-consuming and expensive
to obtain and/or maintain. Further, despite our efforts, we may be unable to prevent third
parties from infringing upon or misappropriating our intellectual property.

Although we have filed multiple U.S.
patent applications, we have currently only been issued a small number of patents. There
is no guarantee that more patents will be issued with respect to our current or future
patent applications. Any patents that are issued to us could be invalidated, circumvented
or challenged. If challenged, our patents might not be upheld or their claims could be
narrowed. Our intellectual property may not be adequate to provide us with competitive
advantage or to prevent competitors from entering the markets for our products.

Additionally, our competitors could
independently develop non-infringing technologies that are competitive with, equivalent
to, and/or superior to our technology. Monitoring infringement and/or misappropriation of
intellectual property can be difficult, and there is no guarantee that we would detect any
infringement or misappropriation of our proprietary rights. Even if we do detect
infringement or misappropriation of our proprietary rights, litigation to enforce these
rights could cause us to divert financial and other resources away from our business
operations. Further, we license our products internationally, and the laws of some foreign
countries do not protect our proprietary rights to the same extent as do the laws of the
United States.

THIRD PARTIES COULD OBTAIN
LICENSES FROM SRI INTERNATIONAL RELATING TO SPEECH SOFTWARE TECHNOLOGIES AND DEVELOP
TECHNOLOGIES TO COMPETE WITH OUR PRODUCTS, WHICH COULD CAUSE OUR SALES TO DECLINE.

Upon our incorporation in 1994, we
received a license from SRI International to a number of patents and other proprietary
rights, including rights in software, relating to speech software technologies developed
by SRI International. This license was exclusive until December 1999, when we chose to
allow the exclusivity to lapse. As a result, SRI International may have, or may in the
future, license these patents and proprietary rights to our competitors. If a license from
SRI International were to enable third parties to enter the markets for our products and
services or to compete more effectively, we could lose market share and our business could
suffer.

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# CERTAIN STOCKHOLDERS MAY
DISAGREE WITH HOW NUANCE USES THE PROCEEDS FROM ITS PUBLIC OFFERINGS.

Management retains broad discretion
over the use of proceeds from our April 2000 initial public offering and September 2000
secondary public offering. Stockholders may not deem these uses desirable and our use of
the proceeds may not yield a significant return or any return at all. Because of the
number and variability of factors that determine our use of the net proceeds from these
offerings, we cannot guarantee that these uses will not vary substantially from our
currently planned uses.

OUR CHARTER AND BYLAWS AND
DELAWARE LAW CONTAIN PROVISIONS WHICH MAY DELAY OR PREVENT A CHANGE OF CONTROL OF NUANCE.

Our Shareholder Rights Plan as well
as provisions of our charter and bylaws may make it more difficult for a third party to
acquire, or discourage a third party from attempting to acquire, control of Nuance. These
provisions could limit the price that investors might be willing to pay in the future for
shares of our common stock. These provisions include:

 the companys Shareholder
Rights Plan adopted in December 2002;

 the division of the board of
directors into three separate classes;

 the elimination of cumulative
voting in the election of directors;

 prohibitions on our
stockholders from acting by written consent and calling special meetings;

 procedures for advance
notification of stockholder nominations and proposals; and

 the ability of the board of
directors to alter our bylaws without stockholder approval.

In addition, our board of directors
has the authority to issue up to 5,000,000 shares of preferred stock and to determine the
price, rights, preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The issuance of preferred
stock, while providing flexibility in connection with possible financings or acquisitions
or other corporate purposes, could have the effect of making it more difficult for a third
party to acquire a majority of our outstanding voting stock.

Since the completion of our initial
public offering on April 13, 2000, we have been subject to the anti-takeover provisions of
the Delaware General Corporation Law, including Section 203, which may deter potential
acquisition bids for our company. Under Delaware law, a corporation may opt out of Section
203. We do not intend to opt out of the provisions of Section 203.

OUR FACILITIES ARE LOCATED NEAR
KNOWN EARTHQUAKE FAULT ZONES, AND THE OCCURRENCE OF AN EARTHQUAKE OR OTHER NATURAL
DISASTER COULD CAUSE DAMAGE TO OUR FACILITIES AND EQUIPMENT, WHICH COULD REQUIRE US TO
CURTAIL OR CEASE OPERATIONS.

Our facilities are located in the San
Francisco Bay Area near known earthquake fault zones and are vulnerable to damage from
earthquakes. In October 1989, a major earthquake that caused significant property damage
and a number of fatalities struck this area. We are also vulnerable to damage from other
types of disasters, including fire, floods, power loss, communications failures and
similar events. If any disaster were to occur, our ability to operate our business at our
facilities could be seriously, or potentially completely, impaired.

# WE RELY ON A CONTINUOUS
POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND AN ENERGY CRISIS COULD DISRUPT OUR OPERATIONS
AND INCREASE OUR EXPENSES.

We currently do not have backup
generators or alternate sources of power in the event of a blackout, and our current
insurance does not provide coverage for any damages we, or our customers, may suffer as a
result of any interruption in our power supply. If blackouts interrupt our power supply,
we would be temporarily unable to continue operations at our facilities. Any such
interruption in our ability to continue operations at our facilities could damage our
reputation, harm our ability to retain existing customers and to obtain new customers, and
could result in lost revenue, any of which could substantially harm our business and
results of operations.

INFORMATION THAT WE MAY PROVIDE TO
INVESTORS FROM TIME TO TIME IS ACCURATE ONLY AS OF THE DATE WE DISSEMINATE IT AND WE
UNDERTAKE NO OBLIGATION TO UPDATE THE INFORMATION.

From time to time, we may publicly
disseminate forward-looking information or guidance in compliance with Regulation FD
promulgated by the Securities and Exchange Commission. This information or guidance
represents our outlook only as of the date that we disseminated it, and we undertake no
obligation to provide updates to this information or guidance in our filings with the
Securities and Exchange Commission or otherwise.

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# ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following section describes our
exposure to market risk related to changes in foreign currency exchange rates and interest
rates. This section contains forward-looking statements that are subject to risks and
uncertainties. Actual results could vary materially as a result of a number of factors
including those set forth in the risk factors section of this quarterly Report on Form
10-Q.

# Foreign Currency
Exchange Rate Risk

To date, all of our recognized
revenues have been denominated in U.S. dollars with majority coming from customers in the
United States, and our exposure to foreign currency exchange rate changes has been
immaterial. We expect, however, that future product license and services revenues derived
from international markets may be denominated in the currency of the applicable market. As
a result, our operating results may become subject to significant fluctuations based upon
changes in the exchange rates of certain currencies in relation to the U.S. dollar.
Furthermore, to the extent that we engage in international sales denominated in U.S.
dollars, an increase in the value of the U.S. dollar relative to foreign currencies could
make our products less competitive in international markets. Although we will continue to
monitor our exposure to currency fluctuations, and when appropriate, may use financial
hedging techniques to minimize the effect of these fluctuations, we cannot assure you that
exchange rate fluctuations will not adversely affect our financial results in the future.

# Interest Rate Risk

As of September 30, 2003, we had
cash, cash equivalents and short-term investments of $107.6 million. Any decline in
interest rates over time would reduce our interest income from our short-term investments.
Based upon our balance of cash and cash equivalents and short-term investments, an
absolute reduction in interest rates of 0.5% would cause a corresponding decrease in our
annual interest income by approximately $0.5 million.

# ITEM 4. CONTROLS AND
PROCEDURES

Evaluation of disclosure controls and
procedures. Our management evaluated, with the participation of our Chief Executive
Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this Quarterly Report on Form 10-Q.
Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have
concluded that our disclosure controls and procedures are effective to ensure that
information we are required to disclose in reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal control over
financial reporting. There was no change in our internal control over financial reporting
that occurred during the period covered by this Quarterly Report on Form 10-Q that has
materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

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# PART II: OTHER
INFORMATION

# ITEM 1. LEGAL PROCEEDINGS

On January 16, 2001, Nuance filed an
opposition proceeding in the European community against a Community Trade Mark application
for NUANCE, owned by Nuance Global Traders, Ltd. The opposition is still pending. The
parties have agreed upon a settlement which will become final upon, among other things,
completion of final settlement documents.

Beginning in March 2001, a number of
putativeshareholder class actions were filed against the Company and certain of
its present and former officers and directors in the United States District Court for the
Northern District of California (the Federal Actions). The actions have been
consolidated as In re Nuance Communications Inc. Securities Litigation, Master File No.
C-01-20320-JW. Lead plaintiffs were appointed and a consolidated complaint was filed on
behalf of a purported class of persons who purchased the Companys stock during the
period January 31, 2001 through March 15, 2001, alleging false and misleading statements
and insider trading in violation of the federal securities laws, specifically Section
10(b), 20(a) and 20A of the Securities Exchange Act of 1934, and seek unspecified damages.
In April 2003, the court granted in part and denied in part defendants most recent
motion to dismiss. No trial date has been set. On August 18, 2003, the parties executed an
agreement to settle this litigation for $ 11 million, which settlement will become final,
upon approval by the Court. The settlement is to be covered by the Companys insurance policies and is
reflected in the accompanying condensed consolidated balance sheet as of September 30, 2003
as an insurance claim receivable and a legal settlement payable. In the event that final
settlement does not occur, and litigation against the Company continues, the
Company believes it has meritorious defenses and intends to defend the case vigorously.

In May and September 2001, putative
shareholder derivative actions were filed in California Superior Court, San Mateo County,
against various of the Companys present and former officers and the Companys
directors (the Derivative Actions). The putative derivative complaints contain
allegations similar to the Federal Actions, and claim that the defendants engaged in
breaches of fiduciary duty and insider trading. The Company appears to be named as nominal
defendant, against whom no recovery is sought. All proceedings in the putative derivative
actions have been stayed by agreement of the parties. An agreement has been reached to
settle these actions, which settlement will become final upon, among other things,
completion of formal settlement papers and Court approval of the settlement.

In August 2001, the first of several
putative shareholder class actions were filed against various of the underwriters for the
Companys initial public offering (IPO), the Company and certain of its
present and former officers and directors in the United States District Court for the
Southern District of New York. Those complaints have been consolidated and a consolidated
amended complaint filed, captioned In re Nuance Communications Inc. Initial Public
Offering Sec. Litig., No. 01-CV-7344. The complaint generally alleges that various
investment bank underwriters engaged in improper activities related to the allocation of
shares in the Companys IPO, that were not disclosed in the registration statements
for the Companys IPO or secondary offerings. The consolidated action is part of a
larger coordinated proceeding, In re Initial Public Offering Securities Litigation, 21 MC
92, involving more than 40 underwriters and 250 issuers. In October 2002, the individual
defendants were dismissed from the action without prejudice pursuant to stipulation. In
February 2003, the court issued a ruling on an omnibus motion to dismiss filed by
defendants in the coordinated proceeding, denying the motion as to the claims against the
Company. No trial date has been set. A proposal has been made for the settlement and
release of claims against the issuer defendants in the case, including the Company.
The settlement is contingent upon a number of conditions, including completion of formal
settlement papers and approval of the Court. In the event that settlement does not occur,
and litigation against Nuance continues, the Company believes it has meritorious
defenses and intends to defend the case vigorously.

Should the respective settlements not
proceed as anticipated, an unfavorable resolution of these litigations could have a
material adverse effect on the Companys business, results of operations, or
financial condition.

# ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held its Annual Meeting
of Stockholders on May 22, 2003. At the meeting, the following proposals received the
votes listed below:

Proposal I:     Election of Class III directors to serve
a three-year term ending in 2006.

|                  | Votes for: | Votes against:
|----------------- | ---------- | --------------
|Charles Berger    | 18,355,272 | 7,440,310     
|Gary Morgenthaler | 25,469,757 | 325,825       

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The Companys Board of Directors
is currently comprised of eight (8) members who are divided into three classes with
overlapping three-year terms. The term for Class I directors (Ronald Croen, Irwin
Federman and Vinton Cerf) will expire at the meeting of stockholders to be held in 2004.
The term for Class II directors (Curtis Carlson, Alan Herzig and Philip Quigley) will
expire at the meeting of stockholders to be held in 2005.

Proposal
II: Approval of Ratification of the appointment of Deloitte & Touche LLP as
independent auditors of the Company for the 2003 fiscal year.

|Votes for:        | 25,761,872
|----------------- | ----------
|Votes against:    | 25,861    
|Abstentions:      | 7,850     
|Broker non-votes: | --        

# ITEM 6. EXHIBITS AND
REPORTS ON FORM 8-K:

(a) Exhibits

|Exhibit Index Exhibit number | Description                                                                                                                                             
|---------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*                         | Restated Certificate of Incorporation
of the Company, as currently in effect.                                                                           
|                             |                                                                                                                                                         
|3.2**                        | Bylaws of the Company, as currently in effect.                                                                                                          
|                             |                                                                                                                                                         
|31.1                         | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302(a)of the Sarbanes-Oxley Act of 2002.
|                             |                                                                                                                                                         
|31.2                         | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302(a)of the Sarbanes-Oxley Act of 2002.
|                             |                                                                                                                                                         
|32.1                         | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  
|                             |                                                                                                                                                         
|32.2                         | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  

---

* Incorporated by reference to the
registrants Registration Statement on Form S-1 (File no. 333-96217) as declared
effectively by the Securities and Exchange Commission on February 2, 2000.

** Incorporated by reference to the
registrants Annual Report on Form 10-K for the fiscal year ended December 31, 2002,
as filed with the Securities and Exchange Commission on March 31, 2003.

(b) Reports on Form 8-K

(i) Form 8-K furnished July 21, 2003, reporting on July 21, 2003, under Item 7
Financial Information and Exhibits, provided under Item 9
          Regulation FD Disclosure the Companys press release
          announcing financial results for the three months ended June 30, 2003. *

* This furnished 8-K shall not be
deemed filed or incorporated by reference into any filing.

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# SIGNATURES

Pursuant to the requirements of the
Securities Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

|                        |  | NUANCE COMMUNICATIONS, INC.                                                                        
|----------------------- |  | ---------------------------------------------------------------------------------------------------
|                        |  | (Registrant)                                                                                       
|                        |  |                                                                                                    
|                        |  |                                                                                                    
|                        |  |                                                                                                    
|                        |  |                                                                                                    
|Date: November 14, 2003 |  | By:           /s/ KAREN BLASING                                                                    
|                        |  | Karen BlasingVice President and
Chief Financial Officer(Principal Financial and Accounting Officer)
|                        |  |                                                                                                    

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# End of Filing