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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 JUNE 30, 2004

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 [ ]

35,530,000 shares of the
registrants common stock, $0.001 par value, were outstanding as of June 30, 2004.

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# NUANCE COMMUNICATIONS,INC. & SUBSIDIARIES

# FORM 10-Q, JUNE 30, 2004

# CONTENTS

|ITEM  NUMBER |                                                                                                                    | PAGE
|------------ | ------------------------------------------------------------------------------------------------------------------ | ----
|             | PART I: FINANCIAL INFORMATION                                                                                      |     
|             |                                                                                                                    |     
|Item 1.      | Financial Statements                                                                                               |     
|             | Condensed Consolidated Balance Sheets:     June 30, 2004 and December 31, 2003 (unaudited)                         | 1   
|             | Condensed Consolidated Statements of Operations:     Three and six months ended June 30, 2004 and 2003 (unaudited) | 2   
|             | Condensed Consolidated Statements of Cash Flows:     Six months ended June 30, 2004 and 2003 (unaudited)           | 3   
|             | Notes to Condensed Consolidated Financial Statements                                                               | 4   
|             |                                                                                                                    |     
|Item 2.      | Management's Discussion and Analysis of      Financial Condition and Results of Operations                         | 17  
|             |                                                                                                                    |     
|Item 3.      | Quantitative and Qualitative Disclosures about Market Risk                                                         | 34  
|             |                                                                                                                    |     
|Item 4.      | Controls and procedures                                                                                            | 34  
|             |                                                                                                                    |     
|             | PART II: OTHER INFORMATION                                                                                         |     
|             |                                                                                                                    |     
|Item 1.      | Legal Proceedings                                                                                                  | 35  
|             |                                                                                                                    |     
|Item 6.      | Exhibits and Reports on Form 8-K                                                                                   | 35  
|             |                                                                                                                    |     
|             | Exhibit Index                                                                                                      | 35  
|             |                                                                                                                    |     
|SIGNATURES   | 37                                                                                                                
|             |                                                                                                                    |     

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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)

|                                                                                                                                                                     | June 30,2004 | December 31,2003
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | ----------------
|ASSETS                                                                                                                                                               |              |                 
|Current assets:                                                                                                                                                      |              |                 
|Cash and cash equivalents                                                                                                                                            |              | $   56,730      
|Short-term investments                                                                                                                                               |              | 42,331          
|Accounts receivable, net of allowance for doubtful accounts of $553                  and $837, respectively                                                          |              | 11,366          
|Prepaid expenses and other current assets                                                                                                                            |              | 4,231           
|                                                                                                                                                                     |              |                 
|Total current assets                                                                                                                                                 |              | 114,658         
|Property and equipment, net                                                                                                                                          |              | 4,573           
|Intangible assets, net                                                                                                                                               |              | 786             
|Restricted cash                                                                                                                                                      |              | 11,136          
|Long-term investments                                                                                                                                                |              | 2,294           
|Other assets                                                                                                                                                         |              | 459             
|                                                                                                                                                                     |              |                 
|Total assets                                                                                                                                                         |              | $  133,906      
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                                 |             
|Current liabilities:                                                                                                                                                 |             
|Accounts payable                                                                                                                                                     |              | $     1,407     
|Accrued vacation                                                                                                                                                     |              | 1,790           
|Accrued liabilities                                                                                                                                                  |              | 5,732           
|Current portion of deferred revenue                                                                                                                                  |              | 6,754           
|Current portion of restructuring accrual                                                                                                                             |              | 9,253           
|Current portion of capital lease                                                                                                                                     |              | --              
|Total current liabilities                                                                                                                                            |              | 24,936          
|Long-term deferred revenue                                                                                                                                           |              | 288             
|Long-term restructuring accrual                                                                                                                                      |              | 39,221          
|Other long-term liabilities                                                                                                                                          |              | 27              
|Total liabilities                                                                                                                                                    |              | 64,472          
|Commitments (Note 9)                                                                                                                                                 |              |                 
|Stockholders Equity                                                                                                                                                 |              |                 
|Common stock, $0.001 par value, 250,000 shares authorized;           
    35,530,000 shares and 34,995,000 shares issued and outstanding,   
           respectively |              | 35              
|Additional paid-in capital                                                                                                                                           |              | 331,282         
|Accumulated other income                                                                                                                                             |              | 517             
|Accumulated deficit                                                                                                                                                  |              | (262,400)       
|Total stockholders equity                                                                                                                                           |              | 69,434          
|Total liabilities and stockholders equity                                                                                                                           |              | $   133,906     

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

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

|                                                            | Three Months Ended | Six 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 credit                                        |                    |                 
|Total operating expenses                                    |                    |                 
|Loss from operations                                        |                    |                 
|Interest and other income, net                              |                    |                 
|                                                            |                    |                 
|Loss before income taxes                                    |                    |                 
|Benefit 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 to condensed
consolidated financial statements 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)

|                                                                          | Six Months Ended
|------------------------------------------------------------------------- | ----------------
|                                                                          | June 30,        
|                                                                          | 2004            
|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                                         |                 
|Provision for doubtful accounts                                           |                 
|Changes in operating assets and liabilities:                              |                 
|Accounts receivable                                                       |                 
|Prepaid expenses, other current assets and other assets                   |                 
|Accounts payable                                                          |                 
|Accrued liabilities and other current and long-term liabilities           |                 
|Restructuring accrual                                                     |                 
|Deferred revenue                                                          |                 
|Net cash used in operating activities                                     |                 
|Cash flows from investing activities:                                     |                 
|Purchase of investments                                                   |                 
|Maturities of investments                                                 |                 
|Purchase of property and equipment                                        |                 
|Decrease in restricted cash                                               |                 
|Net cash provided by (used in) investing activities                       |                 
|Cash flows from financing activities:                                     |                 
|Proceeds from exercise of stock options                                   |                 
|Proceeds from employee stock purchase plan                                |                 
|Net cash provided by financing activities                                 |                 
|Effect of exchange rate fluctuations on cash and cash equivalent          |                 
|Net increase (decrease) in cash and cash equivalents                      |                 
|Cash and cash equivalents, beginning of period                            |                 
|Cash and cash equivalents, end of period                                  |                 
|Suplementary disclosures of cash flow information:                        |                 
|Cash paid during the priod for:                                           |                 
|Interest                                                                  |                 
|Income taxes                                                              |                 
|Suplementary disclosures of non-cash transactions:                        |                 
|Unrealized loss on available-for-sale securities                          |                 

The accompanying notes to condensed
consolidated financial statements 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. (together with its subsidiaries, the Company) was
incorporated in July 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 product lines consist 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 third-party resellers, original equipment manufacturers (OEM)
and system integrators and directly to end users.

# 2.     SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES

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
(GAAP) have been condensed or omitted pursuant to these instructions and
regulations. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments, consisting only of normal
recurring adjustments considered necessary for a fair presentation of the consolidated
financial position as of June 30, 2004 and December 31, 2003, the consolidated results of
operations for the three and six months ended June 30, 2004 and 2003 and cash flow for the
six months ended June 30, 2004 and 2003. 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 24,
2004.

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 condensed consolidated financial statements in conformity with accounting principles generally
accepted in the United States of America (GAAP) 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 condensed 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.

Certain Significant Risks
and Uncertainties

The
Company operates in a dynamic and highly competitive industry and believes that any of the
following potential factors could have a material adverse effect on the Companys
future financial position, results of operations or cash flows: the volatility of, and
rapid change in, the speech software industry; potential competition, including
competition from larger, more established companies with better or less expensive
products or services; the Companys dependence on key employees for technology and
support; the Companys failure to adopt, or develop products based on, new industry
standards; changes in the overall demand by customers and consumers for speech software
products generally, and for the Companys products in particular; changes in, or the
loss of, certain strategic relationships (particularly reseller relationships); the loss
of a significant customer(s) or order(s); litigation or claims against the Company based
on intellectual property, patent, product, regulatory or other factors; the Companys
inability to protect its proprietary intellectual property rights; adverse changes in
domestic and international economic and/or political conditions or regulations; the
Companys inability to attract and retain employees necessary to support growth;
liability with respect to the Companys software and related claims if such software
is defective or otherwise does not function as intended; a lengthy sales cycle, which could
result in the delay or loss of potential sales orders; seasonal variations in the
Companys sales, due to patterns in the budgeting and purchasing cycles of our
customers; the Companys inability to manage its operations and resources in
accordance with market conditions; the need for an increase in the Companys
restructuring accrual for the Pacific Shores facility; the failure to realize anticipated
benefits from any potential acquisition of companies, products, or technologies; the
Companys inability to collect amounts owed to it by its customers; and the
Companys inability to develop localized versions of its products to meet
international demand.

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Revenue
Recognition

Revenues
are generated from licenses, services and maintenance. All revenues generated from the
Companys worldwide operations are approved at its corporate headquarters, located in
the United States. The Company applied the provisions of Statement of Position
(SOP) No. 97-2, Software Revenue Recognition, as amended by SOP
No. 98-9, Modification of SOP No. 97-2, Software Revenue Recognition, With Respect
to Certain Transactions to all transactions involving the sale of software products.
The Company also recognize some revenue based on SOP No. 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts and Emerging
Issues Task Force (EITF) Issue No. 03-05 Applicability of AICPA
Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing
More-Than-Incidental Software.

The
Companys license revenue consists of license fees for our software products. The
license fees for the Companys software products are calculated primarily by
determining the maximum number of calls that may be simultaneously connected to its
software.

For
licensed products requiring significant customization, the Company recognizes 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, the Company determines progress to completionbased on actual direct labor hours incurred to date as a percentage of the estimated
total direct labor hours required to complete the project. The Company periodically
evaluates 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 incurred exceed the 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 the Companys percentage completion of projects in progress.
Significant management judgment and discretion are used to estimate total direct labor
hours required to complete the project. Any changes in or deviation from these estimates
could have a material effect on the amount of revenue the Company recognizes in any
period.

For
licensed products that do not require significant customization of components, the Company
recognizes 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.

The
Company uses a signed contract and either 1) a purchase order, 2) an order form or 3) a
royalty report as evidence of an arrangement.

Products
delivered with acceptance criteria or return rights are not recognized as revenue until
all revenue recognition 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. Occasionally the customer
will require that the Company 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 transaction
completion rates. In the absence of such required acceptance, the Company will defer
revenue recognition until signed acceptance is obtained.

The
Company considers the fee to be fixed and determinable when the price is not subject to
refund or adjustments.

The
Company assesses whether collection of the resulting receivable is probable based on a
number of factors, including the customers past payment history and 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 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 (VSOE) of the fair value of all undelivered elements exists. VSOE of
fair value is based on the price charged when the element is sold separately, or if not
yet sold separately, is established by authorized management. In situations where VSOE of
fair value for undelivered elements does not exist, the entire amount of revenue from the
arrangement is deferred and recognized when VSOE 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 VSOE 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 third-party resellers is
recognized when product has been sold through to an end user and such sales have been
reported to the Company. However, certain third-party reseller agreements include
time-based provisions on which the Company bases revenue recognition, in these instances,
there is no right of returns possible.

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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 No. 81-1; however, judgment is
required in determining the percentage of the project that has been completed. Revenue
recognized from such contracts were $0.8 million and $0.9 million for the three and six
months ended June 30, 2004, respectively, and $1.3 million and $1.3 million for the three
and six months ended June 30, 2003, respectively.

Service
revenue consists of revenue from providing consulting, training and other revenue. Other
revenue consists primarily of reimbursements for consulting out-of-pocket expenses
incurred and recognized, in accordance with EITF No. 01-14, Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred. For services revenue, the Company requires 1) a signed contract, 2)
statement of work and 3) purchase order or order form 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.

The
Companys standard payment terms are generally net 30 to 90 days from the date of
invoice. Thus, a significant portion of the Companys accounts receivable balance at
the end of a quarter is comprised of revenue from that quarter.

Restructuring and Asset
Impairment Charges

The
Company accrues for restructuring costs when management approves and commits to a firm
plan. Historically the main components of the Companys 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 are 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 are made relating to the (1) time period over which the building would remain
vacant (2) sublease terms and (3) sublease rates. The Company establishes the reserves at
the low end of the range of estimable cost against outstanding commitments, net of
estimated future sublease income. These estimates are derived using the guidance provided
in Staff Accounting Bulletin (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 Statement of Financial Accounting Standards (SFAS)
No.146 Accounting for Costs Associated with Exit or Disposal Activities. These
reserves are based upon managements estimate of the time required to sublet the
property and the amount of sublet income that may be generated between the date the
property is not occupied and expiration of the lease for the unoccupied property. These
estimates are 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.

Valuation Allowance for
Doubtful Accounts

The
Company performs ongoing credit evaluations of its customers and adjusts credit limits
based upon payment history and the customers current creditworthiness, as determined
by the Companys review of their current credit information. The Company continuously
monitors collections and payments from customers and maintains a provision for estimated
credit losses based on a percentage of its accounts receivable, the historical experience
and any specific customer collection issues that the Company has identified. While such
credit losses have historically been within the Companys expectations and
appropriate reserves have been established, the Company cannot guarantee that it will
continue to experience the same credit loss rates that the Company has 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.

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Income Taxes

In
preparing the Companys condensed consolidated financial statements, the Company is
required to estimate its income taxes in each of the jurisdictions in which the Company
operates. This process involves estimating actual current tax exposures together with
assessing tax credits and 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. The Company then assesses the likelihood that deferred tax
assets will be recovered from future taxable income, and to the extent it believes that
recovery is not likely, the Company must establish a valuation allowance. To the extent
the Company establishes a valuation allowance or increases this allowance in a period, the
Company includes an expense within the tax provision in its condensed consolidated
statement of operations.

Significant
management judgment is required in determining the Companys provision for income
taxes, income tax credits, the Companys deferred tax assets and liabilities and any
valuation allowance recorded against its net deferred tax assets. The Company has recorded
a valuation allowance due to uncertainties related to its ability to utilize some of its
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 the Company operates
and the period over which deferred tax assets will be recoverable. In the event that
actual results differ from these estimates or the Company adjusts these estimates in
future periods, the Company may need to establish an additional valuation allowance, which
could impact the Companys financial position and results of operations.

Valuation of Long-lived
Assets

The
Company has 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 of Disposal of Long Lived Assets. SFAS
No.144 superceded SFAS No. 121, Accounting for the impairment or Disposal of
Long-lived Assets in 2002. The Company assesses whether it will recognize the future
benefit of long-lived assets, including intangibles in accordance with the provisions of
SFAS No. 144. The Company assesses the impairment of goodwill in accordance with SFAS No.
142, Goodwill and Other Intangible Assets, which became effective in 2002. For
assets to be held and used, including acquired intangibles, the Company initiates its
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 June
30, 2004, the Company has no goodwill balance and no impairment of intangibles was
recorded.

Software Development
Costs  Software to be Sold

Costs
incurred in the research and development of software products are expensed as incurred
until technological feasibility has been established. Once technological feasibility has
been established, these costs are capitalized. The establishment of technological
feasibility and the ongoing assessment of the recoverability of these costs requires
considerable judgment by management with respect to certain external factors, including,
but not limited to, anticipated future gross product revenues, estimated economic life and
changes in software and hardware technologies. Amounts that could have been capitalized
were insignificant and, therefore, no costs have been capitalized to date.

Software Development
Costs  Internal Use

The
Company purchased software for internal use during the six months ended June 30, 2004.
Therefore, external direct costs of software development and payroll and payroll related
costs incurred for time spent on the project by employees directly associated with the
development, are capitalized after the preliminary project stage is completed.
Accordingly, the Company had capitalized $1.0 million and $0 related to the software
development for internal use as of June 30, 2004 and December 31, 2003, respectively.

Comprehensive Loss

The
Company reports comprehensive loss by major components and in a single total, the change
in its net assets from non-owner sources, which for the Company is foreign currency
translation adjustments and changes in unrealized gains and losses on investments.

The
following table presents the components of comprehensive loss for the three and six months
ended June 30, 2004 and 2003:

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|                                         | Three Months Ended June 30, | Six Months Ended June 30,
|---------------------------------------- | --------------------------- | -------------------------
|                                         |                             |                          
|Net loss                                 |                             |                          
|Unrealized loss on investments           |                             |                          
|Foreign currency translation gain (loss) |                             |                          
|Comprehensive loss                       |                             |                          

Stock-based
Compensation.

The
Company accounts for stock-based compensation in accordance with the provisions of
Accounting Principle Board Opinion (APB) No. 25, Accounting for
Stock Issued to Employees, and complies with the disclosure provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No.
148, Accounting for Stock-Based Compensation  Transition and
Disclosures. Stock-based compensation is amortized under SFAS No. 123 under the straight line method. The
Company adopted the disclosure-only provisions of SFAS No. 123.

Pro
forma net loss and net loss per share information, as required by SFAS No. 123, have been
determined as if the Company had accounted for all employee stock options granted,
including shares issued to employees under the Employee Stock Purchase Plan, under SFAS
No. 123s fair value method. The pro forma effect of recognizing compensation expense
in accordance with SFAS No. 123 is as follows:

|                                                                                             | Three Months Ended June 30, | Six Months Ended June 30,
|-------------------------------------------------------------------------------------------- | --------------------------- | -------------------------
|                                                                                             |                             |                          
|Net loss, as reported                                                                        |                             |                          
|Add: Stock-based employee compensation expense (benefit)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                                             |                             |                          

* Restated as described below

As
previously reported, during the preparation of our consolidated financial statements for
the year ended December 31, 2003, we discovered that our pro-forma footnote disclosures
required by SFAS No.148 Accounting for Stock-Based Compensation-Transition and
Disclosure, with respect to the fair value of our stock-based awards for the year
ended December 31, 2002 and 2001 and for the quarters ended March 31, 2003, June 30, 2003
and September 30, 2003, were not calculated correctly. Accordingly, such pro forma amounts
for the three and six months ended June 30, 2003 presented above have been revised. The
effect was to increase the pro forma net loss for the three and six months ended June 30,
2003 by $5.2 million and $10.4 million, respectively. This change did not impact the
Companys condensed consolidated financial position, results of operations, or cash
flows for any of the periods presented.

Reclassifications

Certain
amounts related to financial information presented in the accompanying condensed
consolidated financial statements and related notes as of June 30, 2003 have been
reclassified to conform to the presentation of the three and six months ended June 30,
2004.

# 3.        RECENT
 ACCOUNTING PRONOUNCEMENTS

In
January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. (FIN) 46, Consolidation of Variable Interest
Entities, which was later revised in December 2003. FIN 46 addresses consolidation
of variable interest entities. FIN 46 provides guidance for determining when a primary
beneficiary should consolidate a variable interest entity or equivalent structure that
functions to support the activities of the primary beneficiary. The provisions of FIN 46
are effective immediately for all variable interest entities created after January 31,
2003. It applies in the first year or interim period ending after December 15, 2003 to
variable interest entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003. The Company did not have interest in any variable
interest entities as of June 30, 2004, and the adoption of FIN 46 did not have a material
effect on the Companys financial statements.

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In
November 2003, the EITF reached an interim consensus on Issue 03-01, The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments, to require additional disclosure, for the fiscal years ending after
December 15, 2003, with respect to requirements for securities classified as
available-for-sale or held-to-maturity. Those additional disclosures have been
incorporated into the accompanying footnotes. In March 2004, the EITF reached a final
consensus on this issue, providing additional guidance that companies must follow in
determining whether investment securities have an impairment which should be considered
other-than-temporary. This guidance is applicable for reporting periods beginning after
June 15, 2004. The Company does not believe that adoption of this guidance, if it had been in effect
with respect to its quarter ended June 30, 2004, would have had a material impact on the carrying
value of its investments at June 30, 2004.

# 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 six months ended June 30, 2004 and
2003, the Company had securities outstanding that 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
10,184,377 shares and 9,941,505 shares for the three and six months ended June 30, 2004,
respectively; The total number of shares excluded from diluted net loss per share were
9,751,000 shares and 9,394,000 shares for the three and six months ended June 30, 2003,
respectively.

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

|                                                                             | Three Months Ended June 30, | Six Months Ended June 30,
|---------------------------------------------------------------------------- | --------------------------- | -------------------------
|                                                                             |                             |                          
|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.     
INVESTMENTS

All
our investments are classified as available for sale at June 30, 2004 and December 31,
2003. 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.

As
required by EITF 03-01, Temporary Impairment and Its Application to Certain
Investments, management evaluates investments on a regular basis to determine if an
other-than-temporary impairment has occurred. The Companys investments in debt
instruments of 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 both the six months
ended June 30, 2004 and 2003, the Company has not recorded such an impairment. For all
periods presented, realized gains and losses on available-for-sale investments were not
material.

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# 6.      INTANGIBLE ASSETS

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

|                     | As of June 30, 2004
|-------------------- | -------------------
|                     |                    
|Purchased Technology |                    
|Patents Purchased    |                    
|Total                |                    

|                     | As of December 31, 2003
|-------------------- | -----------------------
|                     |                        
|Purchased Technology |                        
|Patents Purchased    |                        
|Total                |                        

As
of June 30, 2004, total estimated amortization of the purchased technology and the patents is as follows (in
thousands):

|Year Ended December 31,   |   | Amortization Expense
|------------------------- | - | --------------------
|2004 (remaining 6 months) | $ | 206                 
|2005                      |   | 413                 
|2006                      |   | 117                 
|2007                      |   | 50                  
|Total                     | $ | 786                 

# 7.     GUARANTEES,
WARRANTIES AND INDEMNITIES

Guarantees

As
of June 30, 2004, the Companys financial guarantees consist of standby letters of
credit outstanding, representing the restricted cash requirements collateralizing the
Companys lease obligations. As of June 30, 2004, the maximum amount of potential
future payments under the arrangements were $10.9 million related to the Companys
Pacific Shores lease in California and $228,000 related to the Companys Montreal
lease, totaling $11.1 million presented as restricted cash on the Companys condensed
consolidated balance sheets.

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 the
Companys extensive product quality program and processes.

Indemnifications to
Customers

The
Company defends and indemnifies its customers for specified liabilities incurred in any
suit or claim brought against them, alleging that the Companys products infringe a
U.S. patent (worldwide, in some instances), copyright, trade secret or similar right.
If a product becomes the subject of an infringement claim, the Company has an obligation
to, at its 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 the Companys expense and for
the third-party reseller to continue selling the product; or (iv) take back the
infringing product and refund to customer the purchase price paid, less depreciation
amortized on a straight line basis. The Company has not, to date, been required to make
material payments pursuant to these indemnification provisions. The Company has not
identified any losses that are probable under these provisions and, accordingly, the
Company has not recorded a liability related to these indemnification provisions.

Indemnifications to
Officers and Directors

The
Companys corporate by-laws require that the Company indemnify its officers and
directors, as well as those who act as directors and officers of other entities at the
Companys 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, the Company has entered into separate indemnification
agreements with each of its director and board-appointed officer and certain other of its
employees. The agreements provide for indemnification of these directors, officers and
employees under similar circumstances. The indemnification obligations are more fully
described in the by-laws and the indemnification agreements. The Company purchases
insurance to cover claims or a portion of the claims made against its directors and
officers. Since a maximum obligation is not explicitly stated in the Companys
by-laws or in its 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, the Company has not made
payments related to these obligations, and the estimated fair value for these obligations
is zero on the condensed consolidated balance sheets as of June 30, 2004.

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Other Indemnifications

As
is customary in the Companys industry and as provided for in local law in the U.S.
and other jurisdictions, many of the Companys standard contracts provide remedies to
others with whom the Company enters into such contracts, such as defense and settlement
of, or payment of judgments for, intellectual property claims related to the use of the
Companys products. From time to time, the Company indemnifies its suppliers,
contractors, lessors, lessees and others with whom the Company enters into contracts
against loss, expense, or liability arising from various trigger events related to the
sale and the use of the Companys products and services, the use of their goods and
services, the use of facilities, the state of the assets and businesses that the Company
may sell and other matters covered by such contracts, often up to a specified maximum
amount. In addition, from time to time the Company also provides protection to these
parties against claims related to undiscovered liabilities, product liability or
environmental obligations. In the Companys experience, claims made under such
indemnifications are rare and the associated estimated fair value of the liability is not
material. At June 30, 2004, there were no claims for such indemnifications.

# 8.     RESTRUCTURING
 AND ASSET IMPAIRMENTS

Restructuring on Headcount Level

The
Company had approximately 309 full-time employees as of June 30, 2004. In 2001, the
Companys Board of Directors approved a restructuring plan to align the
Companys expenses with revised anticipated demand and create a more efficient
organization. As a result, in 2001, the Company reduced its workforce by 80 employees,
with reductions ranging between 10% and 20% across all functional areas and affecting
several locations. In 2002, in conjunction with the January 2002 and August 2002
restructuring plans approved by its Board of Directors, the Company reduced its workforce
by another 33 and 81 employees, respectively, primarily to realign the sales organization,
to align the cost structure with changing market conditions and to create a more efficient
organization. In August 2003, the Company reduced its general and administrative workforce
by 9%, or 5 employees, to further realign the organization to its structure. The Company
will continue to evaluate its resource and skills requirements and adjust its staffing
appropriately, including by decreasing its workforce in some areas or functions. The Company
may, in the future be required to increase its workforce to respond to changes or growth
in its business, and as a result may need to expand its operational and human resources,
as well as its information systems and controls, to support any such growth. Such
expansion may place significant demands on the Companys management and operational
resources.

Restructuring Charges Based on Different Plans

Fiscal Year 2001

In
April 2001, with the approval of its Board of Directors, the Company implemented a
restructuring plan to align its expenses with revised anticipated demand and to 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.

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 to sublease the building, certain assumptions were made relating 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 restructuring 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

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In
January 2002, with the approval of its Board of Directors, the Company implemented a
restructuring plan to reduce its workforce. The restructuring was primarily to realign the
sales and professional services structure. The Company recorded a restructuring charge of
$1.3 million during 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 the approval of its Board of Directors, the Company implemented a
restructuring plan to reduce its worldwide workforce to realign its 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. It was fully paid off as of December 31, 2003. For the third quarter 2003, it also
reversed an excess accrual for this restructuring plan, which resulted in the recording of
$0.2 million as a credit to the restructuring charge line.

The
restructuring plan also included the consolidation of facilities through the closing of
certain international offices that resulted in a charge of $0.7 million, which was fully
paid out during the first quarter of 2004.

In
addition, in fiscal year 2002, the Company recorded an increase in its previously reported
real estate restructuring accrual related to the new leased facility it does not occupy
and which has not been subleased. This additional charge of $31.8 million resulted from an
analysis of the time period during which the California property is likely to remain
vacant and prospective sub-lease terms and sub-lease rates.

Fiscal Year 2003

In
the third quarter of 2003, the Company reviewed the earlier estimate for the lease loss
for the unoccupied leased facility and the condition of the San Francisco Bay Area
commercial real estate market. The Company estimated that it might take an additional 12
months to sublease this unoccupied facility. The Company also reduced the estimates for
the expected sublease rates. This evaluation resulted in recording an additional lease
loss of $10.4 million, which was recorded as part of the restructuring charges.

For
the third quarter of 2003, the Company reduced its general and administrative workforce to
realign the organizational 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 December 31, 2003, all severance payments were fully paid. In addition,
the Company revised the estimate for the August 2002 restructuring plan, which resulted in
a $0.2 million credit to the restructuring charge line.

As
of June 30, 2004, the Company expects the remaining future net cash outlay for the
restructuring plans to be $48.5 million, of which $9.3 million of the lease loss is to be
paid out over the next 12 months and $39.2 million is to be paid out over the remaining
life of the lease of approximately eight years.

The
Company has recorded a lease loss related to future lease commitments of its Pacific
Shores lease, net of estimated sublease income. However, given the condition of the San
Francisco Bay Area commercial real estate market, the Company may be required to
periodically reevaluate the components of the estimated sublease income, because such
components affect the estimated lease loss for the unoccupied leased facility.
Specifically, the Company is required to reevaluate the time that it might take to
sublease this unoccupied facility, as well as the expected sublease rates. This evaluation
may result in additional lease loss, which would increase the restructuring charges.

The
restructuring charges and balance as of June 30, 2004 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 year ended December 31, 2003            |            |                     | $                | 11,316             
|Amount utilized
in the year ending December 31, 2003          |            |                     |                  | (10,477            
|Balance at December 31, 2003                                  |            |                     | $                | 52,369             
|Current restructuring accrual                                 |            |                     | $                | 9,478              
|Long-term restructuring accrual                               |            |                     | $                | 42,891             
|Total charges for
the quarter ended March 31, 2004            |            |                     | $                | --                 
|Amount utilized
in the quarter ended March 31, 2004           |            |                     |                  | (2,279             
|Balance at March 31, 2004                                     |            |                     | $                | 50,090             
|Total charges for
the quarter ended June 30, 2004             |            |                     | $                | --                 
|Amount utilized
in the quarter ended June 30, 2004            |            |                     |                  | (1,616             
|Balance at June 30, 2004                                      |            |                     | $                | 48,474             
|Current restructuring accrual                                 |            |                     | $                | 9,253              
|Long-term restructuring accrual                               |            |                     | $                | 39,221             
|Q3 2002 Plan                                                  |            |                     |                  |                    
|Balance at December 31, 2003                                  |            |                     | $                | 35                 
|As of December 31, 2003:                                      |            |                     |                  |                    
|Current restructuring accrual                                 |            |                     | $                | 35                 
|Amount utilized in
the quarter ending March 31, 2004          |            |                     |                  | (35                
|Balance at March 31, 2004                                     |            |                     |                  | --                 
|Q3 2003 Plan                                                  |            |                     |                  |                    
|Balance at December 31, 2003                                  |            |                     | $                | --                 
|As of December 31, 2003:                                      |            |                     |                  |                    
|Current restructuring accrual                                 |            |                     | $                | --                 
|Amount utilized in
the quarter ending March 31, 2004          |            |                     |                  | --                 
|Balance at March 31, 2004                                     |            |                     |                  | --                 
|Summary for balance at December 31, 2004 (All plans together) |            |                     |                  |                    
|Total restructuring accrual: Current                          |            |                     | $                | 9,513              
|Total restructuring accrual: Long-term                        |            |                     | $                | 42,891             
|                                                              |            |                     |                  |                    
|Summary for balance at June 30, 2004 (Only 2001 plan left)    |            |                     |                  |                    
|Total restructuring accrual: Current                          |            |                     | $                | 9,253              
|Total restructuring accrual: Long-term                        |            |                     | $                | 39,221             

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# 9.      COMMITMENTS AND
CONTINGENCIES

Operating
leases

The
Company leases its facilities under non-cancelable operating leases with various
expiration dates through July 2012. As of June 30, 2004, 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
|----------------------------------- | - | ----------------
|2004 (remaining 6 months)           | $ | 4,574           
|2005                                |   | 9,023           
|2006                                |   | 9,255           
|2007                                |   | 9,472           
|2008                                |   | 9,537           
|Thereafter                          |   | 35,148          
|Total future minimum lease payments | $ | 77,009          

In
June 2004, the Company signed lease agreements for three office buildings in its Menlo
Park location, under which the Company leases an aggregate of approximately 49,000 square
feet. Each of the leases has a five-year term, expiring in August 2009. The initial
aggregate monthly cash payment for these three leases is approximately $42,000.

In
May 2000, the Company entered into a lease for its Pacific Shore facility. The lease has
an eleven-year term, which began in August 2001. In conjunction with the April 2001
restructuring plans, the Company decided not to occupy this leased facility. The monthly cash payment for the Pacific Shore lease is presently approximately $640,000. For the year
ended December 31, 2003, the Company lowered its estimate for the expected sublease rental
rates for the facility. This estimate revision resulted in recording an additional lease
loss of $10.4 million. Based on reviewing its earlier estimate of the expected sublease opportunities, the Company believes that its estimate that the property may be vacant for
nine months after June 30, 2004 is adequate. The future minimum lease payments table
referenced above does not include estimated sublease income, as there are no sublease
commitments as of June 30, 2004.

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For
all the occupied buildings, rent expense for the three and six months ended June 30, 2004
was approximately $521,000 and $1,053,000, respectively. For all the occupied buildings,
rent expense for the three and six months ended June 30, 2003 was approximately $578,000
and $1,092,000, respectively.

Employment
Agreements

In
April 2003, the Company entered into an employment agreement with its President and Chief
Executive Officer. This employment agreement provides for annual base salary compensation,
variable compensation, stock option grants, and stock option acceleration and severance
payments in the event of termination of employment under certain defined circumstances or
upon a change in control of the Company. Variable and equity compensation are subject to
adjustments according to the Companys financial performance and other factors.

Legal

In
April 2004, the Company was served with a civil complaint filed by Voice Capture, Inc.
against the Company in the United States District Court for the Southern District of Iowa
(the Complaint). The Complaint, which also names as defendants Intel
Corporation and Dialogic Corporation, alleges that certain software and services of the
Company infringe upon certain claims contained in U.S. Patent No. Re 34587
(Interactive Computerized Communications Systems with Voice Input and Output).
The plaintiff is seeking unspecified damages. The Company is currently investigating the
allegations raised in the Complaint. However, the Company believes that the allegations of
the Complaint are without merit and intends to defend the litigation vigorously.

In
August 2001, the first of a number of complaints was filed, in the United States District
Court for the Southern District of New York, on behalf of a purported class of persons who
purchased the Companys stock between April 12, 2000, and December 6, 2000. Those
complaints have been consolidated into one action. The complaint generally alleges that
various investment bank underwriters engaged in improper and undisclosed activities
related to the allocation of shares in the Companys initial public offering of
securities. The complaint makes claims for violation of several provisions of the federal
securities laws against those underwriters, and also against the Company and some of its
directors and officers. Similar lawsuits, concerning more than 250 other companies
initial public offerings, were filed in 2001. In February 2003, the Court denied a motion
to dismiss with respect to the claims against the Company. In the third quarter of 2003, a
proposed settlement in principle was reached among the plaintiffs, issuer defendants
(including the Company) and the issuers insurance carriers. The settlement calls for
the dismissal and release of claims against the issuer defendants, including the Company,
in exchange for a contingent payment to be paid, if necessary, by the issuer
defendants insurance carriers and an assignment of certain claims. The timing of the
conclusion of the settlement remains unclear, and the settlement is subject to a number of
conditions, including approval of the Court. The settlement is not expected to have any
material impact upon the Company, as payments, if any, are expected to be made by
insurance carriers, rather than by the Company. In July 2004, the underwriters filed a
motion opposing approval by the court of the settlement among the plaintiffs, issuers and
insurers. In the event a settlement is not concluded, the Company intends to defend the
litigation vigorously. The Company believes that it has meritorious defenses to the claims
against itself.

In
2001, putative shareholder derivative actions were filed in the California state, alleging
breaches of fiduciary duty and insider trading by several of the Companys directors
and officers. As the Company is named as a nominal defendant, the actions did not appear
to seek any recovery against the Company. The Court approved the settlement and dismissal
of these actions in November 2003. The settlement did not require any payments by the
Company.

In
March 2001, the first of a number of stockholder class action complaints were filed, in
the United States District Court for the Northern District of California, against the
Company and certain of its officers and directors. The lawsuits were consolidated and an
amended complaint was filed on behalf of a purported class of people 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. The plaintiffs were seeking unspecified damages. In November 2003, the Court
approved a settlement and dismissal of the action. The settlement was funded entirely by
the Companys insurers in August and September 2003.

In
addition, the Company is subject to various other legal proceedings, claims and litigation
that arise in the normal course of business. While the outcome of these matters is
currently not determinable, management does not expect that the ultimate costs to resolve
these matters will have a material adverse effect on its consolidated financial position,
results of operations or cash flows.

# 10.      STOCK  BASED
COMPENSATION

Approximately
3,152,000 stock options, at a weighted average exercise price of $8.58, were granted by
the Company before the initial public offering of its securities in 2000. The Company
records deferred stock compensation equal to the difference, if any, between the grant
price and fair value of the Companys common stock on the date of grant. The Company
recorded deferred stock compensation of approximately $8.7 million within
stockholders equity, representing the difference, if any, 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 was presented as a reduction of
stockholders equity and was being amortized over the vesting period of the
applicable options. For the three and six months ended June 30, 2003, the Company recorded
amortization of deferred compensation of $57,000 and $133,000, respectively. The Company
reversed excess amortization of deferred stock compensation, due to termination of
employees, of ($145,000) and ($147,000), respectively, resulting in net benefit of
deferred compensation of ($88,000) and ($14,000), respectively. Also, the Company reversed
unamortized deferred stock compensation, related to the terminated employees, recorded in
Additional Paid-in Capital of $38,000 and $39,000, respectively. Deferred stock-based
compensation was fully amortized as of December 31, 2003.

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In
the first quarter of 2004, the Company accelerated options to purchase 12,500 shares of
common stock to one officer who left the Company on February 9, 2004. In connection with
this acceleration, the Company recorded $73,000 as non-cash stock-based compensation
expense, which was calculated by taking the difference between the fair value of the
common stock on the date of acceleration less the option exercise price times the number
of options accelerated, in its condensed consolidated statement of operations for the six
months ended June 30, 2004.

# 11.     
SEGMENT REPORTING

The
Companys operating segments are defined as components of the Company about which
separate financial information is available that is evaluated regularly by the chief
operating decision maker, or decision making group, in deciding how to allocate resources
and in assessing performance. The Companys chief operating decision maker is the
Chief Executive Officer of the Company.

The
Company derives revenues from three primary sources: (1) license; (2) service; and (3)
maintenance. Revenue and cost of revenue for the segments are identical to those presented
on the accompanying condensed consolidated statement 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 June 30, 2004, occurred through
third-party resellers and through 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):

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|                          | Three Months Ended June 30, | Six Months Ended June 30,
|------------------------- | --------------------------- | -------------------------
|                          |                             |                          
|License Revenue:          |                             |                          
|United States             |                             |                          
|Europe                    |                             |                          
|Asia Pacific              |                             |                          
|Canada                    |                             |                          
|Latin America             |                             |                          
|Total license revenue     |                             |                          
|Service Revenue:          |                             |                          
|United States             |                             |                          
|Europe                    |                             |                          
|Asia Pacific              |                             |                          
|Canada                    |                             |                          
|Latin America             |                             |                          
|Total service revenue     |                             |                          
|Maintenance Revenue:      |                             |                          
|United States             |                             |                          
|Europe                    |                             |                          
|Asia pacific              |                             |                          
|Canada                    |                             |                          
|Latin America             |                             |                          
|Total maintenance revenue |                             |                          
|Total revenue:            |                             |                          
|United States             |                             |                          
|Europe                    |                             |                          
|Asia Pacific              |                             |                          
|Canada                    |                             |                          
|Latin America             |                             |                          
|Total revenue             |                             |                          

# 12.        RELATED
PARTIES

Certain
members of the Companys Board of Directors also serve as directors for companies to
which the Company sells products in the ordinary course of its business. The Company
believes that the terms of its transactions with those companies are no less favorable to
the Company than the terms that would have been obtained absent those relationships.

Specifically,
one member of the Companys Board of Directors is also on the Board of Directors at
MCI, one of the Companys customers. Another member of the Companys
Board of Directors is also on the Board of Directors at Wells Fargo, which is a customer
of the Company. The following table summarizes the revenue generated from these two
customers for the three and six months ended June 30, 2004 and 2003.

|            | Three Months Ended June 30, | Six Months Ended June 30,
|----------- | --------------------------- | -------------------------
|            |                             |                          
|MCI         |                             |                          
|Wells Fargo |                             |                          
|Total       |                             |                          

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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 and with the
information included in our Annual Report on Form 10-K for the year ended December 31,
2003 and subsequent reports filed with the Securities and Exchange Commission. The results
shown herein are not necessarily indicative of the results to be expected for any future
periods.

This
section contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including,
but not limited to, statements regarding revenue and expense trends and cash positions,
sales and marketing, hiring activities, product development and product capabilities and
performance, as well as the Companys expectations, beliefs, intentions or strategies
regarding the future. Words such as anticipates, expects,
intends, may, will, plans,
believes, seeks, projected, assumes 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 Risk Factors below and elsewhere in this Quarterly Report on Form
10-Q and in other reports or documents filed by us from time to time with the Securities
and Exchange Commission.

# OVERVIEW

We
develop, market and support speech software products for automating interactions over the
telephone for a range of industries and applications. Two products were released in 2003:
Nuance Voice Platform (NVP), an open standards-based software platform
optimized for speech solutions, was released in the first quarter 2003 and Nuance Call
Steering (NCS), a packaged application designed to accurately and
cost-effectively route phone calls to the correct customer care destinations, was released
in the second quarter of 2003. In the first quarter 2004, we released a range of new
products, including new versions of its speech recognition software Nuance 8.5,
authentication engines and an update version of the Nuance Voice Platform. During
the second quarter of 2004, we added two new applications, which, like NCS, are designed
to leverage the features inherent in our engines and platform while reducing deployment
time and cost. In April 2004, we launched Nuance Caller Authentication, which is a
packaged speech application that authenticates callers over the phone before allowing
access to private information. The application is powered by Nuance Verifier. In
May, we announced Nuance Flexible Application Suites (FAS), which provide
specific packaged applications designed to speed the delivery and reduce the total cost of
ownership for voice automation solutions across a number of industries:
telecommunications; retail banking; credit card; insurance; healthcare; and utilities.
These two new applications were architected to meet the needs of both our customers and
partners and to empower them to change and maintain the applications themselves.

We
seek to actively support both emerging industry standards as well as proprietary
development environments. Our software is designed to support with 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 third-party resellers 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, and Latin America. We anticipate that markets outside of the United
States will continue to represent a significant portion of total future revenue.

# OVERVIEW OF OPERATIONS

Our
growth and anticipated profitability are heavily dependent upon general economic
conditions and demand for information technology. Our revenue has traditionally been
fueled by sales to the telecommunications and financial services industries. Some
industries have sustained slowdowns over the past several years. Even though information
technology spending appears to be increasing, it is difficult to predict the trend in
information technology spending 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 development tools to increase the speed and ease of deployment, and reduce
the total cost of ownership, of speech systems;

. developing speech
applications designed to reduce deployment time and lower maintenance requirements,

. developing and strengthening
a multi-channel selling model; and

. 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 2002 and 2003, two new products released in 2003, NVP and NCS, sales
execution with a multi-channel strategy, development of a platform Value Added
Reseller (VAR) channel and introduction of two new applications in the
second quarter of 2004; Nuance Caller Authentication and Nuance Flexible Application
Suites. We continue to focus on driving complete speech solutions into the large telecom
and enterprise call center markets. Other operating activities, including new products and
changes to selling and delivery channels, will continue to evolve over the next several
years. 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, 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 possible delays in recognition of revenue. Further, we may
experience periodic fluctuations 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 third-party reseller relationships,
certain third-party reseller relationships may be adversely affected by our introduction
of our own platform product and application products and our direct sales activities,
which may have an unfavorable impact on revenue from certain third-party resellers.

We
are committed to a multi-channel sales approach, and third-party resellers 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 third-party resellers, as well as new third-party resellers. We will
continue to focus efforts on fostering a strong third-party 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 third-party reseller
partners having such complementary capabilities or in establishing third-party 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 or may establish relationships among
themselves or with third parties to increase their technological or selling and marketing
abilities.

# CRITICAL ACCOUNTING
POLICIES AND ESTIMATES

Critical
accounting policies are those that are most significant to the portrayal of our condition
and results of operations and require difficult, subjective and complex judgments by
management in order to make estimates about the effect of matters that are inherently
uncertain.  As previously reported in our Annual Report on Form 10-K for the year
ended December 31, 2003, our most critical accounting policies pertain to revenue
recognition, restructuring and impairment charges, valuation allowance for doubtful
accounts, income taxes and valuation of long-lived assets. In applying such policies
management must record income and expense amounts that are based upon informed judgments
and best estimates.  Because of the uncertainty inherent in these estimates, actual
results could differ from estimates used in applying critical accounting policies. 
Changes in estimates, based on more accurate future information, may affect amounts
reported in future periods.  Management is not aware of any reasonably likely events
or circumstances that would result in different amounts being reported that would
materially affect our financial condition or results of operations. There have been no
changes in any of our critical accounting policies since December 31, 2003.

# DESCRIPTION OF OPERATING
ACCOUNTS

Total
revenue. Total revenues are generated from three primary sources: (1) new software
licenses; (2) services, which include consulting services and training services; and (3)
maintenance, which includes software license updates and customer technical support.
License revenue consists of license fees for our software products. Software license
revenues represent all fees earned from granting customers licenses to use our technology
and applications software and exclude revenue derived from software license updates, which
are included in maintenance revenue. Service revenue consists of revenue from providing
consulting, training and other services. Maintenance revenue consists of fees for
providing technical support and software upgrades. Other revenue consists primarily of
reimbursements for consulting out-of-pocket expenses.

Cost
of Revenue.Cost of license revenue consists primarily of fees payable on third party
software, and amortization of purchased technology. Cost of service revenue consists
primarily of compensation and related overhead costs from employees engaged in consulting
services and amounts paid to subcontractors. Cost of maintenance revenue consists
primarily of compensation and related overhead costs for employees engaged in customer
technical support.

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Sales
and marketing. Sales and marketing expenses consist primarily of compensation and
related costs for sales and marketing employees, travel costs and promotional
expenditures, including public relations, advertising, trade shows and marketing
materials.

Research
and development. Research and development expenses consist primarily of compensation
and related costs for research and development employees and contractors.

General
and administrative. General and administrative expenses consist primarily of
compensation and related costs for administrative employees, legal services, accounting
and audit services and other general corporate expenses.

Non-cash stock-based compensation. We have elected to follow the accounting provisions
of APB No. 25, Accounting for Stock Issued to Employees for stock-based
compensation granted to employees. Accordingly, non-cash stock-based compensation expense
is recognized in our condensed consolidated statement of operations only when options are
granted at an exercise price that is less than the market price of the underlying stock on
the date of the grant.

Restructuring charges (credit). We recognize a liability for restructuring costs at
fair value only when the liability is incurred. The three main components of our
restructuring plans are related to workforce reductions, the lease loss and asset
impairments.

Interest and Other Income, Net.Interest and other income, net, consists primarily of
interest income earned on cash and cash equivalents, short-term and long-term investments,
interest expense, currency gain (loss) related to the remeasurement of certain balance
sheet accounts, and other miscellaneous items.

# RESULTS OF OPERATIONS

We
believe that period-to-period comparisons of our historical operating results are not
necessarily meaningful and should not be relied upon as being indicative of future
performance. Our prospects must be considered in light of the risks, expenses and
difficulties frequently experienced by companies in early stages of development,
particularly companies in new and rapidly changing markets. We have experienced both
significant revenue growth and revenue declines in the past. Furthermore, we may not
achieve or maintain profitability in the future.

The
following table presents selected financial data for the periods indicated as a percentage
of total revenue:

|                               | Three Months Ended June 30, | Six Months Ended June 30,
|------------------------------ | --------------------------- | -------------------------
|                               |                             |                          
|Revenue:                       |                             |                          
|License                        |                             |                          
|Service                        |                             |                          
|Maintenance                    |                             |                          
|Total revenue                  |                             |                          
|Cost of revenue:               |                             |                          
|License                        |                             |                          
|Service                        |                             |                          
|Maintenance                    |                             |                          
|Total cost of revenue          |                             |                          
|Gross profit                   |                             |                          
|Operating expenses:            |                             |                          
|Sales and marketing (1)        |                             |                          
|Research and development (1)   |                             |                          
|General and administrative (1) |                             |                          
|Restructuring credit           |                             |                          
|Total operating expenses       |                             |                          
|Loss from operations           |                             |                          
|Interest and other income, net |                             |                          
|Loss before income taxes       |                             |                          
|Benefit for income taxes       |                             |                          
|Net loss                       |                             |                          

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|                                 | Three Months Ended June 30, | Six Months Ended June 30,
|-------------------------------- | --------------------------- | -------------------------
|                                 |                             |                          
|Gross profits:                   |                             |                          
|License revenue gross profit     |                             |                          
|Service revenue gross profit     |                             |                          
|Maintenance revenue gross profit |                             |                          
|Total revenue gross profit       |                             |                          

Comparison
 of Three and Six Months Periods Ended June 30, 2004 and 2003

Revenue and Cost of
Revenue

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
total revenue increased 11%, with license revenue increasing 15%, service revenue
decreasing 6% and maintenance revenue increasing 25%.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003, total
revenue increased 11%, with license revenue increasing 3%, service revenue increasing 8%
and maintenance revenue increasing 30%.

License revenue and cost
of license revenue.

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
license revenue increased $0.9 million, or approximately 15%. License revenue increased
primarily from the increase in sales of the NVP and Automated Speech Recognition
(ASR) engine. Direct license revenue decreased from $2.3 million to $1.8
million. Indirect license revenue, primarily resulting from sales of our speech products
through our third-party resellers, increased from $4.0 million to $5.3 million. Cost of
license revenue increased 66%, primarily due to the increase in royalty expense. Cost of
license revenue as a percentage of license revenue for those periods were 2% and 1%,
respectively. As a result, gross profit from license revenue remained
relatively constant.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003,
license revenue increased 3%. Direct license revenue decreased from $4.7 million to $2.7
million. Indirect license revenue increased from $7.6 million to $10.0 million. Cost of
license revenue as a percentage of license revenue was 2% and 1%, respectively, for those
periods. As a result, gross profit from license revenue remained relatively constant.

Service revenue and cost
of service revenue.

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
service revenue decreased by $0.2 million, or approximately 6%. This decrease was related
to a large multi-quarter contract with customers in the telecommunications sector, in which a major
portion of revenue from this contract was recognized in the second
quarter of 2003. Cost of service revenue as a percentage of service revenue remained constant at 70%. Service
revenue gross profit remained constant at 30%, primarily due to the steady utilization of
our professional service employees and subcontractors delivering consulting work for our
customers.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003,
service revenue increased by $0.5 million, approximately 8%, primarily resulting from
contracts entered into with two major customers in the first quarter of 2004.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003, cost
of service revenue increased from 23% to 28%, primarily due to the increased compensation expense
resulting from the headcount increase in our professional service area; specifically, headcount
increased by 18, or 50%, from 36 as of June 30, 2003 to 54 as of June 30, 2004.

Maintenance revenue and
cost of maintenance revenue.

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
maintenance revenue increased 25%. The increased maintenance revenue was primarily due to
the increased technical support associated with the increased license revenue. Renewals on
technical support contracts and one-time benefits from fees paid by customers or
third-party resellers to reinstate support contracts also contributed to the increase for
the three month period comparison. For the three months ended June 30, 2004 compared with
the three months ended June 30, 2003, maintenance gross profit increased to 81% from 79%.

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For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003,
maintenance revenue increased 30%, as a result of an increase in the support contract
renewal rate and the increased technical support associated with the increased license revenue.
For the six months ended June 30, 2004 compared with the six months ended
June 30, 2003, cost of maintenance revenue increased 13%, primarily due to the increase in
incentive based compensation to technical support personnel resulting from the increase in
maintenance revenue. For the six months ended June 30, 2004 compared with the six months
ended June 30, 2003, maintenance gross profit increased to 81% from 78%.

Operating Expenses

Sales and marketing.

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
sales and marketing expense increased approximately $0.3 million. This increase was mainly
attributable to the increase in incentive-based compensation as a result of the relative
increase in license revenue and an increase in the cost of our V-world trade show in the
second quarter 2004.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003, sales
and marketing expense decreased approximately $0.6 million. This decrease was almost all
attributable to reduced payroll and related expenses as a result of the decrease in
headcount between the periods. Headcount of sales and marketing personnel decreased by 12
employees, or 12%, from 101 employees at June 30, 2003 to 89 employees at June 30, 2004

For
the balance of fiscal 2004, while we anticipate that sales and marketing expenses will
increase slightly, it will vary as a percentage of total revenue from period to period.

Research and
development.

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
research and development expenses decreased approximately $0.2 million, primarily from the
decrease in payroll related expenses for the two senior engineering managers who left the
Company in the first quarter of 2004.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003,
research and development expenses remained relatively constant, despite headcount for
research and development personnel increasing by 3 employees, or 3%, from 91
employees at June 30, 2003 to 94 employees at June 30, 2004.

For
the balance of fiscal 2004, while we anticipate that research and development expenses
will slightly increase, it will vary as a percentage of total revenue from period to
period.

General and
administrative.

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
general and administrative expenses decreased approximately $1.2 million, or approximately
39%. This decrease was primarily due to a decrease in payroll and related overhead costs
as a result of the headcount reduction, reduced insurance premiums and reduced
professional services expense.

For
the six months ended June 30, 2004, compared with the six months ended June 30, 2003,
general and administrative expenses decreased approximately $2.6 million, or approximately
43%, primarily due to the transitional expenses associated with the hiring of our new CEO
in the first quarter of 2003, which were not incurred in the six months ended June 30, 2004.
We also capitalized certain costs related to our financial system upgrade, which resulted
in lower compensation expenses incurred in that period compared to the six months ended June 30, 2003.
In addition, payroll and related overhead costs decreased due to headcount for general and administrative personnel decreasing by 8 employees, a reduction
of approximately 14%, from 58 employees at June 30, 2003, to 50 employees at June 30,2004.

For
the balance of fiscal 2004, we anticipate that general and administrative expenses will
increase due to increased costs relating to facilitating our internal financial systems
upgrade and mandatory Sarbanes-Oxley 404 compliance.

Non-cash
compensation.

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There
were approximately 3,152,000 stock options granted before our initial public offering, at
a weighted average exercise price of $8.58. We recorded deferred stock-based 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 was
presented as a reduction of stockholders equity and is being amortized over the
vesting period of the applicable options. For the three and six months ended June 30,
2003, we recorded amortization of deferred compensation of 57,000 and $133,000,
respectively. We reversed excess amortization of deferred stock compensation, due to
termination of employees, of ($145,000) and ($147,000), respectively, for those periods,
resulting in net benefit of deferred compensation of ($88,000) and ($14,000),
respectively. Also, we reversed unamortized deferred stock compensation related to the
terminated employees and included the amount in Additional Paid-in Capital of $38,000 and $39,000, respectively.
Deferred stock-based compensation was fully amortized as of December 31, 2003.

In
the first quarter of 2004, we accelerated options to purchase 12,500 shares of common
stock granted to one officer who left Nuance in February, 2004. In connection with this
acceleration, we recorded $73,000 as non-cash stock-based compensation expense, which was
calculated by taking the difference between the fair value of our common stock on the date
of acceleration, less the option exercise price, times the number of options accelerated,
in our condensed consolidated statement of operations for the six months ended June 30,
2004.

Restructuring credits.

For
the three months ended June 30, 2004, we recorded a restructuring credit of $41,000, which
resulted from the partial reversal of the severance accrual recorded for the restructuring
plan during the first quarter 2003. The severance was fully paid as of March 31, 2004.

For
the six months ended June 30, 2003, we recorded a restructuring credit of $943,000, which
resulted from a refund received related to an asset impairment previously recorded for
tenant improvement costs for the facility we do not occupy, following the landlords
reconciliation of tenant improvement costs.

Interest and Other
Income, Net

For
the three months ended June 30, 2004 compared with the three months ended June 30, 2003,
interest and other income, net, increased by approximately $53,000, or 21%.

For
the six months ended June 30, 2004 compared with the six months ended June 30, 2003,
interest income and other income, net, decreased by approximately $179,000, or 25%. This
decrease was mainly caused by the reduction of interest income, resulting from lower cash
balances and decreased interest rates.

Benefit from Income Taxes

We
have incurred operating losses for all periods from inception through June 30, 2004 and
therefore have not recorded a provision for U.S. federal income taxes for any period
through June 30, 2004. We recorded income tax expense relating to foreign income and
royalties taxes of $171,000 and $15,000 for the three months ended June 30, 2004 and 2003,
respectively, and $179,000 and $63,000 for the six months ended June 30, 2004 and 2003,
respectively. The income tax expense has been reduced by foreign tax credits. For the six
months ended June 30, 2004 and 2003, the benefit for income taxes totaled $0.1 million and
$1.6 million, respectively. The benefit in 2004 resulted from the technology tax credits
from our Canadian operations and the benefit in 2003 resulted primarily from the one-time
credits of $1.4 million associated with certain international VAT and income tax
liabilities from Europe.

Liquidity and Capital
Resources

Overall

As
of June 30, 2004, we had cash and cash equivalents of $56.7 million, short-term
investments of $42.3 million and long-term investments of $2.3 million. We believe that
our current cash, cash equivalents, short-term investment and other financing capabilities
will be sufficient to satisfy our working capital, capital expenditure and other liquidity
needs through at least the next 12 months.

We
have incurred losses since our inception, including a net loss of approximately $1.6
million for the three months ended June 30, 2004. As of June 30, 2004, we had an
accumulated deficit of approximately $262.4 million.

Cash, Cash Equivalents
and Investments

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Cash
and cash equivalents consist of highly liquid investments in time deposits held at major
banks, commercial paper, United States government agency notes and bonds, money market
mutual funds and other money market securities with original maturities of 90 days or
less. Short-term investments include similar highly liquid investments that mature by June
30, 2005. Long-term investments include similar highly liquid investments that mature
after June 30, 2005.

The
major use of cash, as well as the decrease in short-term investments in the six months
ended June 30, 2004 was primarily due to operating activities. Long-term investments
increased $2.3 million, primarily due to the slightly longer maturities for a small
portion of our investments. All of the long-term investments mature by August 16, 2005. The largest source of
cash from investing activity was $56.2million from maturities of
investments, offset by the purchases of certain investments of $34.3 million. The largest
provider of cash from financing activity was the proceeds of $0.9 million from the
exercise of stock options.

|                                                    | Six Months Ended June 30,
|--------------------------------------------------- | -------------------------
|                                                    |                          
|Net cash used in operating activities               |                          
|Net cash provided by (used in) investing activities |                          
|Net cash provided by financing activities           |                          
|Increase (Decrease) in cash and cash equivalents    |                          

Net Cash Used in
Operating Activities

Our
operating activities used cash of $4.6 million and $15.4 million during the six months
ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004, the
use of cash resulted primarily from the funding of our operating loss. For the six months
ended June 30, 2004, the restructuring accrual decreased $4.0 million, primarily due to
Pacific Shore lease payments, and severance payments resulting from the
restructuring actions previously taken, being paid. Deferred revenue decreased approximately $1.4
million, principally due to a transaction for which we invoiced a customer, but did not recognize the related
revenues until the second quarter of 2004. These decreases were
offset by accounts receivable decreasing by $2.9 million, mainly due to improved
collection cycles.

Net Cash Provided by
Investing Activities

Our
investing activities provided cash of $20.0 million and used cash of $3.9 million for the
six months ended June 30, 2004 and 2003, respectively. The cash provided from investing
activities was primarily the proceeds from maturities of investments, offset by the
purchase of certain investments. Another use of cash related to the purchase of property
and equipment. For the six months ended June 30, 2004, we made approximately $1.8
million in capital equipment expenditures, of which $1.0 million was a software upgrade expense
and $0.8 million was for a fixed asset acquisition. The software upgrade expense of $1.0
million consisted of $0.8 million for external consulting work and $0.2 million
relating to our employees compensation associated with this upgrade.

Net
Cash Provided by Financing Activities

Our
financing activities provided cash of $1.2 million and $0.6 million for the six months
ended June 30, 2004 and 2003, respectively. These were proceeds from the exercise of stock
options and purchases of our stock under our employee stock purchase plan.

Contractual Commitments

In
June 2004, we signed lease agreements for three office buildings in our Menlo Park
location, under which we lease an aggregate of approximately 49,000 square feet. Each of
the leases has a five-year term, expiring in August 2009. The initial aggregate monthly
cash payment for these three leases is approximately $42,000.

We
have recorded a lease loss related to future commitments on our Pacific Shores
facility lease, net of expected sublease income. We are required to periodically
reevaluate the components of the expected sublease income, because such components affect
the estimated lease loss for the unoccupied leased facility. Specifically, we are required
to reevaluate the time that it might take to sublease this unoccupied facility, as well as
the expected sublease rates. This evaluation may result in additional lease losses.

In
May 2000, the Company entered into a lease for its Pacific Shore facility. The lease has
an eleven-year term, which began in August 2001. In conjunction with the April 2001
restructuring plans, the Company decided not to occupy this leased facility. The monthly cash payment
for the Pacific Shore lease is presently approximately $640,000. For the year
ended December 31, 2003, the Company lowered its estimate for the expected sublease rental
rates for the facility. This estimate revision resulted in recording an additional lease
loss of $10.4 million. Based on reviewing its earlier estimate of the expected sublease opportunities, the Company believes that its estimate that the property may be vacant for
nine months after June 30, 2004 is adequate.

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We
have contractual commitments for non-cancelable operating leases. We provide letters of
credit as guarantees on these leases. The letter of credits underlying amount are
presented as Restricted cash on condensed consolidated balance sheet. As of
June 30, 2004, restricted cash balance was $11.1 million, consisting of a $10.9 million
certificate of deposit required by the landlord as a rent deposit for our Pacific Shore
lease in California and $228,000 related to our Montreal lease. Except for these deposits,
we had no material guarantees or commitments.

Off Balance Sheet
Arrangements

In
the normal course of business, we enter into contractual commitments to purchase materials
and components from suppliers in exchange for favorable pricing or more beneficial terms.
These non-cancelable purchase obligations for materials were not material as of June 30,
2004.

Capital Requirements

Our
capital requirements depend on numerous factors. We may continue to report significant
quarterly operating losses, resulting in significant negative operating cash flows in the future. As of June
30, 2004, we do not plan to spend more than $2.0 million on capital expenditures in the
next six months.

We
believe that our cash, cash equivalents and 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.

# 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.

# RISK FACTORS

Investing in our common stock
involves a high degree of risk.  The risks described below are not the only risks
facing our company.  Additional risks not presently known to us, or that we deem
immaterial, may also impair our business operations.  Any of the following risks
could materially and adversely affect our business, operating results and financial
condition.

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.

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 the following:

 changes or projected changes
in United States or international economic and political conditions;

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

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 delays in 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
revenue actually received, as required by 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 applications, that respond to changing technology trends in a timely
manner;

our ability to manage product
transitions;

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

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

 unexpected customer
non-renewal of maintenance contracts or lower renewal instances than anticipated;

 delays in the negotiation and
documentation of orders, particular large orders and orders from large companies;

 changes in the amount, and the
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 near completion.

Due in part to these factors, and
because the market for certain of our software is relatively new and rapidly changing, and
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. We do not know whether our business will grow rapidly
enough to absorb our expenses. 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. 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
also 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
ORDERS FOR A SUBSTANTIAL PORTION OF OUR REVENUE DURING ANY GIVEN QUARTER. THE LOSS OF, OR
DELAY IN, A SIGNIFICANT 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 direct and indirect customers. We
expect that a small number of customers with significant orders for software products and
professional services will continue to account for a substantial portion of our revenue in
any given quarter. Generally, customers who make significant purchases from us are not
expected to make subsequent, equally large purchases in the short term, and therefore we
must attract new customers or new significant orders from other customers in order to
maintain or increase our revenues in future quarters. If we experience delays or
cancellations in orders from a major customer, if an anticipated sale is not made or is
deferred, if our professional services team does not complete work on large projects
ratably over one or more quarters or if we fail to regularly obtain major new customers,
our revenue in a given period could be impacted negatively and our business could be
harmed.

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

The percentage of our revenue
obtained through indirect sales was 74% in 2002, 58% in 2003, and 61% in the second
quarter of 2004. Although this percentage may decrease in the future, we intend to
continue to rely on third-party resellers for a substantial portion of our future sales.
As a result, our revenues are dependent upon the viability and financial stability of our
third-party resellers, as well as upon their continued interest and success in selling our
products. In addition, some of our third-party resellers are thinly capitalized or
otherwise experiencing financial difficulties. The loss of a significant third-party
reseller or our failure to develop new and viable third-party reseller relationships could
limit our ability to sustain and grow our revenue. Furthermore, expansion, or changes in
the focus of a portion, of our internal sales force, in an effort to increase third-party
reseller sales or replace the loss of a significant third-party reseller, could require
increased management attention and higher expenditures.

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

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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 remains immature and is rapidly changing. In addition, some of our products are
relatively new to the market. Our ability to increase revenue in the future depends on the
acceptance by our customers, third-party 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 of licensing and deploying such
products, as well as by the perceived deployment time and risks of this relatively new
technology. Furthermore, enterprises that have invested substantial resources in existing
call centers or touch-tone-based systems may be reluctant to replace their current systems
with new products. 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 speech software in general
and our products in particular. We may also need to modify or increase our sales and
marketing efforts, or adopt new marketing strategies, to achieve such education. If these
efforts fail, prove excessively costly or otherwise unmanageable, or if speech software
generally does 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:

 acceptance by businesses of
the benefits of speech technology;

 widespread and successful
deployment of speech software applications;

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

 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 and deployment time 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 or the order and
complexity of its terms, the amount of services we are providing, and whether the sale is
made directly by us or indirectly through a third-party reseller.

Speech products often require a
significant expenditure by a customer. Accordingly, a customers decision to purchase
our products typically requires a lengthy 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 in such efforts. Because
of the length of the evaluation period, we are likely to experience a delay, occasionally
significant, between the time we incur these expenditures and the time we generate
revenues, if any, from such expenditures. Furthermore, such expenditures may not result in
a sale of our products.

After purchase by a customer, it may
take time and resources to implement our software and to integrate it with the
customers existing systems. If we are performing services that are essential to the
functionality of the software, in connection with its implementation, we recognize license
and service revenues 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 experienced, and may in the future experience, such delays in
recognizing revenue. Consequently, the length of our sales and implementation cycles, the
deployment process for our products, and the terms and conditions of our license and
service arrangements often make it difficult to predict the quarter in which revenue
recognition may occur and may cause license and service revenue and our 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 Scansoft, IBM and Microsoft. Competitors like IBM
and Microsoft may leverage their existing business relationships with customers to enduce
the customers to use their speech products and services. With respect to our software
platform, there are many vendors, including some of our third-party resellers and channel
partners, who market and sell competing platforms for voice systems. We expect additional
competition from other companies in the platform market. We also have competition in the
professional services market, including for applications. 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 than we do to the development, promotion and sale of speech products.
Accordingly, we may not be able to compete effectively in our markets, competition may
intensify and future competition may cause us to reduce prices 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 COULD BE COSTLY TO US. SUCH CLAIMS COULD ALSO SLOW OUR SALES
CYCLE OR MARKET ADOPTION OF OUR PRODUCTS.

The software industry in general, and
the field of speech and voice technologies in particular, are characterized by the
existence of a significant number of patents. Litigation and threats of litigation based
on allegations of patent infringement and the violation of intellectual property rights
are normal in software markets and appear to be increasing. We attempt to avoid infringing
known proprietary rights of third parties. However, we may be subject to claims and legal
proceedings for alleged infringement , either by us or our customers, of third-party
proprietary rights, such as patents, trade secrets, trademarks or copyrights. In addition,
former employers of our employees may assert that these employees have improperly
disclosed confidential or proprietary information to us.

We typically indemnify our customers
against claims by third parties that our products infringe their intellectual property
rights. Any claims relating to the infringement of third-party proprietary rights, even if
not successful or meritorious, could result in costly litigation, divert managements
attention from our business and require us and our customers to enter into royalty or
license agreements that are costly and otherwise disadvantageous to us. Any such claims
could also require us to defend our customer against the claim and indemnify our customer
for all of its damages as a result of the claim. Any of these effects could have a
material adverse effect on our business and results of operations. Further, parties making
these claims may be able to obtain injunctions, preventing us from selling our products.
These types of claims could also slow our sales cycle and/or market adoption generally
with respect to the affected product, which could harm our business. We may be
increasingly subject to infringement claims as the number and features of our products
grow, we extend our speech application business and the speech market grows.

We understand that holders of a
substantial number of patents have alleged that certain of their patents cover a wide
range of automated services in the call center and computer telephony areas. We believe
that one of such holders has sent letters to many providers of such automated services,
including some of our customers, suggesting that a license under its portfolio is required
in order to provide such automated services. That holder has also sued a number of such
entities, alleging patent infringement. A number of the entities against which that holder
has made such claims have entered into license agreements with respect to the
holders patents. Recently, one of our customers notified us that one of such holders
has claimed that the customers call center operations, which utilize our products,
infringe one or more claims of its patents, and has made a related indemnity claim
against us. It is possible that one or more of our other customers, in response to an
infringement claim by any of such holders, might assert indemnity rights against us,
whether or not meritorious. It is also possible that one or more of such holders might
make a claim against us directly, whether or not meritorious. The costs associated with
resolving any such disputes, regardless of the legal outcome, could be substantial and
could materially and adversely affect our operating results.

WE HAVE A HISTORY OF LOSSES. WE
EXPECT TO CONTINUE TO INCUR LOSSES IN THE NEAR TERM, AND WE MAY NOT ACHIEVE OR MAINTAIN
PROFITABILITY.

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We have incurred losses aggregating
in excess of $262.4 million since our inception, including a net loss of approximately
$19.3 million for the fiscal year ended December 31, 2003, and a net loss of approximately
$1.6 million and $4.2 million for the three and six months , respectively, ended June 30,
2004. We expect to continue to spend significant amounts to develop and enhance our
products, services and technologies and to enhance our delivery capabilities. As a result,
we will need to generate increasing 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. No assurances can be given that we will be profitable or have positive cash
flow at any time in the future.

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 39% of our total revenue in 2003 and approximately 39% of our total revenue
for the first two quarters of 2004. We anticipate that revenue from markets outside the
United States will continue to represent a meaningful portion of our total revenue for the
foreseeable future. We are subject to a variety of risks associated with conducting
business internationally, any of which could harm our business. These risks include the
following:

 difficulties and costs of
staffing and managing foreign operations;

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

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

 longer sales and payment
cycles than we experience in the United States;

 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 and withholding taxes;

the impact of foreign exchange
translations on the expense of our foreign operations; and

 a limited ability, and
significant costs, to enforce agreements, intellectual property rights and other rights in
most foreign countries.

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

Over the past several years, there
has been a global economic downturn, which did not begin to improve until late in 2003. If
United States or global economic conditions deteriorate in the future, it is likely that
capital spending will decline and our sales will be adversely affected. If such
unfavorable economic conditions persist or worsen in the United States or internationally,
such conditions will have 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 in
April 2000, our stock price has been extremely volatile. During that time, the stock
market in general, and 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, suppliers or competitors;

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

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

 material increases in our
capital expenditures, including for infrastructure and information technology;

 economic developments in our
industry as a whole;

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 general market and economic
conditions; and

 general decline and other
changes in information technology and capital spending plans.

These broad market fluctuations may
materially and adversely affect our stock price, regardless of our operating results.
Furthermore, our stock price may fluctuate due to variations in our operating results.

ANY DEFECTS IN, OR OTHER PROBLEMS
WITH, OUR PRODUCTS COULD HARM OUR BUSINESS AND RESULT IN CLAIMS AGAINST US.

Complex software products such as
ours may contain errors, defects and bugs. During the development of any product, we may
discover 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, defects or
bugs, may be technologically unfeasible. Delivery of products with undetected errors,
defects or bugs, or reliability, quality or compatibility problems, could damage our
reputation. The existence of errors, defects or bugs, or reliability, quality or
compatibility problems, could also cause interruptions, delays or cessations of sales to
our customers. We could, as well, 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, or reliability, quality or compatibility problems,
could bring claims against us, the defense of which, even if successful, would likely be
time-consuming and costly for us. Furthermore, if such defense was not successful, we
might be obligated to pay substantial damages, which could materially and adversely affect
our operating results.

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 over time, due in part to volatility in our business, and may continue to
change in the future. We experienced significant growth in the past. However, between
April 2001 and August 2003, in four separate restructuring actions, we reduced our
workforce by approximately 45%. We may be required to expand or contract our business
operations 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, engineering
or other human resources, as well as management information systems and controls, to align
with and support any such growth or contraction. Our failure to successfully manage these
types of changes would place a substantial burden on our business, our operations and our
management team, and could negatively impact sales, customer relationships and other
aspects of our business.

WE COULD BE ADVERSELY IMPACTED BY
THE NEED FOR AN INCREASE IN OUR RESTRUCTURING ACCRUAL FOR OUR PACIFIC SHORES FACILITY.

A significant portion of our
restructuring accrual is represented by a lease loss created by our decision not to occupy
our leased Pacific Shores facility. The accrual assumptions for such loss are based upon
estimates of real estate market conditions and values. These market conditions are subject
to wide fluctuations, and market values may not improve or may decline further, which
could require an additional restructuring accrual. We have attempted to sublease the
Pacific Shores facility, but, to date, have not been successful in those efforts. There
can be no assurances that we will be able to sublease the facility at a lease rate
approximating our estimate of its lease value, or at all. If we are unable to sublease the
facility, we will have to record an additional restructuring charge of up to approximately $40 million ,
which represents the sublease income we have estimated we may receive over the remaining
life of the lease of approximately eight years.

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 our key personnel. Other
than Charles Berger, our President, none of our key technical or senior management
personnel have employment agreements with us, and, as a result, they may leave with little
or no prior notice. If we lose any of our key technical and senior management personnel,
replacing them could be difficult and costly. If we are not able to successfully and
rapidly replace such personnel, our business could be materially harmed. We do not have
key personnel life insurance policies covering any of our employees.

OUR FAILURE TO SUCCESSFULLY
RESPOND TO AND MANAGE RAPID CHANGE IN THE MARKET FOR SPEECH SOFTWARE COULD CAUSE US TO
LOSE REVENUE AND HARM OUR BUSINESS. IT IS ESSENTIAL THAT WE CONTINUE TO DEVELOP NEW
PRODUCTS THAT ACHIEVE COMMERCIAL ACCEPTANCE.

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The speech software industry remains
immature and is rapidly changing. Our future 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 third-party reseller
and end-user requirements and incorporate technological advancements, such as products
that speed deployment and accelerate customers return on investment, as well as
achieve commercial acceptance. Commercial acceptance of 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 third-party resellers. If we are unable to develop or deploy new
products and enhance functionalities or technologies to adapt to these changes, we may be
unable to retain existing customers or attract new customers, which could materially harm
our business. In addition, as we develop new products, sales of existing products may
decrease. If we are unable to offset a decline in revenue from existing products with
sales of new products, our business would be adversely affected.

SPEECH 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, do not perform
accurately in every instance. 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 usually contain provisions designed to limit our exposure to such
liability claims, a claim brought against us based on misrecognition or incorrect
authentication, even if unsuccessful, could be time-consuming, divert managements
attention from our business operations, result in costly litigation and harm our
reputation. If any such claim is successful, we could be exposed to an award of
substantial damages and our reputation could be harmed greatly. Moreover, existing or
future laws or unfavorable judicial decisions could limit the enforceability of
limitations of liability, disclaimers of warranty or other protective provisions contained
in our contracts.

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. In February 2001, we acquired certain non-exclusive intellectual
property rights from a third-party. For the year ended December 31, 2001, we performed an
impairment analysis and determined that our asset related to the SpeechFront acquisition
was impaired and the asset 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, personnel and technologies 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;

 increases in the risk of
claims against us, related to the intellectual property we acquire;

 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 or technologies, or related
personnel, that we might acquire in the future. Our inability to integrate successfully
any business, products, technologies or personnel we may acquire in the future could
materially harm our business.

WE ARE EXPOSED TO THE LIQUIDITY
PROBLEMS OF OUR CUSTOMERS. WE MAY HAVE DIFFICULTY COLLECTING AMOUNTS OWED TO US.  Certain of our customers and third-party resellers have experienced, and may in
the future experience, credit-related issues. We perform ongoing credit evaluations of
customers, but do not 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, we may have difficulty collecting amounts owed to us by such
customers and our business, operating results and financial condition could be adversely
impacted.

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

We currently account for the issuance
of stock options under APB No. 25, Accounting for Stock Issued to Employees.
The Financial Accounting Standards Board has issued an exposure draft that would require
companies to include a compensation expense in their statement of operations relating to
the issuance of employee stock options. 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 for open positions, and we may
have to increase the cash compensation we would have to pay to them. Issuing a number of
stock options comparable to the number we have issued in the past to new or existing
employees would adversely impact our results of operations under the new accounting
requirements, after they take effect.

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

International sales opportunities may
require investing significant resources in creating and refining different language models
for particular languages or dialects. 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 any necessary localized versions of
our products on a timely basis, our ability to address international market opportunities
and to grow our international business will be adversely affected. However, even if we
expend resources to develop localized versions of our products, there can be no assurance
that we will be able to recognize sufficient revenues from these localized versions to
make them profitable.

IF THE INDUSTRY STANDARDS WE HAVE
DETERMINED TO SUPPORT ARE NOT ADOPTED AS THE STANDARDS FOR SPEECH SOFTWARE, CUSTOMERS MAY
NOT USE OUR SPEECH SOFTWARE PRODUCTS.

The market for speech software
remains immature and emerging and industry standards are still being established. We may
not be competitive unless our products support changing industry standards, as in such
circumstance, customers may not use our speech software products. 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.
Furthermore, the existence of multiple standards could chill the market for speech
software in general, until a dominant standard emerges.

Our pre-packaged applications,
V-Builder applications-building tool and our Nuance Voice Platform software are each
designed to work with the recently adopted 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 materially 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. If a third party proprietary technology were to become a
standard, we might be precluded from developing products to conform to that standard
unless we are able to enter into agreements to license the rights to develop such
products. Any such license could require us to pay substantial royalties, whether upfront
or based on sales of such products, which could materially adversely affect our margins
for such products and, as a result, our results of operations.

# 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 through reliance upon 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, maintain or enforce. Further, despite our efforts,
we may be unable to prevent third parties from infringing or misappropriating our
intellectual property or to recover adequate compensation from any such infringers.

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 we will be issued additional patents under our current or future
patent applications. Any patents that are issued to us could be circumvented or
challenged. If challenged, a patent might be invalidated or its claims might be
substantially narrowed. Our intellectual property rights may not be adequate to provide us
with a competitive advantage and, in any event, may not prevent competitors from entering
the markets for our products. Additionally, our competitors could independently develop
non-infringing technologies that are competitive with, equivalent to, or superior to our
technology.

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Monitoring infringement and
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 the
laws of the United States.

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 may discourage a third party from attempting to acquire, control of Nuance.
The plan and 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 division of the board of
directors into three separate classes;

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

 prohibitions on our stockholders
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.

We are 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 presently intend to opt out of the provisions of Section 203.

OUR HEADQUARTERS 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 headquarters 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 struck this area, causing
significant property damage and a number of fatalities. 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 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. If such
interruption became lengthy or occurred repeatedly, it could adversely affect our ability
to conduct operations, which could damage our reputation, harm our ability to retain
existing customers and to obtain new customers, and 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.

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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. We believe there have been no
significant changes in our market risk exposures during the three months ended June 30,
2004, as compared to what was previously disclosed in our annual report on Form 10-K for
the year ended December 31, 2003.

# Foreign Currency
Exchange Rate Risk

To
date, almost all of our recognized revenues have been denominated in U.S. dollars, with a
majority of revenues 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 can not assure that exchange rate fluctuations will not
adversely affect our financial results in the future.

# Interest Rate Risk

As
of June 30, 2004, we had cash, cash equivalents and short-term investments of $99.1
million. Interest rates are presently low. In the event that rates increase in the future,
any subsequent decline in interest rates over time would materially 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

Based on
our managements evaluation (with the participation of our principal executive
officer and principal financial officer) as of the end of the period covered by this
Quarterly Report on Form 10-Q, our principal executive officer and our principal financial
officer have concluded that our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the Exchange Act)) are effective to ensure that information required to be
disclosed by us in reports that we file, or submit, under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the Securities and
Exchange Commission rules and forms. There has been no change in our internal control over
financial reporting that occurred during the period covered by this Quarterly Report on
Form 10-Q that materially affected, or is reasonably likely to materially affect, our
financial reporting.

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# PART II: OTHER
INFORMATION

# ITEM 1. LEGAL PROCEEDINGS

In
April 2004, the Company was served with a civil complaint filed by Voice Capture, Inc.
against the Company in the United States District Court for the Southern District of Iowa
(the Complaint). The Complaint, which also names as defendants Intel
Corporation and Dialogic Corporation, alleges that certain software and services of the
Company infringe upon certain claims contained in U.S. Patent No. Re 34587
(Interactive Computerized Communications Systems with Voice Input and Output).
The plaintiff is seeking unspecified damages. The Company is currently investigating the
allegations raised in the Complaint. However, the Company believes that the allegations of
the Complaint are without merit and intends to defend the litigation vigorously.

In
August 2001, the first of a number of complaints was filed, in the United States District
Court for the Southern District of New York, on behalf of a purported class of persons who
purchased the Companys stock between April 12, 2000, and December 6, 2000. Those
complaints have been consolidated into one action. The complaint generally alleges that
various investment bank underwriters engaged in improper and undisclosed activities
related to the allocation of shares in the Companys initial public offering of
securities. The complaint makes claims for violation of several provisions of the federal
securities laws against those underwriters, and also against the Company and some of its
directors and officers. Similar lawsuits, concerning more than 250 other companies
initial public offerings, were filed in 2001. In February 2003, the Court denied a motion
to dismiss with respect to the claims against the Company. In the third quarter of 2003, a
proposed settlement in principle was reached among the plaintiffs, issuer defendants
(including the Company) and the issuers insurance carriers. The settlement calls for
the dismissal and release of claims against the issuer defendants, including the Company,
in exchange for a contingent payment to be paid, if necessary, by the issuer
defendants insurance carriers and an assignment of certain claims. The timing of the
conclusion of the settlement remains unclear, and the settlement is subject to a number of
conditions, including approval of the Court. The settlement is not expected to have any
material impact upon the Company, as payments, if any, are expected to be made by
insurance carriers, rather than by the Company. In July 2004, the underwriters filed a
motion opposing approval by the court of the settlement among the plaintiffs, issuers and
insurers. In the event a settlement is not concluded, the Company intends to defend the
litigation vigorously. The Company believes that it has meritorious defenses to the claims
against itself.

In
2001, putative shareholder derivative actions were filed in the California state, alleging
breaches of fiduciary duty and insider trading by several of the Companys directors
and officers. As the Company is named as a nominal defendant, the actions did not appear
to seek any recovery against the Company. The Court approved the settlement and dismissal
of these actions in November 2003. The settlement did not require any payments by the
Company.

In
March 2001, the first of a number of stockholder class action complaints were filed, in
the United States District Court for the Northern District of California, against the
Company and certain of its officers and directors. The lawsuits were consolidated and an
amended complaint was filed on behalf of a purported class of people 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. The plaintiffs were seeking unspecified damages. In November 2003, the Court
approved a settlement and dismissal of the action. The settlement was funded entirely by
the Companys insurers in August and September 2003.

In
addition, the Company is subject to various other legal proceedings, claims and litigation
that arise in the normal course of business. While the outcome of these matters is
currently not determinable, management does not expect that the ultimate costs to resolve
these matters will have a material adverse effect on its consolidated financial position,
results of operations or cash flows.

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

(a) Exhibits - DOUG TO UPDATE TOMORROW 08-06-04

|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
Companys Registration Statement on Form S-1 (File No. 333-96217), as declared
effectively by the Securities and Exchange Commission on February 4, 2000.

** Incorporated by reference to the
Companys Form 8-K (file No. 000-30203), as filed on December 13, 2002.

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(b)    
          Reports on Form 8-K

|Date Furnished    | Item No.       | Description                                                                                                                                                                                                                                                                                                                                                                              
|----------------- | -------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                  |                |                                                                                                                                                                                                                                                                                                                                                                                          
|April 6, 2004***  | Items 7 and 12 | On April 6, 2004, the Company furnished a report on Form 8-K to report under
Item 12 that it had changed its estimate for the quarter ended March 31, 2004, and to list under Item 7
a press release furnished with the filing.                                                                                                                                                          
|                  |                |                                                                                                                                                                                                                                                                                                                                                                                          
|April 19, 2004*** | Items 7 and 12 | On April 19, 2004, the Company furnished a report on Form 8-K to report under
Item 12 its financial results for the quarter ended March 31, 2004, and to list under Item 7 a press release furnished
with the filing. The Company's statement of operations and balance sheet for the quarter ended March 31, 2004 were included
with the press release that is an exhibit to the report.
|                  |                |                                                                                                                                                                                                                                                                                                                                                                                          
|April 21, 2004    | Item 5         | On April 21, 2004, the Company furnished a report on Form 8-K to report under
Item 5 that the Company was served with a civil complaint filed by Voice Capture, Inc.                                                                                                                                                                                                                     

***
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: August 6, 2004 |  | By:           /s/ KAREN BLASING                        
|                     |  | Karen BlasingVice President and
Chief Financial Officer
|                     |  |                                                        

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## End of Filing