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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                 _______________
                                    FORM 10-K

(Mark One)

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

         For the fiscal year ended December 31, 2001

                                       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 or other jurisdiction of                       (I.R.S. Employer
    incorporation or organization)                    Identification Number)
         1005 Hamilton Court

          Menlo Park, California                                 94025
 (Address of principal executive offices)                     (Zip Code))

       Registrant's telephone number, including area code: (650) 847-0000

           Securities registered pursuant to Section 12(b) of the Act:
                                      None

           Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $0.001 par value

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. No [_]

The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $232,551,146 as of December 31, 2001 based on the
closing price of the Common Stock as reported on The Nasdaq Stock Market for
that date. Shares of Common Stock held by each executive officer and director
and by each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. The determination
of affiliate status is not necessarily a conclusive determination for other
purposes. There were 33,198,051 shares of the Registrant's Common Stock issued
and outstanding on December 31, 2001.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Certain sections of Nuance Communications, Inc.'s definitive Proxy
Statement for the 2002 Annual Meeting of Stockholders, tentatively scheduled to
be held on May 23, 2002, are incorporated by reference in Part III of this Form
10-K to the extent stated herein.

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                                    PART I

ITEM 1. BUSINESS

     The description of Nuance's business set forth below contains
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act, including but not limited to statements
regarding the timing of release of our products, the growth of our sales through
distributors and the market for our products in general. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks" and
"estimates" and other similar expressions are intended to identify
forward-looking statements. These statements are not guarantees of future
performance and actual actions or results may differ materially. These
statements are based on information available to us on the date hereof, and we
assume no obligation to update any such forward-looking statements. These
statements involve risks and uncertainties and actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including, but not limited to, those set forth in
"Company Risk Factors" and elsewhere in this Report on Form 10-K and in other
reports or documents filed by us from time to time with the Securities and
Exchange Commission. In particular, see "Company Risk Factors -- Voice interface
may not achieve widespread acceptance by businesses and telecommunications
carriers, which could limit our ability to grow our business", "Our ability to
accurately forecast our quarterly sales is limited, our costs are relatively
fixed in the short term and we expect our business to be affected by
seasonality. As a result, our quarterly operating results may fluctuate" and "We
depend on resellers for a significant portion of our sales. The loss of a key
reseller, or their inability to resell our products and services, would limit
our ability to sustain and grow our revenue".

Industry Background

     The use of the telephone - wireless and wireline - is increasing rapidly.
By the year 2005 more than two billion telephones will be in use around the
world according to market analysts Yankee Group. Because the telephone is a key
way for businesses to connect with their customers, companies are actively
seeking better ways to do business via telephone. For example in the area of
customer care, they're eliminating confusing touchtone menus to improve customer
service and satisfaction; they're reducing costs by automating tasks previously
handled by human call center agents; and they're increasing revenues by
delivering new products and enhanced services. Speech recognition, voice
authentication and text-to-speech software products make these advances
possible.

The Nuance Solution

     Nuance develops, markets and supports software that enables enterprises and
telecommunications carriers to automate the delivery of information and services
over the telephone. This automation gives businesses the opportunity to increase
customer satisfaction and reduce costs.

     Our software platform consists of software servers that run on
industry-standard hardware and perform speech recognition, text-to-speech
synthesis and voice authentication. Speech recognition is used to recognize what
a person says, and through the use of natural language understanding, derives
the meaning of what is said. Text-to-speech synthesis converts text, for
example, from a database, an email, a web page or another document, into speech.
Voice authentication verifies the identity of a speaker based on the unique
qualities of that speaker's voice. We actively support industry standards and
our software is designed to work with Voice eXtensible Markup Language referred
to in this document as ("VoiceXML") the recognized industry standard language
for the

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creation of voice-driven products and services. We also offer a range of
consulting, support and education services that enable our customers and channel
partners to develop voice-driven applications that use our software.

     Our products and services can create the following benefits for businesses:

     Increased Revenue Opportunities. By delivering their automated applications
over the telephone through a voice user interface, businesses are able to
increase their revenue opportunities by:

     .    exploiting the relative ubiquity of the telephone to provide an
          increasingly mobile population of customers and employees with more
          convenient access to products, services and information;

     .    reducing the number of callers that hang up because of the long wait
          to speak with customer service representatives; and

     .    introducing new revenue-generating, value-added services such as voice
          dialing, automated personal agents and voice portals.

     Reduced Operational Costs. Our products and services reduce operating costs
for businesses by increasing the availability and efficiency of customer contact
centers. We believe that speech software can cut the average cost of inquiry
handling to less than $0.35 per call, a substantial savings when compared to the
average cost of a call handled by a customer service representative, which can
cost $5.00 or more. Even for businesses which offer some services through a
touch-tone interface, we believe a voice interface made possible through speech
recognition can reduce the number of callers who elect to speak directly to a
customer service representative, thereby significantly reducing overall customer
contact costs.

     Increased Customer Retention. Our products and services help businesses
offer personalized services such as voice dialing of numbers in stored personal
contact lists and access to stock portfolios and other customizable information.
Our software also provides enterprises and telecommunications carriers with the
ability to introduce new value-added services, allowing them to better
differentiate themselves from their competitors. By improving the
personalization and differentiation of their services, these businesses are able
to improve customer loyalty and increase customer retention.

     Increased Customer Satisfaction. Because users can speak naturally to
systems using our software, they can obtain information or perform transactions
more quickly than by navigating through the menus of a touch-tone system.
Shorter calls allow businesses to handle more users, which in turn leads to
shorter hold times.

     Enhanced Security. Our voice authentication software allows businesses to
offer applications that are more secure, more personalized and more convenient
for end users than traditional security methods such as personal identification
numbers and account numbers. Just as individuals can be authenticated by their
fingerprints, they also can be authenticated by their voiceprints. Our software
can use a caller's voiceprint to authenticate his/her identity over the
telephone with high reliability. An individual's voiceprint is less likely to be
lost, stolen or shared than a password or a personal identification number. When
implemented together with our speech recognition capabilities, voice
authentication also increases the usability of an application by reducing the
time and complexity of identifying and authenticating a caller. A caller can
simply speak his telephone number or name and, while our speech recognition
software recognizes what has been spoken, our voice authentication software
authenticates the caller's identity.

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Products and Services

     Our product line consists of our speech recognition, voice authentication
and text-to-speech products. We also offer services to facilitate the
development, implementation and support of applications operating with our
software.

  Software Suite

     Nuance 8.0. The Nuance 8.0 software server provides speech recognition and
natural language understanding capabilities, enabling recognition and
understanding of both simple responses, such as "yes" and "no," and complex
phrases, such as "buy 333 shares at 3 and 3/4." Nuance 8.0 is designed to
operate on standard CPU hardware architectures and operating systems such as
UNIX and Windows NT within a variety of leading telephony systems. The Nuance
8.0 software platform's distributed server architecture enables speech
recognition to be performed on a single hardware server or on multiple hardware
servers in a network. When used on multiple servers in a network, Nuance 8.0
efficiently balances the load of speech recognition requests across available
servers and automatically compensates for a hardware or software failure on one
or more of these servers.

     Nuance Verifier 3.0. The Nuance Verifier 3.0 software server uses
voiceprinting capabilities for verifying the identity of a speaker. Users enroll
voiceprints by speaking information requested by the application. The software
is then able to authenticate the caller's claimed identity by comparing his
speech to the previously enrolled voiceprint. Nuance Verifier is tightly
integrated with Nuance 8.0 and operates within the same distributed
architecture, allowing for the same software scalability and robustness. This
integration provides a key point of differentiation for Nuance, since users can
be recognized and authenticated simultaneously for the highest accuracy and
security. For example, when a caller speaks his telephone number, our software
will understand what phone number was spoken and use that same statement to
authenticate the caller. We believe that Nuance Verifier's technology delivers a
high degree of accuracy for voice authentication, which provides callers with
high levels of security and convenience.

     Nuance Vocalizer 2.0. The Nuance Vocalizer 2.0 software server synthesizes
text into speech. It delivers a high-quality natural-sounding and understandable
voice interface to access information and services. This software enables
companies to deploy new and complex applications, reading text from a variety of
data sources and devices. Applications such as reading email, reviewing
appointments from a desktop calendar, checking sales data or accessing stock
quotes and bank accounts can be created with the Nuance Vocalizer product.
Nuance Vocalizer 2.0 eliminates the jarring transition between recorded prompts
and text-to-speech output in speech based applications with Speak As One(TM).
Speak As One uses the same voice for text-to-speech synthesis as it uses for the
recorded prompts in an application, creating a seamless caller experience.
Nuance is the only speech technology provider that can deliver a complete,
seamless voice user interface solution by combining synthesized speech with
recorded human voice.

     Nuance Voice Web Server. The Nuance Voice Web Server is comprised of the
Nuance speech recognition server and the Nuance VoiceXML interpreter. VoiceXML
is a standards-based markup language which enables rapid development of speech
applications. It is endorsed by the World Wide Web Consortium (W3C) as the
industry standard and thus enables speech applications to leverage existing web
infrastructure and developer communities. Just as HTML defines the display and
delivery of text and images to PCs connected to the Internet, VoiceXML enables
voice content to be delivered by phone. The Nuance VoiceXML interpreter is
software that can process content developed in the VoiceXML language.

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     Nuance Developer Tools. The Nuance Developer Tools facilitate the
prototyping, development, deployment and optimization of voice interfaces for
applications. These tools include V-Optimizer, a product that is used by
developers to analyze and tune system performance, and V-Builder, a product that
provides developers with the capability to create speech applications using
VoiceXML.

  Services

We offer a range of services for implementation of applications using our
software platform. We offer professional services for customer projects, and
believe that our experience in the design and deployment of voice interface
systems is of value to our customers and provides us with a competitive
advantage. We draw on this experience to provide professional services that
include prototype development, user interface design, grammar development,
system testing, performance optimization and end-user acceptance studies. We
offer maintenance to our customers which consists of upgrades and enhancements
to our software and telephone support. We also offer technical support services
for customers and developers to assist with development, integration and
operation of our software products, as well as education services through our
Speech University program.

Customers

     We sell our software to a broad range of companies and organizations,
including those in the air travel, banking and brokerage, government services,
healthcare, retail, telecommunications, and utilities. As of December 31, 2001,
we had sold software and/or services to more than 500 corporate enterprises,
government service organizations and telecommunications carriers around the
world.

Sales and Marketing

     We sell our products both directly through a sales force and indirectly
through third-party value added resellers, original equipment manufacturers, or
"OEMs", voice application service providers, and systems integrators. As of
December 31, 2001, we had 88 employees in sales and marketing serving the United
States market and 46 employees in sales and marketing serving international
markets. We also had sales offices in twelve different countries. International
sales, as a percentage of total revenue, were 42% in 2001, 47% in 2000 and 21%
in 1999.

     Our sales force focuses on generating demand for our products that is
fulfilled either by Nuance directly or indirectly through our channel resellers.
We believe that, as the market for speech software solutions continues to
develop, sales through our indirect channel will represent a significant
percentage of our sales.

     Our resellers increase our sales coverage worldwide and address the broad
range of market and application opportunities for our software. In addition,
these resellers provide end users of our software platform with access to
additional resources to design, install and customize applications. Our five
largest resellers based on revenue in 2001 were Nortel Networks, Edify (a
subsidiary of S1 Corporation), Avaya, Syntellect and Intervoice-Brite. Nortel
Networks accounted for more than 10% of total revenue for 2001, 2000 and 1999.

Marketing

     Our marketing programs are designed to create awareness for our products
and services and support our direct and indirect sales efforts. We have
implemented an integrated mix of marketing activities, including

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public relations, promotional events such as seminars and an annual user
conference, demonstration systems, web sites and channel programs.

     As our channel is strategic to our growth, we intend to continue investing
in providing our partners with the information, tools, and training that is
required to make them successful.

     The Nuance Developer Network is a program for providing developers of
voice-enabled applications with tools and information. The Nuance Partner
Alliance is comprised of a select group of our resellers, OEMs, voice
application service providers and integrators. We screen applicants to the
Nuance Partner Alliance based on their commitments to sell and to market our
software and services and to provide relevant training to their employees. We
perform joint marketing activities with Nuance Partner Alliance members and we
provide them with introductions to prospective customers.

Research and Development

     To remain competitive in the voice software industry, we must continue to
develop highly accurate and efficient speech recognition, natural language
understanding, voice authentication and text-to-speech products. Since our
formation, we have invested significantly in developing and improving this core
technology, the software architecture and related products. Our current research
and development activities include improvements to recognition and verification
accuracy, continued enhancements to the Nuance 8.0 software architecture to
broaden functionality, improve software efficiency and expand integration
options, and development of text-to-speech products. Our research and
development expenses were $18.8 million in 2001, $20.2 million in 2000 and $11.8
million in 1999. As of December 31, 2001, we had 103 employees dedicated to
research and development. We believe that new and timely development of products
and technologies is important to our competitive position in the market and
intend to continue to invest in research and development activities.

Competition

     A number of companies have developed, or are expected to develop, products
that compete with our products. Competitors in the Voice Interface software
market include IBM, Microsoft, Philips Electronics, SpeechWorks International,
Veritel, Vocalis, T-NETIX and Scansoft. Furthermore, 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 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 to address the needs
of our prospective customers.

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

     We believe that the principal competitive factors affecting our market
include the breadth and depth of solutions, product quality and performance,
core technology, product scalability and reliability, product features, customer
service, the ability to implement solutions, the value of a given solution, the
creation of a

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base of referenceable customers and the strength and breadth of reseller and
channel relationships. Although we believe that our solutions currently compete
favorably with respect to these factors, particularly with respect to product
quality and performance, our market is relatively new and is changing rapidly.

Intellectual Property

     We rely upon a combination of patent, copyright, trade secret and trademark
laws as well as contractual protections to protect our intellectual property. We
have filed multiple U.S. patent applications, resulting in the issuance of 5
patents, and we have taken steps to preserve our rights in various foreign
countries. We have issued registrations and pending applications for our Nuance
mark in the United States and in our key foreign markets. In addition, we have
issued registrations and pending applications in the United States for most of
our key products. Although we rely on patent, copyright, trade secret and
trademark law and contractual protections to protect our technology, we believe
that factors such as the technological and creative skills of our employees, new
product developments, frequent product enhancements and reliable product
maintenance are more essential to establishing and maintaining a technology
leadership position. We cannot guarantee that others will not develop
technologies that are similar or superior to our technology.

     To protect our trade secrets, technical know-how and other proprietary
information, our employees are required to enter into agreements providing for
the maintenance of confidentiality and assignment of rights to inventions made
by them while employed by us. We also enter into non-disclosure agreements to
protect our confidential information delivered to third parties and control
access to and distribution of our proprietary information. Despite our efforts
to protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise to obtain and use our technology or to develop products with the same
functionality as our products. Monitoring unauthorized use of our proprietary
information and technology is difficult, and we cannot be certain that the steps
we have taken will prevent misappropriation of our technology, particularly in
foreign countries where the laws may not protect proprietary rights as fully as
do the laws of the United States. In addition, some of our license agreements
require us to place the source code for our products into escrow.

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

Employees

     As of December 31, 2001, we had 417 full time employees. From time to time,
we also retain independent technical contractors and temporary employees. Except
for three employees in Brazil, none of our employees are represented by a labor
union or are subject to a collective bargaining agreement. We have not
experienced any work stoppages and we consider our relations with our employees
to be good.

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ITEM 1A. COMPANY RISK FACTORS

We have a history of losses. We expect to continue to incur losses and we may
not achieve or maintain profitability.

     We have incurred losses since our inception, including a loss of
approximately $110.4 million in the year ended December 31, 2001. As of December
31, 2001, we had an accumulated deficit of approximately $167.7 million. We
expect to have net losses and negative cash flow for at least the next 12
months. As a result, we will need to generate significant additional 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.

Our ability to accurately forecast our quarterly sales is limited, our costs are
relatively fixed in the short term and we expect our business to be affected by
seasonality. As a result, our quarterly operating results may fluctuate.

     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.
For example, in March 2001, we announced our revised expectations for our first
quarter financial results based upon our then-current outlook, including a
revenue shortfall and a larger than expected net loss for the quarter due to
general economic conditions which have led customers and customer prospects to
postpone capital investment in Nuance products and service offerings based on
Nuance products. These quarterly variations are caused by a number of factors,
including:

     .    general economic downturn and delays or cancellations in orders by
          customers who are reducing spending;

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

     .    timing of product deployments and completion of project phases,
          particularly for large orders;

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

     .    our ability to develop, introduce, ship and support new and enhanced
          products, such as our voice browser and new versions of our software
          platform, that respond to changing technology trends in a timely
          manner and our ability to manage product transitions;

     .    the amount and timing of expenses; and

     .    the utilization rate of our professional services personnel.

     Due to these factors, and because the market for our software is new and
rapidly changing, our ability to accurately forecast our quarterly sales is
limited. In addition, most of our costs are for personnel and facilities, which
are relatively fixed in the short term. If we have a shortfall in revenue in
relation to our expenses, we may be unable to reduce our expenses quickly enough
to avoid lower quarterly operating results. We do not know whether our business
will grow rapidly enough to absorb the costs of these

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employees and facilities. 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 quarter of each year
due to patterns in the capital budgeting and purchasing cycles of our current
and prospective customers. We also expect that sales may decline during summer
months. These seasonal variations in our sales may lead to fluctuations in our
quarterly operating results. Because we have limited operating history, it is
difficult for us to evaluate the degree to which this seasonality may affect our
business.

We sell our products directly to customers, however, we also depend upon
resellers for a significant portion of our sales. The loss of a key reseller, or
their inability to resell our products and services, would limit our ability to
sustain and grow our revenue.

     In 1999, 56% of our revenue was achieved by indirect sales through
resellers. The percentage of revenue through indirect sales increased to 72% in
2000 and to 75% in 2001. We intend to continue to rely on resellers for a
substantial portion of our sales in the future. As a result, we are dependent
upon the continued viability and financial stability of our resellers, as well
as upon their continued interest and success in selling our products. The loss
of a key reseller or our failure to develop new and viable reseller
relationships could limit our ability to sustain and grow our revenue.
Significant expansion of our internal sales force to replace the loss of a key
reseller would require increased management attention and higher expenditures.

     Our contracts with resellers generally do not require a reseller to
purchase our products. We cannot guarantee that any of our resellers will
continue to market our products or devote significant resources to doing so. In
addition, we may, from time to time, terminate some of our relationships with
resellers. Any termination could have a negative impact on our business and
result in threatened or actual litigation. Finally, these resellers possess
confidential information concerning our products, product release schedules and
sales, marketing and reseller operations. Although we have nondisclosure
agreements with our resellers, we cannot guarantee that any reseller would not
use our confidential information in competition with us or otherwise. If our
resellers do not successfully market and sell our products for these or any
other reasons, our sales could be adversely affected and our revenue could
decline.

We depend on a limited number of customer orders for a substantial portion of
our revenue during any given period. The loss of, or delays in, a key order
could substantially reduce our revenue in any given period and harm our
business.

     We derive a significant portion of our revenue in each period from a
limited number of customers. For example, in 2001, five customers made up 38% of
our total revenue, and one of those customers, acting as a reseller, accounted
for approximately 18% of our total revenue.

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

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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 42% of our revenue in 2001,
47% of our revenue in 2000 and 21% of our revenue in 1999, and we anticipate
that revenue from markets outside the United States will continue to represent a
significant portion of our total revenue. We are subject to a variety of risks
associated with conducting business internationally, any of which could harm our
business. These risks include:

     .    difficulties and costs of staffing and managing foreign operations;

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

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

     .    longer sales cycles;

     .    political and economic instability outside the United States;

     .    import or export licensing and product certification requirements;

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

     .    potential adverse tax consequences, including higher marginal rates;

     .    unfavorable fluctuations in currency exchange rates; and

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

In order to increase our international sales, we must develop localized versions
of our products. If we are unable to do so, we may be unable to grow our revenue
and execute our business strategy.

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

We are currently engaged in various securities class action litigations, which,
if resulting in unfavorable resolution, could adversely affect our business,
results of operations or financial condition.

     We have been sued in various shareholder lawsuits in federal district court
in California and New York (See "Item 3 - Legal Proceedings"). We believe that
the allegations against us are without merit and

                                       -9-

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intend to defend the litigation vigorously. An unfavorable resolution of the
lawsuits could have a material adverse effect on our business, results of
operations, or financial condition.

Our stock price may be volatile due to factors outside of our control.

     Since our initial public offering on April 13, 2000, our stock price has
been extremely volatile. During that time, the stock market in general, and The
Nasdaq National Market and the securities of technology companies in particular,
has 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 our operating results;

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

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

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

     .    economic developments in our industry as a whole;

     .    general market and economic conditions;  and

     .    general decline in information technology and capital spending plans.

     These broad market fluctuations may materially adversely affect our stock
price, regardless of our operating results. Our stock price may also fluctuate
due to variations in our operating results. For example, on March 15, 2001, we
announced our revised expectations for our first-quarter revenues based upon our
then-current outlook. As a result, the trading price of our common stock
declined rapidly and significantly.

Speech software products may not achieve widespread acceptance by businesses and
telecommunications carriers, which could limit our ability to grow our business.

     The market for speech software products is relatively new and rapidly
changing. Our ability to increase revenue in the future depends on the
acceptance by both our customers and their end users of speech software
products. The adoption of speech software products could be hindered by the
perceived costs of this new technology, as well as the reluctance of enterprises
that have invested substantial resources in existing call centers or
touch-tone-based systems to replace their current systems with this new
technology. Accordingly, in order to achieve commercial acceptance, we will have
to educate prospective customers, including large, established
telecommunications companies, about the uses and benefits of speech software in
general and our products in particular. If these efforts fail, or if speech
software platforms do not achieve commercial acceptance, our business could be
harmed.

     The continued development of the market for our products also will depend
upon the following factors:

     .    widespread deployment of speech software applications by third
          parties, which is driven by consumer demand for services 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 sites;

                                       -10-

<PAGE>

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

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

     Our products can have a long sales and implementation cycle and, as a
result, our quarterly operating results may fluctuate. The sales cycles for our
products have typically ranged from three to twelve months, depending on the
size and complexity of the order, the amount of services to be provided by us
and whether the sale is made directly by us or indirectly through a value added
reseller, a voice application service provider or a systems integrator.

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

     In addition, during any quarter we may receive a number of orders that are
large relative to our total revenues for that quarter or subsequent quarters.

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

Our current and potential competitors, some of whom have greater resources and
experience than we do, may market or develop products 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 in the speech software market
include IBM, Microsoft, Philips Electronics, SpeechWorks International, Veritel,
Vocalis, T-NETIX and Scansoft. We expect additional competition from other
companies, our competitors may combine with each other, and other companies may
enter our markets by acquiring or entering into strategic relationships with our
competitors. Current and potential competitors 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
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

                                      -11-

<PAGE>

standards or customer requirements, or devote greater resources to the
development, promotion and sale of their products than we do. Accordingly, we
may not be able to compete effectively in our markets, competition may intensify
and future competition may harm our business.

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, and
in February 2001, we acquired non-exclusive intellectual property rights from a
third-party. Any future acquisitions would be accompanied by risks such as:

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

     .    diversion of our management's attention from ongoing business
          concerns;

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

     .    additional expense associated with amortization of acquired assets;

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

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

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

Our failure to respond to rapid change in the market for speech software could
cause us to lose revenue and harm our business.

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

     Commercial acceptance of our products and technologies will depend, among
other things, on:

     .    the ability of our products and technologies to meet and adapt to the
          needs of our target markets;

     .    the performance and price of our products and our competitors'
          products; and

                                       -12-

<PAGE>

     .    our ability to deliver customer service directly and through our
          resellers.

We are exposed to general economic conditions, which may continue to harm our
business.

     As a result of recent unfavorable economic conditions and reduced capital
spending, it is possible that our sales will decline. This economic downturn
became particularly acute following the events of September 11, 2001. We
experienced a decline in revenues during 2001 due in part to delays in purchases
by our customers and to prevailing economic conditions. If the economic
conditions in the United States worsen or if a wider or global economic slowdown
occurs, we may experience a material adverse impact on our business, operating
results and financial condition.

     If we do not manage our operations in accordance with changing economic
conditions, our resources may be strained which could harm our chances of
achieving profitability.

     Our operations have changed significantly due to volatility in our
business. We experienced significant growth in the past; however, in April 2001,
we reduced our workforce by approximately 20%. Additionally, in January 2002, we
announced a restructuring plan that has reduced our workforce by approximately
another 10%. We may be required to expand or contract our business operations in
the future, and as a result may need to expand or contract our management,
operational, financial and human resources, as well as management information
systems and controls, to support any such growth or contraction. Our failure to
manage these types of changes would place a burden on our business and our
management team, which could cause our business to suffer.

Our products are not 100% accurate and we could be subject to claims related to
the performance of our products. Any claims, whether successful or unsuccessful,
could result in significant costs and could damage our reputation.

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

Any software defects in our products could harm our business and result in
litigation.

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

                                       -13-

<PAGE>

          and bugs could bring claims against us which, even if unsuccessful,
          would likely be time-consuming and could result in costly litigation
          and payment of damages.

Our products may infringe the intellectual property rights of others, and
resulting claims against us could be costly and require us to enter into
disadvantageous license or royalty arrangements.

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

If we are unable to hire and retain select personnel, our business could be
harmed.

     We intend to hire select personnel during the year. Competition for these
individuals can be intense, and we may not be able to attract, assimilate, or
retain additional highly qualified personnel in the future. The failure to
attract, integrate, motivate and retain these employees could harm our business.
The decline in the value of our common stock may also make it more difficult to
retain our employees.

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 of these key employees, such as Ronald
Croen, our Chief Executive Officer. We cannot guarantee that we will be able to
retain all key personnel. For example, our former Chief Financial Officer,
Graham Smith, left Nuance in January, 2001. None of our key technical or senior
management personnel are bound by employment agreements, and, as a result, any
of these employees could leave with little or no prior notice. If we lose any of
our key technical and senior management personnel, our business could be harmed.
We do not have key person life insurance policies covering any of our employees.

Any inability to adequately protect our proprietary technology could harm our
ability to compete.

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

     Although we have filed multiple U.S. patent applications, we have currently
only been issued a small number of patents. There is no guarantee that more
patents will be issued with respect to our current or future

                                       -14-

<PAGE>

patent applications. Any patents that are issued to us could be invalidated,
circumvented or challenged. If challenged, our patents might not be upheld or
their claims could be narrowed. Our intellectual property may not be adequate to
provide us with competitive advantage or to prevent competitors from entering
the markets for our products.

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

Third parties could obtain licenses from SRI International relating to speech
software technologies and develop technologies to compete with our products,
which could cause our sales to decline.

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

If the standards we have selected to support are not adopted as the standards
for speech software, businesses might not use our speech software products for
delivery of applications and services.

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

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

Certain stockholders may disagree with how Nuance uses the proceeds from its
public offerings.

     Management retains broad discretion over the use of proceeds from our April
2000 initial public offering and September 2000 secondary public offering.
Stockholders may not deem these uses desirable and our use of the proceeds may
not yield a significant return or any return at all. Because of the number and

                                       -15-

<PAGE>

variability of factors that determine our use of the net proceeds from these
offerings, we cannot guarantee that these uses will not vary substantially from
our currently planned uses.

Our charter and bylaws and Delaware law contain provisions which may delay or
prevent a change of control of Nuance.

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

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

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

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

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

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

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

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

Our facilities are located near known earthquake fault zones, and the occurrence
of an earthquake or other natural disaster could cause damage to our facilities
and equipment, which could require us to curtail or cease operations.


     Our facilities are located in the San Francisco Bay Area near known
earthquake fault zones and are vulnerable to damage from earthquakes. In October
1989, a major earthquake that caused significant property damage and a number of
fatalities struck this area. We are also vulnerable to damage from other types
of disasters, including fire, floods, power loss, communications failures and
similar events. If any disaster were to occur, our ability to operate our
business at our facilities could be seriously, or potentially completely,
impaired. The insurance we maintain may not be adequate to cover our losses
resulting from disasters or other business interruptions.

We rely on a continuous power supply to conduct our operations, and an energy
crisis in California could disrupt our operations and increase our expenses.

     California recently experienced an energy crisis that increased our
expenses and could have disrupted our operations. In the event of an acute power
shortage, that is, when power reserves for the State of

                                       -16-

<PAGE>

California fall below 1.5%, California has on some occasions implemented, and
may in the future continue to implement, rolling blackouts throughout
California. 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
California experiences a similar energy crisis in the future, any such
interruption in our ability to continue operations at our facilities could
damage our reputation, harm our ability to retain existing customers and to
obtain new customers, and could result in lost revenue, any of which could
substantially harm our business and results of operations.

Information that we may provide to investors from time to time is accurate only
as of the date we disseminate it, and we undertake no obligation to update the
information.

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

ITEM 2. PROPERTIES

     Our headquarters are located in Menlo Park, California in two office
buildings in which we lease an aggregate of 60,000 square feet. The leases on
both buildings expire in August 2004. In May 2000, we also signed a lease for a
new 141,000 square-foot headquarters facility in Redwood City, California. The
lease term is for eleven years, which began in August 2001. In April 2001, in
conjunction with the restructuring plan, management decided not to occupy this
corporate headquarter facility and put the facility up for sublease (see Note
9). In January 2000, we signed a lease, which was amended in August 2000, for
approximately 36,000 square feet of office space in Montreal, Canada for our
Montreal operations. The lease term is for seven years from the lease inception
date of November 1, 2000. In January 2001, we signed a lease for approximately
9,400 square feet of office space in Ottawa, Canada in relation to an existing
facility being leased by SpeechFront. The lease term is for two and a half years
from the lease inception date of January 1, 2001. We also lease facilities with
lease terms ranging from two to three years in Hong Kong and Japan. In
conjunction with the restructuring plan in January 2002, we decided to vacate
the facility in Hong Kong. (see Note 17). In addition, we also lease, on a
short-term basis, sales office space in Boston, Massachusetts; Oakbrook,
Illinois; El Dorado, California; Korea, Singapore, France, Germany and United
Kingdom. We do not own any real estate.

ITEM 3. LEGAL PROCEEDINGS

     In March 2001, the first of a number of stockholder complaints was filed in
the United States District Court for the Northern District of California against
Nuance and certain of its officers. Those lawsuits have been consolidated and an
amended complaint has been filed on behalf of a purported class of people who
purchased our 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 are seeking unspecified damages. We
believe that these allegations are without merit and we are defending the
litigation vigorously. We filed a motion to dismiss the amended, consolidated
complaint and in response to our motion, the Court has ordered the plaintiffs to
file a new amended complaint. An unfavorable resolution of this litigation could
have a material adverse effect on our business, results of operations, or
financial condition.

                                       -17-

<PAGE>

     In June and July 2001, putative shareholder derivative actions were filed
in California state court alleging breaches of fiduciary duty and insider
trading by various of our directors and officers. While we are named as a
nominal defendant, the lawsuits do not appear to seek any recovery against us.
Proceedings in these actions have been stayed.

     In August 2001, the first of a number of complaints was filed in federal
district court for the Southern District of New York on behalf of a purported
class of persons who purchased Nuance stock between April 12, 2000 and December
6, 2000. The complaint generally alleges that various investment bank
underwriters engaged in improper and undisclosed activities related to the
allocation of shares in our initial public offering of securities. The
complaints bring claims for violation of several provisions of the federal
securities laws against those underwriters, and also against us and some of our
directors and officers. Similar lawsuits concerning more than 300 other
companies' initial public offerings have been filed in 2001. We believe that the
allegations against us are without merit and intend to defend the litigation
vigorously.

     We are 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 our
consolidated financial position, results of operations, or cash flows.

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

     There were no submissions of matters to a vote of security holders during
the quarter ended December 31, 2001.

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Our common stock has been quoted on the Nasdaq National Market under the
symbol "NUAN" since April 13, 2000. The following table presents, for the
periods indicated, the high and low closing prices per share of the common stock
as reported on the Nasdaq National Market.

                                                     HIGH          LOW
                                                  ---------      --------

Fiscal 2001
First Quarter ...............................     $   57.73      $   9.38
Second Quarter ..............................     $   19.60      $   9.21
Third Quarter ...............................     $   19.65      $   6.00
Fourth Quarter ..............................     $   12.20      $   6.00

Fiscal 2000
Second Quarter (since April 13, 2000) .......     $   83.31      $  25.00
Third Quarter ...............................     $  175.00      $  83.19
Fourth Quarter ..............................     $  128.02      $  30.56

     As of February 28, 2002, there were approximately 525 holders of record of
our common stock. Because many shares of our common stock are held by brokers
and other institutions on behalf of stockholders, we are unable to estimate the
total number of stockholders represented by these record holders.

                                      -18-

<PAGE>

Dividend Policy

     We have never declared or paid any dividends on our common stock or other
securities. We do not anticipate paying any cash dividends in the foreseeable
future. We currently intend to retain future earnings, if any, to finance
operations and the expansion of our business. Any future determination to pay
cash dividends will be at the discretion of the board of directors and will
depend upon our financial condition, operating results, capital requirements and
other factors the board of directors deems relevant.

Changes In Securities and Use of Proceeds

     The effective date of our Registration Statement filed on Form S-1 under
the Securities Act of 1933 (File No. 333-96217), relating to our initial public
offering of our common stock was April 12, 2000. Public trading commenced on
April 13, 2000. The offering closed on April 18, 2000. The managing underwriters
of the public offering were Goldman, Sachs & Co., Thomas Weisel Partners LLC,
Dain Rauscher Wessels and Wit SoundView. In the offering (including the exercise
of the underwriters' overallotment option on April 20, 2000), we sold an
aggregate of 5,175,000 shares of our common stock for an initial price of $17.00
per share.

     The aggregate proceeds from the offering were $88.0 million. We paid
expenses of approximately $7.7 million, of which approximately $5.4 million
represented underwriting discounts and commissions and approximately $2.3
million represented expenses related to the offering. Net proceeds from the
offering were approximately $80.3 million. As of December 31, 2001,
approximately all of the remaining net proceeds have been invested in
interest-bearing cash equivalents, short-term investments and long-term
investments.

ITEM 6. SELECTED FINANCIAL DATA

         The following selected financial data should be read in conjunction
with our consolidated financial statements and related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this report. The historical results presented below are
not necessarily indicative of future results (in thousands except per share
data):

<TABLE>
<CAPTION>
                                                                                   Year Ended December 31,
                                                               -----------------------------------------------------------------
                                                                  2001         2000          1999         1998          1997
                                                               -----------   -----------  -----------   -----------  -----------
<S>                                                            <C>           <C>          <C>           <C>          <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue ..............................................   $   39,225    $   51,818   $   19,567    $   11,755   $    4,382
Gross profit ...............................................       23,033        41,066       14,107         8,656        3,218
Loss from operations .......................................     (117,781)      (29,825)     (19,149)       (7,536)      (3,758)
Net loss ...................................................     (110,365)      (23,474)     (18,474)       (6,938)      (3,554)
                                                               ==========    ==========   ==========    ==========   ==========
Basic and diluted net loss per share .......................   $    (3.40)   $    (1.03)  $    (6.32)   $    (3.19)  $    (2.46)
                                                               ==========    ==========   ==========    ==========   ==========
Shares used to compute basic and diluted net loss per
   share ...................................................       32,480        22,717        2,924         2,173        1,443
                                                               ==========    ==========   ==========    ==========   ==========
</TABLE>

     For a description of shares used in computing basic and diluted net loss
per share, see note 2 of notes to consolidated financial statements.

                                       -19-

<PAGE>

<TABLE>
<CAPTION>
                                                                               December 31,
                                                   -------------------------------------------------------------------
                                                      2001          2000          1999          1998           1997
                                                   ----------    ----------    ----------    ----------     ----------
<S>                                                <C>           <C>           <C>           <C>            <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents ......................   $  132,618    $  219,047    $   18,073    $    1,642     $    2,056
Working capital ................................      128,672       226,366        33,907        12,406          4,028
Total assets ...................................      208,231       279,338        53,722        20,199          6,940
Long-term debt, less current portion ...........           --            32         1,333            --            815
Total stockholders' equity .....................      154,825       251,991        36,951        14,260          4,384
</TABLE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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

     The section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" set forth below contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act, including but not limited to our expectations for
results during the current fiscal year, statements regarding revenue and expense
trends and cash positions, statements regarding our sales and marketing and
hiring activities and our outlook for the Company, as well as our expectations,
beliefs, intentions or strategies regarding the future. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks" and
"estimates" and other similar expressions are intended to identify
forward-looking statements. These statements are not guarantees of future
performance and actual actions or results may differ materially. These
statements are based on information available to us on the date hereof, and we
assume no obligation to update any such forward-looking statements. These
statements involve risks and uncertainties and actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including, but not limited to, those set forth in
"Company Risk Factors" and elsewhere in this Report on Form 10-K and in other
reports or documents filed by us from time to time with the Securities and
Exchange Commission. In particular, see "Company Risk Factors -- Our ability to
accurately forecast our quarterly sales is limited, our costs are relatively
fixed in the short term and we expect our business to be affected by
seasonality. As a result, our quarterly operating results may fluctuate", "If we
do not manage our operations in accordance with changing economic conditions,
our resources may be strained which could harm our chances of achieving
profitability." and "Our products can have a long sales and implementation cycle
and, as a result, our quarterly operating results may fluctuate".

Overview

     Nuance develops, markets and supports software that enables enterprises and
telecommunications carriers to automate the delivery of information and services
over the telephone. We were incorporated in July 1994 and began operations in
October 1994. Prior to 1996, our revenue was derived from technical consulting
services. In 1996, we deployed the first version of our software platform and
began to generate software license revenue. Today, we offer a range of software
products. To support the sale, deployment and operation of our products, we also
provide a number of services that include consulting, training, maintenance
updates and technical support.

                                      -20-

<PAGE>

     We sell products to our customers both directly through our sales force and
indirectly through resellers and systems integrators. Customers exceeding 10% of
total revenue are:

     .    Nortel Networks who, acting as a reseller, accounted for 18% of total
          revenue for 2001, 22% of total revenue for 2000 and 25% of total
          revenue for 1999;

     .    Fidelity, a stockholder of Nuance, accounted for less than 10% of
          total revenue for each of 2001 and 2000, and 20% of total revenue for
          1999.

     No other customers or resellers accounted for more than 10% of our revenue
for 2001, 2000 or 1999.

     We sell our products to customers in North America, South America, Europe,
Asia and Australia. International sales accounted for approximately 42% of our
total revenue for 2001, 47% of our total revenue for 2000 and 21% of our total
revenue for 1999. We anticipate that markets outside the United States will
continue to represent a significant portion of total future revenue. We intend
to keep our sales and marketing activities constant with respect to
international licensing of our software and provisioning of our services in the
foreseeable future. International sales are currently denominated in U.S.
dollars. However, we may denominate sales in foreign currencies in the future.

Acquisitions

     On November 10, 2000 in an acquisition accounted for under the purchase
method of accounting, we acquired all the outstanding shares of SpeechFront Inc.
("SpeechFront") for approximately $7.1 million, including acquisition costs of
approximately $129,000. The consideration included approximately 16,590 shares
of the Company common stock valued at $1.7 million and cash of approximately
$5.3 million. The purchase agreement contained additional payments, of
approximately $4.1 million, to be made in common stock, approximately 38,710
shares, contingent upon the continued employment of the founders of SpeechFront.
Maximum future payments, contingent solely on continued employment of the
founders, is $1.7 million, approximately 16,590 shares, and is payable upon the
eighteen month anniversary of the acquisition date. The remaining $2.4 million,
approximately 22,120 shares, also relates to the continued employment of the
founders, and is payable upon the twelve month anniversary of the acquisition
date, or earlier if certain performance milestones are achieved. The contingent
payments will be accounted for as compensation expense over the term of the
employment condition and not as part of the purchase price. Upon consummation of
the acquisition, the Company established an escrow for these contingent
payments. At the time of acquisition, we expensed $1.5 million of purchased
in-process research and development. Other purchased intangible assets,
including goodwill and workforce, of approximately $5.5 million are being
amortized on a straight-line basis over their estimated useful lives of
thirty-six and eighteen months, respectively.

     During 2001, we entered into an agreement with a third-party that gives us
non-exclusive intellectual property rights to text to speech software code. We
paid $7.0 million for this purchased technology which has been capitalized in
the accompanying Consolidated Balance Sheets as the technology has alternative
use and will be amortized over its useful life estimated to be five years. We
are in the process of incorporating the text to speech technology into our
platform. During the development stage, this technology is being amortized to
research and development expense, and when the product is generally available
for sale, which is expected to be in the first quarter of 2002, the technology
will be amortized to cost of sales. The agreement includes a royalty clause in
which we will pay 5% of all net revenue attributable to sublicenses of this
technology to a third party. The term of the royalty payments is eight years.

     As a part of our business strategy, we may in the future make acquisitions
of, or significant investments in, complementary companies, products or
technologies. Any future acquisitions would be accompanied by risks such as
difficulties in assimilating the operations and personnel of acquired companies;
diversion of our management's attention from ongoing business concerns; our
potential inability to maximize our financial and strategic position through the
successful incorporation of acquired technology and rights into our products and
services; additional expense associated with amortization of acquired assets;
maintenance of uniform standards, controls, procedures and policies; and
impairment of existing relationships with employees, suppliers and customers. We
cannot guarantee that we will be able to successfully integrate any business,
products, technologies or personnel that we might acquire in the future, and our
inability to do so could harm our business.

                                      -21-

<PAGE>

Restructuring and Assets Impairments

     In April 2001, our Board of Directors approved a restructuring plan to
align our expenses with revised anticipated demand and create a more efficient
organization.

     In conjunction with the April 2001 restructuring plan, we decided not to
occupy a new leased facility. This decision has resulted in a lease loss of
$32.6 million, comprised of a sublease loss, broker commissions and other
facility costs, and an asset impairment charge of $20.4 million, which
represents the related leasehold improvements. To determine the sublease loss,
the loss after our cost recovery efforts from subleasing the building, certain
assumptions were made related to the (1) time period over which the building
will remain vacant (2) sublease terms and (3) sublease rates. The lease loss is
an estimate under SFAS No. 5 "Accounting for Contingencies" and represents the
low end of the range and will be adjusted in the future upon triggering events
(change in estimate of time to sublease, actual sublease rates, etc.). We have
estimated that the high end of the lease loss could be $55 million if operating
lease rental rates continue to decrease in these markets or should it take
longer than expected to find a suitable tenant to sublease the facility.

     In connection with the April 2001 restructuring plan, we recorded $1.5
million in costs associated with severance and related benefits. We reduced our
headcount by approximately 80 employees, with reductions ranging between 10% and
20% across all functional areas and affecting several locations. We expect to
save an estimated $8.0 million annually of salary and related benefits as a
result of this reduction in headcount. In addition, the real estate
restructuring plan is expected to lower facilities expenses, which would have
been incurred had we occupied the new leased facility.

     In January 2002, we announced a restructuring plan that would reduce our
workforce by approximately 10%. These charges are being recorded primarily to
realign the sales organization, to align our cost structure with changing market
conditions and to create a more efficient organization (See Note 17). We may,
however, be required to expand our business operations in the future, and as a
result may need to expand our management, operational, financial and human
resources, as well as information systems and controls, to support any such
growth.

     During the year, we recorded $7 million related to purchased text to speech
technology. For the period ending December 31, 2001, we amortized $1.2 million
to research and development as the product was being developed into Nuance's
text to speech product offering. During the quarter ending December 31, 2001, we
reviewed the current value of these intangible assets based on an analysis which
considered existing business conditions and economic declines including the
overall declines in industry growth rates that have negatively impacted expected
future revenue. Based on consideration of these factors, we performed an
evaluation of the recoverability of this asset using undiscounted cash flows.
This analysis indicated that the asset was impaired, accordingly, such asset was
written down by $4.4 million to estimated fair value based on estimated
discounted future cash flows.

     During the year ending December 31, 2001, we purchased $550,000 of
third-party software to complement our core platform product line. At year-end,
we evaluated this third party software and wrote-off $275,000 of excess
inventory caused by lower-than-expected demand. We will continue to assess the
remaining carrying value of the inventory in relation to recovery of future
revenues.

     In connection with our SpeechFront acquisition in November 2000, we
allocated purchase price to goodwill and workforce of $5.5 million. During the
quarter ending December 31, 2001, we reviewed the existing business conditions
and determined that the voice instant messaging system technologies under
development during 2001 will not be utilized by the Company. As a result, we
decided to cease the development of instant messaging system technologies and
impair the remaining asset balance as of December 31, 2001, which has resulted
in a charge of $3.2 million relating to the impairment of Speechfront
intangibles, which represented the remaining balances at December 31, 2001.

                                      -22-

<PAGE>

Critical Accounting Policies

     Our critical accounting policies are as follows:

        .    revenue recognition;

        .    estimating valuation allowances and lease loss;

        .    accounting for income taxes; and

        .    valuation of intangible assets and goodwill.

Revenue Recognition

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

     We apply the provisions of Statement of Position 97-2, "Software Revenue
Recognition," as amended by Statement of Position 98-9 "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to all
transactions involving the sale of software products and sales of hardware where
the software is not incidental.

     All revenues generated from our worldwide operations are approved at our
corporate headquarters, located in the United States. We recognize revenue from
the sale of software licenses when persuasive evidence of an arrangement exists,
the product has been delivered, the fee is fixed and determinable and collection
of the resulting receivable is probable.

     We use a signed contract or purchase order as evidence of an arrangement
for licenses and maintenance renewals. For services, we use a signed statement
of work to evidence an arrangement. Software is delivered to customers either
electronically or on a CD-ROM. We assess whether the fee is fixed and
determinable based on the payment terms associated with the transaction. We
assess collectibility based on a number of factors, including the customer's
past payment history and its current creditworthiness. If we determine that
collection of a fee is not reasonably assured, we defer the revenue and
recognize it at the time collection becomes reasonably assured, which is
generally upon receipt of cash payment.

     We recognize license revenue either upon issuance of the permanent software
license key or on system acceptance, if the customer has established acceptance
criteria (which occurs only in a small minority of cases). In those contracts
having acceptance criteria, criteria typically consist of a demonstration to the

                                      -23-

<PAGE>

customer that, upon implementation, the software performs in accordance with
specified system parameters, such as recognition accuracy or call completion
rates.

     We use the residual method to recognize revenue when a license agreement
includes one or more elements to be delivered at a future date if evidence of
the fair value of all undelivered elements exists. If evidence of the fair value
of the undelivered elements does not exist, revenue is deferred and recognized
when delivery occurs. License revenue from value-added resellers and OEMs is
recognized when product has been sold through to an end user and such
sell-through has been reported to the Company.

     The timing of license revenue recognition is affected by whether we perform
consulting services in the arrangement and the nature of those services. In the
majority of cases, we either perform no consulting services or we perform
standard implementation services that are not essential to the functionality of
the software. When we perform consulting services that are essential to the
functionality of the software, we recognize both license and consulting revenue
utilizing contract accounting based on the percentage of the consulting services
that have been completed.

     Service revenue consists of revenue from providing consulting and training.
Our consulting service contracts are bid either on a fixed-fee basis or on a
time-and-materials basis. For a fixed-fee contract, we recognize revenue using
the percentage of completion method. For time-and-materials contracts, we
recognize revenue as services are performed. Training service revenue is
recognized as services are performed. Losses on services 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 enhancements. We recognize all maintenance revenue ratably
over the contract term. Customers renew maintenance agreements annually.

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

     We record deferred revenue primarily as a result of payments from customers
received in advance of recognition of revenue. As of December 31, 2001, deferred
revenue was $10.8 million. The deferred revenue amount includes unearned
license, prepaid maintenance and professional services that will be recognized
as revenue in the future as we deliver licenses and perform services.

Estimating Valuation Allowance for Doubtful Accounts and Lease Loss

     We perform ongoing credit evaluations of our customers and adjust credit
limits based upon payment history and the customer's current creditworthiness,
as determined by our review of their current credit information. We continuously
monitor collections and payments from our customers and maintain a provision for
estimated credit losses based on a percentage of our accounts receivable, our
historical experience and any specific customer collection issues that we have
identified. While such credit losses have historically been within our
expectations and appropriate reserves have been established, we cannot guarantee
that we will

                                       -24-

<PAGE>

continue to experience the same credit loss rates that we have experienced in
the past. Material differences may result in the amount and timing of revenue
and or expenses for any period if management made different judgments or
utilized different estimates.

     We restructured our business and have established reserves at the low end
of the range of estimable cost (as required by accounting standards) against
outstanding commitments for leased property that we have not occupied. These
reserves are based upon management's estimate of the time required to sublet the
property and the amount of sublet income that might be generated between the
date the property was not occupied and expiration of the lease for each of the
unoccupied property. These estimates 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.

Accounting For Income Taxes

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

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

Valuation of Goodwill and Intangible Assets

     We periodically assess the realizability of long-lived assets, including
intangibles in accordance with the provisions of Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long
Lived Assets and for Long Lived Assets to be Disposed Of". We also periodically
assess the impairment of goodwill in accordance with the provisions of APB
Opinion No. 17,"Intangible Assets". For assets to be held and used, including
acquired intangibles, we initiate our review annually or whenever events or
changes in circumstances indicate that the carrying amount of a long-lived asset
may not be recoverable. Recoverability of an asset is measured by comparison of
its carrying amount to the expected future undiscounted cash flows (without
interest charges) that the asset is expected to generate. Any impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds its fair market 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.

                                       -25-

<PAGE>

     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. For the year ending December 31, 2001, we
recorded two impairments on intangible assets (see Note 10).

     In 2002, SFAS No. 142, "Goodwill and Other Intangible Assets" became
effective. This will not have an impact on our financial statements as all
goodwill has been amortized or impaired.

     The above listing is not intended to be a comprehensive list of all of our
accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by accounting principles generally accepted
in the United States, with no need for management's judgment in their
application. There are also areas in which the exercise of management's judgment
in selecting an available alternative would not produce a materially different
result. See our audited consolidated financial statements and notes thereto
which begin on page F-1 of this Annual Report on Form 10-K and which contain
accounting policies and other disclosures required by generally accepted
accounting principles.

Cost of Revenue and Operating Expenses

     Cost of license revenue consists primarily of fees payable on third-party
software products and documentation, media costs and inventory writedowns. Cost
of service revenue consists of compensation and related overhead costs for
employees engaged in consulting, training and maintenance for our customers.

     Our operating expenses are classified into seven general categories: sales
and marketing, research and development, general and administrative, in-process
research and development, amortization of intangibles, restructuring charge and
asset impairments and non-cash compensation. We classify all charges to these
operating expense categories based on the nature of the expenditures. Although
each category includes expenses that are unique to the category, some
expenditures, such as compensation, employee benefits, recruiting costs,
equipment costs, travel and entertainment costs, facilities costs and
third-party professional services fees, occur in each of these categories,
except for non-cash compensation and restructuring charge and asset impairments.

     We allocate the total costs for information services and facilities to each
functional area that uses information services and facilities based on relative
headcount. These allocated costs include rent and other facility-related costs
for our offices, communication charges and depreciation expense for property and
equipment, computer hardware and software maintenance.

     We had 417 full-time employees as of December 31, 2001. In April 2001, our
Board of Directors approved a restructuring plan to align our expenses with
revised anticipated demand and create a more efficient organization. As a
result, we reduced our workforce by approximately 20%. Additionally, in
conjunction with the January 2002 restructuring plan, we reduced our workforce
by another 10% primarily to realign the sales organization, to align our cost
structure with changing market conditions and to create a more efficient
organization. We may, however, be required to increase our workforce as business
grows in the future, and as a result may need to expand our operational and
human resources, as well as information systems and controls, to support any
such growth. Such expansion may place significant demands on our management and
operational resources.

     From our inception through December 31, 2001, we have incurred
approximately $274.7 million of operating costs and expenses, including
approximately $65.2 million of research and development expenditures used to
develop our current and future software products. Costs incurred in the research
and

                                      -26-

<PAGE>

development of software products are expensed as incurred until technological
feasibility has been established. Once established, these costs would be
capitalized. Amounts that could have been capitalized were insignificant and,
therefore, no costs have been capitalized to date.

     As a result of these and other operating expenditures, we have incurred net
operating losses in each year since inception. We anticipate that our operating
expenses will increase in the foreseeable future as we build our sales and
marketing organizations and as we continue to invest in research and
development. Accordingly, we expect to incur operating losses for at least the
next twelve months.

     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 decline
in the past. Furthermore, we may not achieve or maintain profitability in the
future.

Results Of Operations

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

<TABLE>
<CAPTION>
                                                                             Year ended December 31,
                                                                  -------------------------------------------
                                                                    2001              2000             1999
                                                                  -------           -------          --------
<S>                                                               <C>               <C>              <C>
Revenue:
    License .................................................          53%               72%              70%
    Service .................................................          25                16               15
    Maintenance .............................................          22                12               15
                                                                  -------           -------          -------
       Total revenue ........................................         100               100              100
Cost of revenue:
    License .................................................          --                --               --
    Service and maintenance .................................          41                21               28
                                                                  -------           -------          -------
       Total cost of revenue ................................          41                21               28

Gross profit ................................................          59                79               72
Operating expense:
    Sales and marketing .....................................          99                66               90
    Research and development ................................          48                39               60
    General and administrative ..............................          34                19               18
    Acquired in-process research and development ............          --                 3               --
    Amortization of SpeechFront intangibles .................           5                 1               --
    Non-cash compensation expense ...........................          14                 9                2
    Restructuring charge and asset impairment ...............         159                --               --
                                                                  -------           -------          -------
</TABLE>

                                       -27-

<PAGE>

       Total operating expenses ..............      359         137        170
Loss from operations .........................     (300)        (58)       (98)
Interest and other income, net ...............       20          13          4
Loss before provision for income taxes .......     (280)        (45)       (94)
Provision for income taxes ...................        1           1         --
                                                -------     -------    -------
Net loss .....................................     (281)%       (46)%      (94)%
                                                =======     =======    =======

Comparison Of The Years Ended December 31, 2001, 2000 and 1999.

Revenue

     Total revenues were $39.2 million, $51.8 million and $19.6 million in 2001,
2000 and 1999, respectively, representing a decrease of 24% from 2000 to 2001
and an increase of 165% from 1999 to 2000.

     License revenues were $20.8 million, $37.6 million and $13.6 million in
2001, 2000 and 1999, respectively, representing a decrease of 45% from 2000 to
2001 and an increase of 176% from 1999 to 2000. License revenue represented 53%
of total revenue for 2001, 72% of total revenue for 2000 and 70% of total
revenue for 1999. The decline in license revenue in absolute dollars from 2000
to 2001 was due to an uncertain economic environment that caused customers to
delay purchases or make smaller purchases than originally forecast in the year
ending December 31, 2001. The increase in license revenue in absolute dollars
from 1999 to 2000 was due to an increased number of distribution partners, an
increase in our internal sales force, and an increased acceptance of our
products in the marketplace.

     Service and maintenance revenues were $18.5 million, $14.3 million and $6.0
million in 2001, 2000 and 1999, respectively, representing an increase of 29%
from 2000 to 2001 and an increase of 140% from 1999 to 2000. Service revenue
represented 47% of total revenue for 2001, 28% of total revenue for 2000 and 30%
of total revenue for 1999. The increase in service revenue in absolute dollars
from 2000 to 2001 was due primarily to the recognition of previously deferred
service revenue as well as growth in professional services headcount, which
enabled completion of more professional service projects. Service revenue growth
has slowed partially due to the decline in license revenue as well as the
reduction in customers' project implementations in light of general economic
conditions. The increase of service revenue in absolute dollars from 1999 to
2000 was due to growth in license revenue and revenue for certain non-recurring
engineering work performed in the second and third quarters of 2000.

Cost of Revenue

     Cost of license revenue consists primarily of fees payable on third party
software products and documentation, media costs and inventory writedowns. Cost
of license revenues were $275,000 in 2001 and $53,000 for 2000 and $0 for 1999.
During the 2001 year, we purchased $550,000 of third-party software to
complement our core platform product line. At year-end, we evaluated the third
party software and wrote-off $275,000 of excess inventory caused by
lower-than-expected demand. We will continue to assess the remaining carrying
value of the inventory in relation to recovery of future revenues. We anticipate
that cost of license revenue will increase moderately in absolute dollars, in
part due to royalty payments in relation to our new Vocalizer product as well as
recording the inventory costs for third party software product when the product
is sold.

     Cost of service revenue consists of compensation and related overhead costs
for employees engaged in consulting, training and maintenance for our customers.
Cost of service revenues were $15.9 million, $10.7

                                       -28-

<PAGE>

     million and $5.5 million in 2001, 2000 and 1999, respectively, representing
an increase of 49% from 2000 to 2001 and an increase of 96% from 1999 to 2000.
Cost of service and maintenance revenue as a percentage of service revenue was
86% for 2001, 75% for 2000 and 92% for 1999. The increase in cost of revenues
from 2000 to 2001, as well as the decrease in the service margin percentages,
was primarily due to hiring 12 additional personnel in the professional
services, technical support and training groups and a decline in professional
services utilization rates. Cost of maintenance revenue increased year to year
due to increase of customer base. Although the number of headcount for
professional services, technical support and training groups personnel decreased
from year-end to year-end as a result of the restructuring plan, payroll and
related expenses increased due to the acceleration of our hiring of personnel in
the beginning of the year. The increase in cost of revenues from 1999 to 2000
was due to hiring 90 additional employees, many in the fourth quarter of 2000,
in the professional services, technical support and training groups and
utilization of outside organizations. We anticipate that cost of service and
maintenance revenue will decrease in absolute dollars, in connection with the
first quarter 2002 restructuring plan, although cost of service and maintenance
revenue will vary as a percentage of total revenue from period to period. We
may, however, be required to expand our service operations in the future and as
a result may need to expand our operational and human resources, as well as
information systems and controls to support any such growth. Such expansion
would likely increase expenses associated with professional services, technical
support and training groups.


Operating Expenses

     Sales and Marketing. Sales and marketing expenses consist of compensation
and related costs for sales and marketing employees and promotional
expenditures, including public relations, advertising, trade shows, marketing
materials and bad debt. Sales and marketing expenses were $38.9 million, $34.1
million and $17.6 million in 2001, 2000 and 1999, respectively, representing
increases of 14% from 2000 to 2001 and 93% from 1999 to 2000. The increase in
sales and marketing expenses from 2000 to 2001 was attributable to the addition
of sales and marketing personnel, which added approximately $5.1 million in
payroll and related expenses, and increases in travel and related expenses of
approximately $1.1 million. Although the number of headcount for sales and
marketing personnel decreased from year-end to year-end as a result of the
restructuring plan, payroll and related expenses increased due to the
acceleration of our hiring personnel in the beginning of the year. These
increases were partially offset by a decrease in commissions expense of $1.7
million, resulting from the relative decrease in revenue, and a reduction in bad
debt expense of $900,000. The increase in sales and marketing expense from 1999
to 2000 was attributable to the addition of 70 sales and marketing employees,
which added approximately $7.9 million in payroll and related expenses and $2.6
million in commission and bonus expense. Travel and related costs also increased
by $1.8 million and recruiting costs increased by $600,000. Higher marketing
costs due to expanded promotional activities added approximately $700,000 in
expenses, while bad debt expense increased by $1.2 million.

     As a percentage of total revenue, sales and marketing expenses were 99% in
2001, 66% in 2000 and 90% in 1999. We anticipate that sales and marketing
expenses will decrease in absolute dollars and will vary as a percentage of
total revenue from period to period. We may, however, be required to expand our
sales and marketing operations in the future, and as a result may need to expand
our operational and human resources, as well as information systems and
controls, to support any such growth. Such expansion would likely increase
expenses associated with sales and marketing.

     Research and Development. Research and development expenses consist of
compensation and related costs for research and development employees and
contractors. Research and development expenses were $18.8 million, $20.2 million
and $11.8 million in 2001, 2000 and 1999, respectively, representing a decrease
of 7% from 2000 to 2001 and an increase of 71% from 1999 to 2000. The decrease
in research and development expenses from 2000 to 2001 was attributable to the
reduction of research and development personnel, which resulted in approximately
$643,000 reduction in payroll-related and travel expenses. Additionally, the use
of external consultants was reduced by approximately $875,000. The increase in
research and development expenses from 1999 to 2000 was attributable to the
addition of

                                      -29-

<PAGE>

approximately 25 employees, which added approximately $4.4 million in expenses
and the cost of technical contractors, which added approximately $1.1 million in
expenses.

     As a percentage of total revenue, research and development expenses were
48% in 2001, 39% in 2000 and 60% in 1999. We anticipate that research and
development expenses will decrease in absolute dollars and will vary as a
percentage of total revenue from period to period. We may, however, be required
to expand our research and development operations in the future, and as a result
may need to expand our operational and human resources, as well as information
systems and controls, to support any such growth. Such expansion would likely
increase expenses associated with research and development.

     General and Administrative. General and administrative expenses consist of
compensation and related costs for administrative employees, legal services,
accounting services and other general corporate expenses. General and
administrative expenses were $13.5 million, $10.0 million and $3.5 million in
2001, 2000 and 1999, respectively, representing increases of 35% from 2000 to
2001 and 184% from 1999 to 2000. The increase in general and administrative
expenses from 2000 to 2001 was largely due to the addition of administrative
employees, which added approximately $1.3 million in payroll related expenses
and increased legal and professional fees of approximately $1.2 million. The
additional expenses enhanced our administrative infrastructure to strengthen
controls and accommodate growth. Although the number of headcount for general
and administrative functions decreased during the year as a result of the
restructuring plan, payroll and related expenses increased due to the
acceleration of our hiring personnel in the beginning of the year. The increase
in general and administrative expenses from 1999 to 2000 was attributable to the
addition of approximately 35 administrative employees, which added approximately
$4.0 million in expenses and approximately $500,000 in recruiting costs.
Increased legal and professional fees added approximately $500,000 in expense
while increased insurance costs, primarily consisting of directors and officers
insurance, also increased by $500,000.

     As a percentage of total revenue, general and administrative expenses were
34% in 2001, 19% in 2000 and 18% in 1999. We anticipate that general and
administrative expenses will decrease in absolute dollars and will vary as a
percentage of total revenue from period to period. We may, however, be required
to expand our general and administrative operations in the future, and as a
result may need to expand our operational and human resources, as well as
information systems and controls, to support any such growth. Such expansion
would likely increase expenses associated with general and administrative
functions.

     Acquired In-Process Research and Development. In connection with the
acquisition of SpeechFront, Inc. ("SpeechFront") on November 10, 2000, Nuance
allocated approximately $1.5 million of the purchase price to in-process
research and development projects. This allocation represented the estimated
fair value based on risk-adjusted cash flows related to the incomplete research
and development projects. At the date of acquisition, the development of these
projects had not yet reached technological feasibility, and the research and
development in progress had no alternative future uses. Accordingly, these costs
were expensed as of the acquisition date.

     At December 31, 2001, we reviewed the current value of the recorded assets
relating to the SpeechFront acquisition based on existing business conditions
and determined that the voice instant messaging system technologies under
development during the year 2001 were not aligned with the Company's revised
strategy and will not be utilized. As a result, we impaired the intangible
assets and recorded a charge of $3.2 million (see Note 10).

                                      -30-

<PAGE>

     Amortization of Intangibles. Goodwill and other acquired intangible assets
of $5.5 million were recorded in connection with the acquisition of SpeechFront
in November 2000. Amortization of intangibles were $1.9 million in 2001 and
$319,000 for 2000. There was no amortization of intangibles for the year ended
December 31, 1999.

     Non-Cash Compensation. In connection with the grant of stock options prior
to our initial public offering, we recorded deferred stock compensation of
approximately $8.7 million within stockholders' equity, representing the
difference between the estimated fair value of the common stock for accounting
purposes and the option exercise price of these options at the date of grant.
This amount is presented as a reduction of stockholders' equity and will be
amortized over the vesting period of the applicable options in a manner
consistent with Financial Accounting Standards Board Interpretation No. 28. We
recorded amortization of deferred stock compensation of $2.0 million, $4.3
million and $310,000 in the years ending December 31, 2001, 2000 and 1999,
respectively, relating to approximately 3,152,000 stock options granted at a
weighted average exercise price of $8.58. For the year ending December 31, 2001,
we reversed approximately $999,000 of deferred stock compensation and additional
paid-in-capital, which represented unamortized deferred stock compensation
relating to employees terminated under the restructuring plan.

     In connection with our SpeechFront acquisition, we recorded deferred
compensation of $4.1 million. Of that amount, $1.7 million relates to retention
of the founders of SpeechFront, and, is payable upon the eighteen month
anniversary of the acquisition date, which is May 2002. The remaining $2.4
million also relates to retention of the founders and is payable upon the
twelve-month anniversary of the acquisition date, which is November 2001, or
earlier if certain performance milestones are achieved. These amounts are being
amortized over 18 months and 12 months, respectively. Upon consummation of the
acquisition, we established an escrow account for these contingent payments. As
of December 31, 2001, $2.4 million was released from the escrow account.
Approximately $3.1 million and $580,000 were amortized in 2001 and 2000 related
to these deferred compensation amounts.

     In December 2000, we issued to a customer a warrant to purchase 100,000
shares of common stock at an exercise price of $138.50 per share subject to
certain anti-dilution adjustments. The warrant is exercisable at the option of
the holder, in whole or part, at any time between January 17, 2001 and August
2002. In January 2001, we valued the warrant at $526,000, utilizing the
Black-Scholes valuation model using the following assumptions: risk-free
interest rate of 5.5%, expected dividend yields of zero, expected life of 1.5
years and expected volatility of 80%. The warrant is being amortized over 20
months to compensation expense. We amortized $320,000 related to this warrant in
the year ended December 31, 2001. During the year, we performed services of
$72,000 for this customer and reduced the warrant expense for the period by this
amount.

     In July 2001, an employee was terminated effective September 2001. The
employee was allowed to continue to vest in his stock options which resulted in
a pre tax non-cash compensation charge of $216,000 in accordance with the FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation."

     We expect to amortize $1.3 million and $209,000 and $10,000 of non-cash
compensation in 2002, 2003 and 2004, respectively.

                                      -31-

<PAGE>

     Restructuring Charges and Assets Impairments. In April 2001, our Board of
Directors approved a restructuring plan that would align our expenses with
revised anticipated demand and create a more efficient organization. For the
year ending December 31, 2001, we recorded a restructuring charge of $34.1
million for our lease loss and severance costs, and an asset impairment charge
of $20.4 million on tenant improvements.

     In conjunction with the restructuring plan, we decided not to occupy a new
leased facility. This decision has resulted in a lease loss of $32.6 million,
comprised of a sublease loss, broker commissions and other facility costs. To
determine the sublease loss, the loss after our cost recovery efforts from
subleasing the building, certain assumptions were made related to the time
period over which the building will remain vacant (1) sublease terms and
sublease rates. The lease loss is an estimate under SFAS No. 5 "Accounting for
Contingencies" and represents the low end of the range and will be adjusted in
the future upon triggering events such as a change in estimate of time to
sublease and actual sublease rates. We have estimated that the lease loss could
be as much as $55 million if operating lease rental rates continue to decrease
in these markets or if it takes longer than expected to find a suitable tenant
to sublease the facility.

     In connection with the April 2001 restructuring plan, we recorded $1.5
million in costs associated with severance and related benefits. We reduced our
headcount by approximately 80 employees, with reductions ranging between 10% and
20% across all functional areas and affecting several locations. We expect to
save an estimated $8.0 million annually of salary and related benefits as a
result of this reduction in headcount. In addition, the real estate
restructuring plan is expected to lower facilities expenses which would have
been incurred had we occupied the new leased facility.

The restructuring charges for the year ending December 31, 2001 are as follows
(in millions):

<TABLE>
<CAPTION>
                                                                                       Severance and
                                                                                          Related             Total
                                                                        Lease Loss        Benefits        Restructuring
                                                                        ----------     -------------      -------------
<S>                                                                      <C>               <C>                <C>
Total charge in the year ending December 31, 2001 ..................     $  32.6           $  1.5             $  34.1
Amount utilized for the year ending December 31, 2001 ..............     $  (3.6)          $ (1.4)            $  (5.0)
                                                                         -------           ------             -------

Accrual balance at December 31, 2001 ...............................     $  29.0           $  0.1             $  29.1
                                                                         =======           ======             =======
</TABLE>

     Total cash outlay for the restructuring plan is expected to be $34.1
million, of which $5.0 million was paid through December 31, 2001 and the $29.1
million remain accrued at December 31, 2001. We expect $8.9 million of the lease
loss to be paid out over the next twelve months and the remaining $20.1 million
to be paid out over the remaining life of the lease of approximately 10 years.
We expect the remaining $100,000 of employee severance and related benefits
accrual to be paid out by March 31, 2002.

     In January 2002, we announced a restructuring plan that would reduce our
workforce by approximately 10%. These charges are being recorded primarily to
realign the sales organization, to align our cost structure with changing market
conditions and to create a more efficient organization (See Note 17).

     For the quarter ending June 30, 2001, we recorded an asset impairment
charge of $20.9 million related to leasehold improvement. Included in the $20.9
million asset impairment charge was approximately

                                       -32-

<PAGE>

$900,000 for leasehold improvements under construction. During the quarter ended
December 31, 2001, we decreased the estimate by approximately $475,000.

     For the year ending December 31, 2001, we recorded a $7.6 million charge
related to impairments of intangible assets in accordance with the accounting
principles under SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." The impairment consisted of
the SpeechFront intangibles and the purchased technology.

Interest and Other Income, Net

     Interest and other income, net, consists primarily of interest earned on
cash and cash equivalents and short-term and long-term investments. Interest and
other income, net, was $8.0 million in 2001, $6.7 million in 2000 and $697,000
in 1999 representing an increase of 19% from 2000 to 2001 and an increase of
861% from 1999 to 2000. These increases were due to higher interest income
earned on higher average cash balances, primarily the result of cash proceeds
raised in our initial public offering in April 2000 and our follow-on offering
in September 2000.

Provision for Income Taxes

     We have incurred operating losses for all periods from inception through
December 31, 2001 and therefore have not recorded a provision for domestic
federal income taxes for any period through December 31, 2001. We recorded
income tax expense relating to foreign taxes for the periods ended December 31,
2001 and 2000 of $413,000 and $350,000, respectively.

     A valuation allowance of $79.5 million is required for the total domestic
deferred tax asset for the period ended December 31, 2001 based upon our limited
operating history, our lack of profitability to date, and the uncertainty of
future profitability at that time. Management believes it is more likely than
not that we will realize a deferred tax benefit of $348,000 from deferred tax
assets related to foreign taxes.

                                       -33-

<PAGE>

     Our income taxes payable for federal and state purposes has been reduced,
and the deferred tax assets increased, by the tax benefits associated with
taxable dispositions of employee stock options. When an employee exercises a
stock option issued under a nonqualified plan or has a disqualifying disposition
related to a qualified plan, we receive an income tax benefit calculated as the
difference between the fair market value of the stock issued at the time of the
exercise and the option price, tax effected. A portion of our valuation
allowance relates to the equity benefit of our net operating losses. We had
approximately $10.5 million, $18.9 million and $122,000 of taxable dispositions
of employee stock options for the years ended December 31, 2001, 2000 and 1999,
respectively. A portion of the valuation allowance, when reduced, will be
credited directly to stockholders' equity. These benefits amounted to $3.7
million, $6.6 million and $43,000 for the years ended December 31, 2001, 2000
and 1999, respectively.

Quarterly Results of Operations

     The following tables set forth a summary of our unaudited quarterly
operating results for each of the eight quarters in the period ended December
31, 2001. The information has been derived from our unaudited consolidated
financial statements that, in management's opinion, have been prepared on a
basis consistent with the audited consolidated financial statements contained
elsewhere in this document and include all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of such
information when read in conjunction with our audited consolidated financial
statements and associated notes. The operating results for any quarter are not
necessarily indicative of results for any future period.

<TABLE>
<CAPTION>
                                                                            Quarter ended
                                      ----------------------------------------------------------------------------------------------
                                      31-Dec-01   30-Sep-01   30-Jun-01   31-Mar-01   31-Dec-00   30-Sep-00   30-Jun-00   31-Mar-00
                                      ---------   ---------   ---------   ---------   ---------   ---------   ---------   ----------
<S>                                   <C>         <C>         <C>         <C>         <C>         <C>         <C>         <C>
Consolidated Statement of Operations
Data
Revenue:
   License .....................       $  5,002    $  5,065    $  5,030    $  5,662    $ 12,366    $ 10,465    $  8,692    $  6,028
   Service .....................          1,984       1,866       2,991       3,089       2,725       2,574       1,834       1,001
   Maintenance .................          2,044       2,250       1,986       2,255       2,323       1,421       1,477         912
                                       --------    --------    --------    --------    --------    --------    --------    --------
     Total Revenue .............          9,030       9,181      10,007      11,006      17,414      14,460      12,003       7,941
                                       --------    --------    --------    --------    --------    --------    --------    --------
Cost of Revenue:
   License .....................            275          --          --           -          --          40          13          --
   Service and maintenance .....          3,305       3,502       4,221       4,889       3,919       3,055       2,120       1,605
                                       --------    --------    --------    --------    --------    --------    --------    --------
     Total Cost of Revenue .....          3,580       3,502       4,221       4,889       3,919       3,095       2,133       1,605
                                       --------    --------    --------    --------    --------    --------    --------    --------
Gross Profit ...................          5,450       5,679       5,786       6,117      13,495      11,365       9,870       6,336
                                       --------    --------    --------    --------    --------    --------    --------    --------
   Service and maintenance
     Revenue Margin ............            723         614         756         455       1,129         940       1,191         308
Operating Expenses:
   Sales and Marketing .........          7,941       8,822      10,328      11,784      10,740       8,493       8,053       6,786
   Research and Development ....          4,091       4,360       5,088       5,239       5,777       5,283       4,727       4,396
   General and Administrative ..          3,231       3,089       3,657       3,510       3,178       2,502       2,627       1,671
   Acquired in-process Research
     and Development ...........             --          --           -           -       1,500          --          --          --
   Amortization of SpeechFront
     Intangibles ...............            478         478         477         478         296          --          --          --
   Non-cash Compensation .......            741       1,763       1,475       1,591       1,570       1,138       1,138       1,016
   Restructuring Expense .......           (473)         --      55,028          --          --          --          --          --
   Asset Impairments ...........          7,636          --          --          --          --          --          --          --
                                       --------    --------    --------    --------    --------    --------    --------    --------
     Total Operating Expenses ..         23,645      18,152      76,053      22,602      23,061      17,416      16,545      13,869
                                       --------    --------    --------    --------    --------    --------    --------    --------
Loss from Operations ...........        (18,195)    (12,833)    (70,267)    (16,485)     (9,566)     (6,051)     (6,675)     (7,533)
Interest and Other Income, net .            952       1,675       2,317       3,046       3,694       1,529       1,154         324
Loss before Provision for Income
taxes ..........................        (17,243)    (11,158)    (67,950)    (13,439)     (5,872)     (4,522)     (5,521)     (7,209)
Provision for Income taxes .....            (29)        218         187         198         119          85         146          --
                                       --------    --------    --------    --------    --------    --------    --------    --------
Net Loss .......................       $(17,214)   $(11,376)   $(68,137)   $(13,637)   $ (5,991)   $ (4,607)   $ (5,667)   $ (7,209)
                                       ========    ========    ========    ========    ========    ========    ========    ========
</TABLE>

     Our revenue and operating results are difficult to forecast and will
fluctuate, and we believe that period-to-period comparisons of our operating
results will not necessarily be meaningful. As a result, they should not be
relied upon as an indication of future performance.

                                       -34-

<PAGE>

Liquidity and Capital Resources

     As of December 31, 2001, we had cash and cash equivalents aggregating
$132.6 million and investments totaling approximately $42.0 million. In April
2000, we raised approximately $80.3 million through the completion of our
initial public offering of common stock. In October 2000, we completed a
follow-on offering of common stock, which generated net proceeds to us of $143.2
million. From inception through March 31, 2000, we financed our operations
primarily from private sales of convertible preferred stock totaling $70.0
million and, to a lesser extent, from bank financing.

     Our operating activities used cash of $29.6 million, $21.1 million and
$13.9 million during 2001, 2000 and 1999, respectively. The negative operating
cash flow in 2001 resulted principally from our net losses, partially offset by
a decrease in accounts receivable and an increase in the restructuring accrual
and the asset impairments. The negative operating cash flow in 2000 resulted
principally from our net losses and increases in accounts receivable, prepaid
expenses and other assets. These factors were partially offset by increases in
accrued liabilities, deferred revenue and non-cash compensation and other
expenses. The negative operating cash flow in 1999 resulted principally from our
net losses as we invested in the development of our products, expanded our sales
force and expanded our infrastructure to support our growth.

     Our investing activities used cash of $64.3 million, $9.1 million and $12.7
million during 2001, 2000 and 1999, respectively. Our use of cash for investing
activities in 2001 relates primarily to the purchases of short-term and
long-term investments, property and equipment and purchased technology offset by
maturities of short-term investments. The use of cash for investing activities
in 2000 relates primarily to restricted cash as security for a letters of credit
on new facility leases, purchases of property and equipment and our acquisition
of SpeechFront, offset by maturities of short-term investments. The use of cash
for investing activities in 1999 relates primarily to purchases of short-term
investments and purchases of property and equipment.

     Our financing activities generated cash of $7.6 million, $231.2 million and
$43.1 million during 2001, 2000 and 1999, respectively. Net cash provided by
financing activities in 2001 related primarily to cash proceeds from the sale of
common stock of $8.0 million. Net cash provided by financing activities in 2000
related primarily to the cash proceeds from the sale of common stock of $223.3
million offset by the payment of debt of $2.3 million. Net cash provided by
financing activities in 1999 related to the sale of preferred stock of $40.4
million.

     Our capital requirements depend on numerous factors. We may continue to
report significant quarterly operating losses resulting in future negative
operating cash flows. We do not plan to spend more than $5 million on capital
expenditures in the next 12 months. We believe that our cash and cash
equivalents, our short-term and long-term investments, and our borrowing
capacity 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.

     The following table summarizes our obligations and commercial commitments
to make future payments under contracts:

                                       -35-

<PAGE>

<TABLE>
<CAPTION>
                                                                                                        After 5
Contractual Obligations                          TOTAL       Current       1-3 years     4-5 years       years
-----------------------                         -------    -----------     ---------     ---------      -------
<S>                                             <C>         <C>            <C>           <C>            <C>
Operating leases .........................      $98,387     $ 9,658         $27,457       $17,487       $43,785
</TABLE>



<TABLE>
<CAPTION>
                                                           Less than 1                                  After 5
Other Commercial Commitments                     TOTAL        year         1 - years     4-5 years       years
-----------------------                         -------    -----------     ---------     ---------      -------
<S>                                             <C>         <C>            <C>           <C>            <C>
Standby Letters of Credit.................      $11,983     $     -         $     -       $     -       $11,983
</TABLE>

The restricted cash secures our letters of credit of approximately $12.0 million
invested with a bank, as required by landlords to meet rent deposits
requirements for our leases on facilities (see Note 2).

Related Party

     Fidelity, one of our stockholders, is one of our customers. Revenues
generated from this customer were approximately $237,000, $592,000 and $3.8
million for the years ending December 31, 2001, 2000 and 1999.

     Certain members of our Board of Directors also serve as directors for
companies to which we sell products in the ordinary course of our business. We
believe that the terms of our transactions with those companies are no less
favorable to us than the terms that would have been obtained absent those
relationships. In addition, certain members of our Board of Directors serve as
directors or principals of entities that are investors in Nuance.

Recently Issued Accounting Pronouncements

     On June 29, 2001, the FASB approved for issuance SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Intangible Assets." Major
provisions of these Statements are as follows: all business combinations
initiated after June 30, 2001 must use the purchase method of accounting; the
pooling of interest method of accounting is prohibited except for transactions
initiated before July 1, 2001; intangible assets acquired in a business
combination must be recorded separately from goodwill if they arise from
contractual or other legal rights or are separable from the acquired entity and
can be sold, transferred, licensed, rented or exchanged, either individually or
as part of a related contract, asset or liability; goodwill and intangible
assets with indefinite lives are not amortized but are tested for impairment
annually using a fair value approach, except in certain circumstances, and
whenever there is an impairment indicator; other intangible assets will continue
to be valued and amortized over their estimated lives; in-process research and
development will continue to be written off immediately; all acquired goodwill
must be assigned to reporting units for purposes of impairment testing and
segment reporting; effective January 1, 2002, existing goodwill will no longer
be subject to amortization. Goodwill acquired subsequent to June 30, 2001 will
not be subject to amortization.

     Because we did not initiate any business combinations after June 30, 2001,
the adoption of SFAS No. 141 does not have a material impact on our financial
position or results of operations. SFAS No. 142 is effective beginning in the
first quarter of 2002 with the exception of goodwill and intangibles assets
acquired after June 30, 2001, which will be subject immediately to the
non-amortization and amortization provisions.

     In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of,"and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS No. 144 retains the requirements of SFAS No. 121
whereby an impairment loss should be recognized if the carrying value of the
asset is not recoverable from its undiscounted cash flows and develops one
accounting model for long-lived assets that are to be disposed of by sale. SFAS
No. 144 eliminates goodwill from its scope, therefore it does not require
goodwill to be allocated to long-lived assets. SFAS No. 144 broadens the scope
of APB 30 provisions for the presentation of discontinued operations to include
a component of an entity (rather than a segment of a business). The statement is
effective for fiscal years beginning after December 15, 2001, with

                                       -36-

<PAGE>

early adoption permitted. We are currently assessing the provisions of
this statement to determine their impact on our consolidated results of
operations and financial position.

     SpeechFront intangible assets amortization for the year ended December 31,
2001 was approximately $1.8 million. For the year ended December 31, 2001, we
performed an impairment analysis of identifiable assets and goodwill and we
recorded a charge of $7.6 million to the impairment of goodwill and other
intangible assets. As of December 31, 2001, we have approximately $1.4 million
remaining in intangible assets and no goodwill recorded in our financial
statements.

     In November 2001, the FASB issued an announcement on the topic of "Income
Statement Characterization of Reimbursements Received for Out of Pocket Expenses
Incurred" ("the Announcement"). The Announcement requires companies to
characterize reimbursements received for out of pocket expenses incurred as
revenue in the statement of operations. We have netted reimbursements received
for out of pocket expenses against the related expenses in the accompanying
consolidated statements of operations. The Announcement is to be applied in
financial reporting periods beginning after December 15, 2001 and comparative
financial statements for prior periods are to be reclassified to comply with the
guidance in this announcement. Management is currently assessing the provisions
of this announcement to determine its impact on our consolidated results of
operations and financial position.

     In July 2001, the FASB's Emerging Issues Task Force (EITF) reached final
consensus on EITF No. 00-25, "Vendor Income Statement Characterization of
Consideration Paid to a Reseller of the Vendor's Products," EITF 00-25 generally
requires that the consideration, including equity instruments, given to a
customer be classified in a vendor's financial statements not as an expense, but
as an offset of revenue up to the amount of cumulative revenue recognized or to
be recognized. In November 2001, the EITF reached consensus on EITF No. 01-09,
"Accounting for Consideration Given by a Vendor to a Customer or Reseller of the
Vendor's Products." EITF 01-09 clarifies and modifies certain items discussed in
EITF 00-25. The Company is required to adopt these new standards no later than
the quarter ending March 31, 2002, and comparative financial statements are
required to be reclassified to comply with the new pronouncement. The Company is
assessing the impact EITF 00-25, EITF 01-09 on the Company's results of
operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

     The following discusses our exposure to market risk related to changes in
foreign currency exchange rates and interest rates. This discussion 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 Annual Report on Form 10-K.

Foreign Currency Exchange Rate Risk

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

Interest Rate Risk

     As of December 31, 2001, we had cash and cash equivalents, short-term
investments and long-term investments of $174.6 million. Any decline in interest
rates over time would reduce our interest income from our short-term and
long-term investments. Based upon our balance of cash and cash equivalents,
short-term investments and long term investments, a decrease in interest rates
of 0.5% would cause a corresponding decrease in our annual interest

                                      -37-

<PAGE>

income by approximately $870,000.

     The following table summarizes the types and maturities of our investments
for December 31, 2001 (in thousands):

<TABLE>
<CAPTION>
                               Maturity                                 Maturity in
                             Less than 1     Maturity      Maturity     excess of 5    Total Fair
Source of Fair Value             year       1-3 years     4-5 years        years         Value
--------------------         -----------    ---------    ------------   -----------    ----------
<S>                        <C>              <C>          <C>            <C>            <C>
U.S. Treasury notes            $ 5,175             -                -             -     $ 5,175
U.S. Government agency
 bonds                           2,001        22,386                -             -     $24,387
Corporate bonds                  6,157         3,361                -             -       9,518
Commercial paper                 2,897             -                -             -       2,897
                               -------       -------     ------------   -----------     -------
Total                          $16,230       $25,747     $          -   $         -     $41,977
                               =======       =======     ============   ===========     =======
</TABLE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

     Reference is made to the Index to Consolidated Financial Statements which
appears on page F-1 of this report. The Report of Independent Public
Accountants, Consolidated Financial Statements and Notes to Consolidated
Financial Statements which are listed in the Index to Financial Statements and
which appear beginning on page F-2 of this report are incorporated into this
Item 8.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     There are no changes in and disagreements with our accountants on
accounting and financial disclosure to date.

                                       -38-

<PAGE>

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Executive Officers and Directors

     The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2002 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2001.

ITEM 11. EXECUTIVE COMPENSATION

     The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2002 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2001.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2002 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2001.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2002 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2001.

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1)   INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                            PAGE
                                                                                                            ----
<S>                                                                                                         <C>
Report of Independent Public Accountants ................................................................   F-2
Consolidated Balance Sheets at December 31, 2001 and 2000 ...............................................   F-3
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 ..............   F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000, and 1999 ...   F-5
Consolidated Statements of Cash Flow for the years ended December 31, 2001, 2000 and 1999 ...............   F-6
Notes to Consolidated Financial Statements ..............................................................   F-7
</TABLE>

(a)(2)   CONSOLIDATED FINANCIAL STATEMENT SCHEDULES

         Schedule II -- Schedule of Valuation and Qualifying Accounts Schedule


                                       -39-

<PAGE>

       Schedules not listed have been omitted because the information required
to be set forth therein is not applicable or is included in the Financial
Statements or notes thereto.

(a)(3) EXHIBITS

       See Index to Exhibits after Schedule II. The Exhibits listed on the
accompanying Index of Exhibits are filed or incorporated by reference as part of
this document.

(b)    REPORTS ON FORM 8-K

       Not applicable.

                                       -40-

<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Menlo
Park, State of California on April 1, 2002.

                                     By: /s/ Ronald Croen
                                         ---------------------------------------
                                          Ronald Croen
                                          President and Chief Executive Officer

                                POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints, jointly and severally, Ronald
Croen and William Dewes, and each of them, as his or her attorney-in-fact, with
full power of substitution, for him or her in any and all capacities, to sign
any and all amendments to this report, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming his or her signatures as
they may be signed by his or her said attorney to any and all amendments to said
report.

     PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED:

<TABLE>
<CAPTION>
                   Signature                                        Title                           Date
---------------------------------------------     ------------------------------------------   ---------------
<S>                                               <C>                                          <C>
   /s/ Ronald Croen                               President, Chief Executive Officer and
---------------------------------------------
                  Ronald Croen                    Director (Principal Executive Officer)       April 1, 2002

   /s/ William Dewes                              Vice President and Chief Financial Officer
---------------------------------------------     (Principal Financial and Accounting          April 1, 2002
                 William Dewes                    Officer)

   /s/ Curtis Carlson                             Director                                     April 1, 2002
---------------------------------------------
                 Curtis Carlson

   /s/ Vinton Cerf                                Director                                     April 1, 2002
---------------------------------------------
                  Vinton Cerf

   /s/ Yogen Dalal                                Director                                     April 1, 2002
---------------------------------------------
                  Yogen Dalal

   /s/ Irwin Federman                             Director                                     April 1, 2002
---------------------------------------------
                 Irwin Federman

   /s/ Alan Herzig                                Director                                     April 1, 2002
---------------------------------------------
                  Alan Herzig

   /s/ Gary Morgenthaler                          Director                                     April 1, 2002
---------------------------------------------
               Gary Morgenthaler


   /s/ Philip Quigley                             Director                                     April 1, 2002
---------------------------------------------
                  Philip Quigley
</TABLE>

                                       -41-

<PAGE>

                              NUANCE COMMUNICATION
                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S>                                                                        <C>
    Nuance Communications, Inc.:
        Report of Arthur Andersen LLP, Independent Public Accountants ....  F-2
        Consolidated Balance Sheets ......................................  F-3
        Consolidated Statements of Operations ............................  F-4
        Consolidated Statements of Stockholders' Equity ..................  F-5
        Consolidated Statements of Cash Flows ............................  F-6
        Notes to Consolidated Financial Statements .......................  F-7
        Schedule II--Valuation and Qualifying Accounts ................... F-29
</TABLE>

                                      F-1

<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Nuance Communications, Inc:

     We have audited the accompanying consolidated balance sheets of Nuance
Communications, Inc.  (a Delaware corporation) and subsidiaries as of December
31, 2001 and 2000, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements, and the schedule referred
to below, are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Nuance Communications, Inc.
and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America.

     Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of the
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.


                                   Arthur Andersen LLP
                                   San Jose, California
                                   January 21, 2002
                                   (except with respect to the matters discussed
                                   in Note 17, as to which the
                                   dates are January 24, 2002
                                   and March 1, 2002, respectively)

                                       F-2

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS )

<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                               ----------------------
                                                                                  2001         2000
                                                                               ---------    ---------
<S>                                                                            <C>          <C>
                               ASSETS

Current assets:
    Cash and cash equivalents ..............................................   $ 132,618    $ 219,047
    Short-term investments .................................................      16,230        8,728
    Accounts receivable, net of allowance for doubtful accounts of
       $1,312 and $1,823, respectively .....................................       6,399       19,106
    Prepaid expenses and current assets ....................................       4,920        4,280
                                                                               ---------    ---------
       Total current assets ................................................     160,167      251,161
    Property and equipment, net ............................................       8,502        9,414
    Intangible assets ......................................................       1,393        5,217
    Restricted Cash ........................................................      11,983       11,628
    Long-term investments ..................................................      25,747           --
    Other assets ...........................................................         439        1,918
                                                                               ---------    ---------
       Total assets ........................................................   $ 208,231    $ 279,338
                                                                               =========    =========

                LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Current portion of long-term debt ......................................   $      --    $      12
    Accounts payable .......................................................       1,385        1,649
    Accrued liabilities ....................................................      10,300       12,389
Current-Restructuring accrual ..............................................       8,974           --
    Deferred revenue .......................................................      10,836       10,745
                                                                               ---------    ---------
       Total current liabilities ...........................................      31,495       24,795
    Long-term debt, less current portion ...................................          --           32
    Long-term-Restructuring accrual ........................................      20,169           --
    Other liabilities ......................................................       1,742        2,520
                                                                               ---------    ---------
       Total liabilities ...................................................      53,406       27,347
                                                                               ---------    ---------
Commitments and Contingencies (Note 11)
Stockholders' Equity
    Common stock, $.001 par value, 250,000,000 shares authorized; 33,198,051
       shares and 32,158,875 shares issued and outstanding, respectively ...          33           32
    Additional paid-in capital .............................................     324,371      316,958
    Deferred stock compensation ............................................      (1,532)      (7,636)
    Accumulated other comprehensive loss ...................................        (335)         (16)
    Accumulated deficit ....................................................    (167,712)     (57,347)
                                                                               ---------    ---------
       Total stockholders' equity ..........................................     154,825      251,991
                                                                               ---------    ---------
       Total liabilities and stockholders' equity ..........................   $ 208,231    $ 279,338
                                                                               =========    =========
</TABLE>

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

                                       F-3

<PAGE>

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

<TABLE>
<CAPTION>
                                                                               Year Ended December 31,
                                                                        ------------------------------------
                                                                           2001         2000         1999
                                                                        ----------   ----------   ----------
<S>                                                                     <C>          <C>          <C>
Revenue:
    License .....................................................       $  20,759    $  37,551    $  13,613
    Service .....................................................           9,931        8,134        3,042
    Maintenance .................................................           8,535        6,133        2,912
                                                                        ---------    ---------    ---------
       Total revenue ............................................          39,225       51,818       19,567
                                                                        ---------    ---------    ---------
Cost of revenue:
    License .....................................................             275           53           --
    Service and maintenance......................................          15,917       10,699        5,460
                                                                        ---------    ---------    ---------
       Total cost of revenue ....................................          16,192       10,752        5,460
                                                                        ---------    ---------    ---------
Gross profit ....................................................          23,033       41,066       14,107
                                                                        ---------    ---------    ---------
Operating expenses:
    Sales and marketing (1) .....................................          38,876       34,072       17,636
    Research and development (1) ................................          18,779       20,160       11,793
    General and administrative (1) ..............................          13,487        9,978        3,517
    Acquired in-process research and development ................              --        1,500           --
    Amortization of SpeechFront intangible assets ...............           1,912          319           --
    Non-cash compensation expense ...............................           5,569        4,862          310
    Restructuring charge and asset impairments ..................          62,191           --           --
                                                                        ---------    ---------    ---------
       Total operating expenses .................................         140,814       70,891       33,256
                                                                        ---------    ---------    ---------
Loss from operations ............................................        (117,781)     (29,825)     (19,149)
    Interest and other income, net ..............................           7,990        6,701          697
                                                                        ---------    ---------    ---------
Loss before provision for income taxes ..........................        (109,791)     (23,124)     (18,452)
    Provision for income taxes ..................................             574          350           22
                                                                        ---------    ---------    ---------
       Net loss .................................................       $(110,365)   $ (23,474)   $ (18,474)
                                                                        =========    =========    =========
Basic and diluted net loss per share .............................      $   (3.40)   $   (1.03)   $   (6.32)
                                                                        =========    =========    =========
Shares used to compute basic and diluted net loss per share.......         32,480       22,717        2,924
                                                                        =========    =========    =========

__________

(1)  Excludes non-cash compensation as follows:

Sales and marketing .............................................       $   2,161    $   1,171    $      95
Research and development ........................................           2,688        2,293          125
General and administrative ......................................             720        1,398           90
                                                                        ---------    ---------    ---------
                                                                        $   5,569    $   4,862    $     310
                                                                        =========    =========    =========
</TABLE>

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

                                       F-4

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                          Preferred Stock            Common Stock
                                                     -------------------------  ------------------------                     Stock
                                                                                                              Paid-in       Compen-
                                                        Shares        Amount       Shares       Amount        Capital       sation
                                                     ------------   ----------  ------------   ---------    ----------    ----------
<S>                                                  <C>            <C>         <C>            <C>           <C>          <C>
Balance at December 31, 1998 ......................  $ 15,226,022   $      15      2,749,679   $      3      $  29,641     $     --
Issuance of warrant to purchase preferred stock....            --          --             --         --            124           --
Issuance of common stock for services provided.....            --          --          6,423         --             43           --
Exercise of common stock options ..................            --          --        484,247         --            285           --
Deferred stock compensation .......................            --          --             --         --          5,924       (5,924)
Amortization of deferred stock compensation .......            --          --             --         --             --          310
Issuance of Series E convertible preferred
  stock, net ......................................     4,499,964           5             --         --         40,398           --
Net loss ..........................................            --          --             --         --             --           --
                                                     ------------   ----------  ------------   ---------    ----------    ---------
Balance at December 31, 1999 ......................    19,725,986          20      3,240,349          3         76,415       (5,614)
Fidelity exercise of preferred Series D warrant....       200,000          --             --         --          1,000           --
Conversion of preferred stock to common stock......   (19,925,986)         20     19,925,986         20             --           --
Additional Series E financing costs ...............            --          --             --         --           (161)          --
Issuance of common stock in Initial Public
  Offering, net of offering costs of $7,700 .......            --          --      5,175,000          5         80,245           --
Issuance of common stock in Follow-on offering,
  net of offering costs of $8,832 .................            --          --      1,256,793          2        143,240           --
Exercise of common stock options ..................            --          --      2,371,235          2          7,127           --
Repurchase of common stock ........................            --          --         (9,334)        --             (8)          --
ESPP common stock issued ..........................            --          --        157,965         --          2,127           --
Restricted stock granted ..........................            --          --          1,000         --             --           --
Issuance of common stock for services provided.....            --          --          8,860         --             89           --
Cashless exercise of Series B Warrant .............            --          --         31,021         --             --           --
Foreign currency translation loss .................            --          --             --         --             --           --
Deferred stock compensation .......................            --          --             --         --          2,818       (2,818)
Deferred stock compensation related to
  acquisition of SpeechFront ......................            --          --             --         --          4,066       (4,066)
Amortization of deferred stock compensation .......            --          --             --         --             --        4,862
Net loss ..........................................            --          --             --         --             --           --
                                                     ------------   ----------  ------------   ---------    ----------    ---------
Balance at December 31, 2000 ......................            --          --     32,158,875         32        316,958       (7,636)
Exercise of common stock options ..................            --          --        649,233          1          4,075           --
Repurchase of common stock ........................            --          --        (68,947)        --           (365)          --
Issuance of Onstar warrant ........................            --          --             --         --            526           --
ESPP common stock issued ..........................            --          --        458,890         --          3,960           --
Non-cash compensation for change in stock
  options .........................................            --          --             --         --            216           --
Amortization of deferred stock compensation .......            --          --             --         --             --        5,105
Deferred stock compensation adjustment ............            --          --             --         --           (999)         999
Change in unrealized loss on investment ...........            --          --             --         --             --           --
Foreign currency translation loss .................            --          --             --         --             --           --
Net loss ..........................................            --          --             --         --             --           --
                                                     ------------   ----------  ------------   ---------    ----------    ---------
Balance at December 31, 2001 ......................            --   $      --     33,198,051   $     33        324,371     $ (1,532)
                                                     ============   ==========  ============   =========    ==========    =========

<CAPTION>
                                                        Accumulated
                                                           Other
                                                        Comprehensive    Accumulated    Stockholders'    Comprehensive
                                                            Loss           Deficit         Equity            Loss
                                                        -----------      -----------    ------------     -------------
<S>                                                    <C>               <C>            <C>              <C>
Balance at December 31, 1998 ......................        $     --      $  (15,399)     $   14,260      $  (14,925)
Issuance of warrant to purchase preferred stock....              --              --             124              --
Issuance of common stock for services provided ....              --              --              43              --
Exercise of common stock options ..................              --              --             285              --
Deferred stock compensation .......................              --              --              --              --
Amortization of deferred stock compensation .......              --              --             310              --
Issuance of Series E convertible preferred
  stock, net ......................................              --              --          40,403              --
Net loss ..........................................              --         (18,474)        (18,474)        (18,474)
                                                           --------      ----------      ----------      ----------
Balance at December 31, 1999 ......................              --         (33,873)         36,951         (18,474)
                                                                                                         ==========
Fidelity exercise of preferred Series D warrant....              --              --           1,000              --
Conversion of preferred stock to common stock .....              --              --              --              --
Additional Series E financing costs ...............              --              --            (161)             --
Issuance of common stock in Initial Public
  Offering, net of offering costs of $7,700 .......              --              --          80,250              --
Issuance of common stock in Follow-up offering,
  net of offering costs of $8,832 .................              --              --         143,242              --
Exercise of common stock options ..................              --              --           7,129              --
Repurchase of common stock ........................              --              --              (8)             --
ESPP common stock issued ..........................              --              --           2,127              --
Restricted stock granted ..........................              --              --              --              --
Issuance of common stock for services provided ....              --              89              --              --
Cashless exercise of Series B Warrant .............              --              --              --              --
Foreign currency translation loss .................             (16)             --             (16)            (16)
Deferred stock compensation .......................              --              --              --              --
Deferred stock compensation related to
  acquisition of SpeechFront ......................              --              --              --              --
Amortization of deferred stock compensation .......              --              --           4,862              --
Net loss ..........................................              --         (23,474)        (23,474)        (23,474)
                                                           --------      ----------      ----------      ----------
Balance at December 31, 2000 ......................             (16)        (57,347)        251,991         (23,490)
                                                                                                         ==========
Exercise of common stock options ..................              --              --           4,076              --
Repurchase of common stock ........................              --              --            (365)             --
Non-cash compensation associated with Onstar
  warrant .........................................              --              --             526              --
ESPP common stock issued ..........................              --              --           3,960              --
Non-cash compensation for change in stock
  options .........................................              --              --             216              --
Amortization of deferred stock compensation .......              --              --           5,105              --
Deferred stock compensation adjustment ............              --              --               0              --
Change in unrealized loss on investment ...........            (108)             --            (108)           (108)
Foreign currency translation loss .................            (211)             --            (211)           (211)
Net loss ..........................................              --        (110,365)     $ (110,365)     $ (110,365)
                                                           --------      ----------      ----------      ----------
Balance at December 31, 2001 ......................        $   (335)     $ (167,712)     $  154,825      $ (110,684)
                                                           ========      ==========      ==========      ==========
</TABLE>

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

                                       F-5

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                            Year Ended December 31,
                                                                                   -----------------------------------------
                                                                                      2001            2000            1999
                                                                                   ---------       ---------       ---------
<S>                                                                                <C>             <C>             <C>
Cash flows from operating activities:
   Net Loss .................................................................      $(110,365)      $ (23,474)      $ (18,474)
   Adjustments to reconcile net loss to net cash used in operating activities
       Asset impairments ....................................................         28,061              --              --
       Depreciation and amortization on property and equipment ..............          4,409           2,663           1,179
       Write-off of in-process research and development .....................             --           1,500              --
       Loss on fixed asset disposals ........................................            355              --              --
       Amortization of SpeechFront intangibles and purchased technology .....          3,188             319              --
       Non-cash compensation expense ........................................          5,569           4,951             353
       Provision for doubtful accounts ......................................            521           1,464             221
       Deferred income taxes ................................................           (238)           (110)             --
       Write-off  of excess inventory .......................................            275              --              --
       Fair value of common stock options and warrants ......................             --              --             124
Changes in operating assets and liabilities:
   Accounts receivable ......................................................         12,186         (15,678)         (3,278)
   Prepaids and other assets ................................................            371          (2,953)         (2,498)
   Restructuring accrual ....................................................         29,143              --              --
   Accounts payable .........................................................           (264)         (1,375)          1,622
   Accrued liabilities and other liabilities ................................         (2,870)          5,554           4,054
   Deferred revenue .........................................................             91           6,408           2,780
                                                                                   ---------       ---------       ---------
       Net cash used for operating activities ...............................        (29,568)        (20,731)        (13,917)
                                                                                   ---------       ---------       ---------
Cash flows from investing activities:
   Purchase of short-term investments .......................................        (16,253)        (22,394)        (76,908)
   Purchase of long-term investments ........................................        (25,832)             --              --
   Maturities of short-term investments .....................................          8,728          37,019          67,779
   Purchase of property and equipment .......................................        (24,275)         (7,735)         (3,587)
   Cash used for SpeechFront acquisition, less cash received ................             --          (4,743)             --
   Purchase of technology ...................................................         (7,000)             --              --
   Increase in restricted cash ..............................................            355         (11,628)             --
                                                                                   ---------       ---------       ---------
       Net cash used for investing activities ...............................        (64,277)         (9,481)        (12,716)
                                                                                   ---------       ---------       ---------
Cash flows from financing activities:
   Proceeds from issuance of preferred stock, net ...........................             --              --          40,403
   Purchase of common stock .................................................           (365)             (8)             --
   Proceeds from issuance of common stock, net ..............................             --         223,331              --
   Proceeds from exercise of stock options ..................................          4,076           7,129             285
   Proceeds from exercise of preferred stock warrant ........................             --           1,000              --
   Proceeds from ESPP .......................................................          3,960           2,127              --
   Proceeds from borrowings .................................................             --              --           2,835
   Repayment of borrowings ..................................................            (44)         (2,377)           (459)
                                                                                   ---------       ---------       ---------
   Net cash provided by financing activities ................................          7,627         231,202          43,064
                                                                                   ---------       ---------       ---------
Effect of exchange rate fluctuations on cash and cash equivalents ...........           (211)            (16)             --
                                                                                   ---------       ---------       ---------
Net (decrease) increase in cash and cash equivalents ........................        (86,429)        200,974          16,431
Cash and cash equivalents, beginning of period ..............................        219,047          18,073           1,642
                                                                                   ---------       ---------       ---------
Cash and cash equivalents, end of period ....................................        132,618         219,047          18,073
                                                                                   =========       =========       =========

Supplementary disclosures of cash flow information:
   Cash paid during the period for:
       Interest..............................................................      $      17       $     113       $      62
       Income taxes..........................................................      $     257       $       8       $      --

Supplementary disclosures of non-cash transactions:
       Warrant issued to OnStar..............................................      $     526       $      --       $      --
       Unrealized loss on available-for-sale securities......................      $     108       $      --       $      --
</TABLE>

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

                                       F-6

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   ORGANIZATION AND OPERATIONS:

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

     The Company is subject to a number of risks associated with companies in a
similar stage of development, including a history of net losses and the
expectation to continue to incur losses; volatility of and rapid change in the
speech software industry; potential competition from larger, more established
companies; and dependence on key employees for technology and support.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

                           Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany transactions have been
eliminated.

    Use of Estimates in the Preparation of Consolidated Financial Statements

     The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.

                            Cash and Cash Equivalents

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

                                   Investments

     The Company's investments are comprised of U.S. Treasury notes, U.S.
Government agency bonds, corporate bonds and commercial paper. Investments with
maturities of less than one year are considered to be short-term. All
investments are primarily held in the Company's name at a major financial
institution. At December 31, 2001, all of the Company's investments are
classified as available-for-sale and carried at fair value, which is determined
based on quoted market price, with net unrealized gain or loss included in the
"Accumulated Other Comprehensive Loss," in the accompanying consolidate balance
sheets.

                                       F-7

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                             Property and Equipment

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


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

During the year ended December 31, 2001, in conjunction with the restructuring
plan, the Company recorded a write-off $20.4 million of leasehold improvements
relating to the new facility the Company did not occupy (see Note 9).

                                 Restricted Cash

     The Company had $12.0 million and $11.6 million restricted cash for the
years ended December 31, 2001 and 2000, respectively. The restricted cash
secures letters of credit required by landlords to meet rent deposit
requirements for certain leased facilities. The restricted cash represents
investments in certificate of deposits.

                                Intangible assets

     Goodwill and intangible assets are amortized using the straight-line method
over periods ranging from 18 months to five years. The Company periodically
evaluates whether events and circumstances have occurred that indicate the
remaining estimated useful life of goodwill and other intangible assets may
warrant revision or that the remaining balance may not be recoverable. When
factors indicate that goodwill and other intangible assets should be evaluated
for possible impairment, the Company uses an estimate of undiscounted future net
cash flows over the remaining life of the asset to determine if impairment has
occurred. An impairment in the carrying value of an asset is assessed when the
undiscounted expected future operating cash flows derived from the asset are
less than its carrying value. If the Company determines an asset has been
impaired, the impairment is recorded based on the fair value of the impaired
asset. For the year ending December 31, 2001, we recorded a $7.6 million charge
related to the impairment of goodwill and intangible assets in accordance with
the accounting principles under SFAS No. 121, II Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of II (see Note
10).

     The Company's intangible assets consisted of the following (in thousands):

                                              2001                 2000
                                           ----------          ------------
Goodwill ..............................    $    5,336          $      5,336

                                       F-8

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     Workforce ...................................        200         200
     Purchased technology.........................      7,000           -
                                                   ----------  ----------
     Total intangible assets......................     12,536       5,536
     Less: Accumulated amortization ..............     (3,507)       (319)
     Less: Asset impairments......................     (7,636)          -
                                                   ----------  ----------
                                                   $    1,393  $    5,217
                                                   ==========  ==========

     Amortization of goodwill and workforce are recorded as "Amortization of
SpeechFront intangibles" and purchased technology is amortized as "Research and
development" expense in the accompanying consolidated Statement of Operations.

     As of December 31, 2001, goodwill and workforce have been fully amortized
or impaired (see Note 10).

                               Revenue Recognition

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

     We apply the provisions of Statement of Position 97-2, "Software Revenue
Recognition," as amended by Statement of Position 98-9 "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to all
transactions involving the sale of software products and sales of hardware where
the software is not incidental.

     All revenues generated from our worldwide operations are approved at our
corporate headquarters, located in the United States. We recognize revenue from
the sale of software licenses when persuasive evidence of an arrangement exists,
the product has been delivered, the fee is fixed and determinable and collection
of the resulting receivable is probable.

     We use a signed contract or purchase order as evidence of an arrangement
for licenses and maintenance renewals. For services, we use a signed statement
of work to evidence an arrangement. Software is delivered to customers
electronically or on a CD-ROM. We assess whether the fee is fixed and
determinable based on the payment terms associated with the transaction. We
assess collectibility based on a number of factors, including the customer's
past payment history and its current creditworthiness. If we determine that
collection of a fee is not reasonably assured, we defer the revenue and
recognize it at the time collection becomes reasonably assured, which is
generally upon receipt of cash payment.

     We recognize license revenue either upon issuance of the permanent software
license key or on system acceptance, if the customer has established acceptance
criteria (which occurs only in a small minority of cases). In those contracts
having acceptance criteria, criteria typically consist of a demonstration to the
customer that, upon implementation, the software performs in accordance with
specified system parameters, such as recognition accuracy or call completion
rates.

     We use the residual method to recognize revenue when a license agreement
includes one or more elements to be delivered at a future date if evidence of
the fair value of all undelivered elements exists. If evidence of the fair value
of the undelivered elements does not exist, revenue is deferred and recognized
when

                                       F-9

<PAGE>

                  NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

delivery occurs. License revenue from value-added resellers and OEMs is
recognized when product has been sold through to an end user and such
sell-through has been reported to the Company.

     The timing of license revenue recognition is affected by whether we perform
consulting services in the arrangement and the nature of those services. In the
majority of cases, we either perform no consulting services or we perform
standard implementation services that are not essential to the functionality of
the software. When we perform consulting services that are essential to the
functionality of the software, we recognize both license and consulting revenue
utilizing contract accounting based on the percentage of the consulting services
that have been completed.

     Service revenue consists of revenue from providing consulting and training.
Our consulting service contracts are bid either on a fixed-fee basis or on a
time-and-materials basis. For a fixed-fee contract, we recognize revenue using
the percentage of completion method. For time-and-materials contracts, we
recognize revenue as services are performed. Training service revenue is
recognized as services are performed. Losses on services contracts, if any, are
recognized as soon as such losses become known.

     Maintenance revenue consists of fees for providing technical support and
software updates. We recognize all maintenance revenue ratably over the contract
term. Customers renew maintenance agreements annually.

     Cost of license revenue consists primarily of license fees payable on
third-party software products, documentation, media costs and inventory
writedowns. Cost of service revenue consists of compensation and related
overhead costs for employees engaged in consulting, training and maintenance for
our customers.

                                Deferred Revenue

     Deferred revenue includes unearned license revenue and prepaid for
maintenance and professional services that will be recognized as revenue in the
future as the Company delivers licenses and performs services.

                                   Commissions

     The Company records deferred commission costs primarily as a result of
sales commissions due or paid to employees relating to contracts that have been
signed for which revenue has not yet been recognized. The Company will recognize
the commission expense in the future in the period in which the related revenue
is recognized under the contracts. The Company has recorded $185,000 and $1.3
million of deferred commission costs in prepaid and other current assets as of
December 31, 2001 and December 31, 2000, respectively.

                           Software Development Costs

                                       F-10

<PAGE>

                  NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     Under SFAS No. 86, "Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed," costs incurred in the research and
development of software products are expensed as incurred until technological
feasibility has been established. Once established, these costs would be
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 under SFAS No. 86 were insignificant and, therefore, no costs have
been capitalized to date.

                          Foreign Currency Translation

     The functional currency of the Company's foreign subsidiaries is deemed to
be the local country's currency. Consequently, assets and liabilities recorded
in foreign currencies are translated at year-end exchange rates; revenues and
expenses are translated at average exchange rates during the year. The effects
of foreign currency translation adjustments are included in stockholders' equity
as a component of "Accumulated Other Comprehensive Loss" in the accompanying
consolidated balance sheets. The effects of foreign currency transactions are
included in "Interest and Other Income, net" in the accompanying consolidated
statements of operations.

                               Comprehensive Loss

     Comprehensive loss includes net loss and all non-owner charges to
stockholders' equity, which for the Company, is foreign currency translation and
changes in unrealized gains and losses on investments. The Company had no items
of comprehensive loss prior to January 1, 2000. For the years ended December 31,
2001 and 2000, cumulative foreign currency translation losses are $227,000 and
$16,000, respectively. For the years ended December 31, 2001 and 2000,
unrealized in from investments are $108,000 and $0, respectively.

                               Net Loss Per Share

     Net loss per share is calculated under SFAS No. 128, "Earnings Per Share."
Basic net loss per share on a historical basis 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 conversion of the convertible preferred stock, stock options,
warrants and exchangeable shares held in escrow are antidilutive. 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. The total
number of shares excluded from diluted net loss per share was 8,281,000 shares,
6,645,000 shares and 5,729,000 shares for fiscal years 2001, 2000 and 1999,
respectively.

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

                                                Year Ended December 31,
                                       -----------------------------------------
                                          2001            2000            1999
                                       ---------       ---------       ---------

                                    F-11

<PAGE>

                  NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
<S>                                                                  <C>             <C>             <C>
Net loss ......................................................      $(110,365)      $ (23,474)      $ (18,474)
                                                                     =========       =========       =========
Basic:
Weighted average shares of common stock outstanding ...........         32,738          23,249           2,958
Less: Weighted average shares of common stock subject to
   repurchase .................................................           (258)           (532)            (34)
                                                                     ---------       ---------       ---------
Weighted average shares used in computing basic and diluted net
   loss per share .............................................         32,480          22,717           2,924
                                                                     =========       =========       =========
Basic and diluted net loss per share ..........................      $   (3.40)      $   (1.03)      $   (6.32)
                                                                     =========       =========       =========
</TABLE>

Recent Accounting Pronouncements

     On June 29, 2001, the FASB issued SFAS No. 141, "Business Combinations",
and SFAS No. 142, "Goodwill and Intangible Assets." Major provisions of these
Statements are as follows: all business combinations initiated after June 30,
2001 must use the purchase method of accounting; the pooling of interest method
of accounting is prohibited except for transactions initiated before July 1,
2001; intangible assets acquired in a business combination must be recorded
separately from goodwill if they arise from contractual or other legal rights or
are separable from the acquired entity and can be sold, transferred, licensed,
rented or exchanged, either individually or as part of a related contract, asset
or liability; goodwill and intangible assets with indefinite lives are not
amortized but are tested for impairment annually using a fair value approach,
except in certain circumstances, and whenever there is an impairment indicator;
other intangible assets will continue to be valued and amortized over their
estimated lives; in-process research and development will continue to be written
off immediately; all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting; effective January 1, 2002,
existing goodwill will no longer be subject to amortization. Goodwill acquired
subsequent to June 30, 2001 will not be subject to amortization.

     Because the Company did not initiate any business combinations after June
30, 2001, the adoption of SFAS No. 141 does not have a material impact on the
Company's financial position or results of operations. SFAS No. 142 is effective
beginning in the first quarter of 2002.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 144 retains the requirements of SFAS No. 121 whereby an
impairment loss should be recognized if the carrying value of the asset is not
recoverable from its undiscounted cash flows and develops one accounting model
for long-lived assets that are to be disposed of by sale. SFAS No. 144
eliminates goodwill from its scope, therefore it does not require goodwill to be
allocated to long-lived assets. SFAS No. 144 broadens the scope of APB 30
provisions for the presentation of discontinued operations to include a
component of an entity (rather than a segment of a business). The statement is
effective for fiscal years beginning after December 15, 2001, with early
adoption permitted. Management is currently assessing the provisions of this
statement to determine its impact on the Company's consolidated results of
operations and financial position.

                                       F-12

<PAGE>
                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

    Goodwill amortization for the year ended December 31, 2001 was
approximately $1.9 million. For the year ended December 31, 2001, we performed
an impairment analysis of identifiable assets and goodwill and we recorded a
charge of $7.6 million to the impairment of goodwill and other intangible
assets. As of December 31, 2001, we have approximately $1.4 million remaining in
intangible assets and no goodwill recorded in our financial statements.

     In November 2001, the FASB issued an announcement on the topic of "Income
Statement Characterization of Reimbursements Received for Out of Pocket Expenses
Incurred" ("the Announcement"). The Announcement requires companies to
characterize reimbursements received for out of pocket expenses incurred as
revenue in the statement of operations. The Company has netted reimbursements
received for out of pocket expenses against the related expenses in the
accompanying consolidated statements of operations. The Announcement is to be
applied in financial reporting periods beginning after December 15, 2001 and
comparative financial statements for prior periods are to be reclassified to
comply with the guidance in this announcement. The Company will adopt the
Announcement beginning in the first quarter of 2002.

     In July 2001, the FASB's Emerging Issues Task Force (EITF) reached final
consensus on EITF No. 00-25, "Vendor Income Statement Characterization of
Consideration Paid to a Reseller of the Vendor's Products," EITF 00-25 generally
requires that the consideration, including equity instruments, given to a
customer be classified in a vendor's financial statements not as an expense, but
as an offset of revenue up to the amount of cumulative revenue recognized or to
be recognized. In November 2001, the EITF reached consensus on EITF No. 01-09,
"Accounting for Consideration Given by a Vendor to a Customer or Reseller of the
Vendor's Products." EITF 01-09 clarifies and modifies certain items discussed in
EITF 00-25. The Company is required to adopt these new standards no later than
the quarter ending March 31, 2002, and comparative financial statements are
required to be reclassified to comply with the new pronouncement. The Company is
assessing the impact EITF 00-25, EITF 01-09 on the Company's results of
operations.

Reclassification

     Certain prior year amounts have been classified to conform with current
year presentation.

3. ACQUISITION:

     On November 10, 2000, in an acquisition accounted for under the purchase
method of accounting, the Company acquired all the outstanding shares of
SpeechFront Inc. ("SpeechFront") for approximately $7.1 million, including
acquisition costs of approximately $129,000. SpeechFront was a developer of
voice instant messaging systems. The consideration included approximately 16,590
shares of the Company common stock valued at $1.7 million and cash of
approximately $5.3 million. The purchase agreement contained additional
payments, of approximately $4.1 million, to be made in common stock,
approximately 38,710 shares, contingent upon the continued employment of the
founders of SpeechFront. Maximum future payments, contingent solely on continued
employment of the founders, is $1.7 million, approximately 16,590 shares, and is
payable upon the eighteen month anniversary of the acquisition date, which is
May 2002. The remaining $2.4 million, approximately 22,120 shares, also relates
to the continued employment of the founders, and is payable upon the twelve
month anniversary of the acquisition date, which is November 2001, or earlier if
certain performance milestones are achieved. The contingent payments are
recorded as compensation expense over the term of the employment condition and
not as part of the purchase price. Upon consummation of the acquisition, the
Company established an escrow account for these contingent payments.

     The allocation of the purchase price to the assets acquired and liabilities
assumed based on estimates of fair value are as follows (in thousands):

Cash ...................................................  $   136
Other current assets ...................................        7
Property and equipment .................................       66
Acquired in-process research and development ...........    1,500
Goodwill ...............................................    5,336
Workforce ..............................................      200
                                                          -------
                                                            7,245
Less: Liabilities assumed ..............................      (95)
                                                          -------
                                                          $ 7,150
                                                          =======

                                      F-13

<PAGE>

                 NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     The proforma net sales and results of operations for this acquisition, had
the acquisition occurred at the beginning of 1999, are not significant, and
accordingly, have not been presented.

     At the time of acquisition, the Company expensed $1.5 million of purchased
in-process research and development. Other purchased intangible assets,
including goodwill and workforce of approximately $5.5 million are being
amortized a straight-line basis over their estimated useful lives of thirty-six
and eighteen months, respectively. Beginning on November 10, 2000, SpeechFront's
operating results were included with those of the Company. The value assigned to
purchased in-process technology, based on the income method prepared by an
independent third-party was determined by identifying research projects in areas
for which technological feasibility had not been established. SpeechFront's
in-process projects included the research and development associated with the
voice instant messaging + Mobile HQ product.

     The value of in-process research and development was determined by
estimating the costs to develop the purchased in-process technology into a
commercially viable product, estimating the resulting net cash flows from such
project and discounting the net cash flows back to their present value. The
discount rate includes a risk-adjusted discount rate to take into account the
uncertainty surrounding the successful development of the purchased in-process
technology. The risk-adjusted discount rate applied to the projects' cash flows
was 30% for the in-process technology. The Company believed that the estimated
in-process technology amounts represent fair value and do not exceed the amount
a third-party would pay for the projects. The valuation included cash inflows
from in-process technology through 2006 with revenues commencing in 2002. Where
appropriate, the Company allocated anticipated cash flows from an in-process
research and development project to reflect contributions of the core
technology.

     At the time of the acquisition, SpeechFront's remaining tasks were
approximately 35 percent complete based on engineering man-month data and
technological progress. The Company estimates that it will cost approximately
$466,000 to complete the project with significant remaining development efforts,
which were expected to be completed in the next 4 to 6 months. If the projects
are not successful or completed in a timely manner, management's product pricing
and growth rates may not be achieved and Nuance may not realize the financial
benefits expected from the projects.

     For the year ending December 31, 2001, we reviewed the carrying value of
the assets related to the SpeechFront acquisition based on existing business
conditions and determined that the voice instant messaging system technologies
under development during the year 2001 were not aligned with our revised
strategy and will not be utilized. As a result, we recorded an asset impairment
(see Note 10).

     During 2001, we entered into an agreement with a third-party that gives us
non-exclusive intellectual property rights to text to speech software code. We
paid $7.0 million for this purchased technology which has been capitalized in
the accompanying Consolidated Balance Sheets as the technology has alternative
use and will be amortized over its useful life estimated to be five years. The
Company is in the process of incorporating the text to speech technology into
their platform. During the development stage, this technology is being amortized
to research and development expense, and when the product is generally available
for sale which is expected to be in the first quarter of 2002, the technology
will be amortized to cost of sales. The agreement includes a royalty clause in
which Nuance will pay 5% of all net revenue attributable to sublicenses of this
technology to a third party. The term of the royalty payments is 8 years.

     For the year ending December 31, 2001, we recorded a $7.6 million charge
related to impairments of intangible assets in accordance with the accounting
principles under SFAS No. 121, "Accounting for the Impairment of Long-Lived
assets and for the Long-Lived Assets to be Disposed Of." (see Note 10).

4.   SIGNIFICANT CONCENTRATIONS:

     Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of accounts receivable. The
Company performs periodic credit evaluations of its customers' financial
condition and generally does not require collateral. Five customers comprised
approximately 42% and 41% of the accounts receivable balance at December 31,
2001 and 2000, respectively.

                                      F-14

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     For the years ended December 31, 2001 and 2000, certain customers accounted
for 10% or more of the accounts receivable balance as follows:

<TABLE>
<CAPTION>
                                                                      December 31,
                                                            ------------------------------
                                                                 2001            2000
                                                            --------------  --------------
<S>                                                         <C>             <C>
Customer A ..............................................             10%             10%
Customer B ..............................................             10%              *
</TABLE>

     For the years ended December 31, 2001, 2000 and 1999, certain customers
individually accounted for more than 10% of revenue as follows:

<TABLE>
<CAPTION>
                                                                        Year Ended December 31,
                                                            ----------------------------------------------
                                                                 2001            2000            1999
                                                            --------------  --------------  --------------
<S>                                                         <C>             <C>             <C>
Customer A ..............................................        18%             22%             25%
Customer C ..............................................          *              *              20%
</TABLE>

________________
* Represents less than 10% for the indicated period.

     In 2001, 2000 and 1999, the Company's revenue attributable to indirect
sales through resellers was 75%, 72% and 56%, respectively. One reseller
accounted for 18%, 22% and 25% of total revenue in 2001, 2000 and 1999,
respectively.

5.   INVENTORY:

     During the year ended December 31, 2001, the Company purchased $550,000 of
third-party software to complement its core platform. This inventory of
software is recorded at the lower of cost or market. At December 31, 2001, we
evaluated the third party software and charged the excess inventory to cost of
goods sold of $275,000, which was caused by lower-than-expected demand. We will
continue to assess the remaining carrying value of the inventory in relation to
recovery of future revenues.

6.   BALANCE SHEET DETAIL:

     The Company's property and equipment and accrued liabilities consisted of
the following (in thousands):

<TABLE>
<CAPTION>
                                                                      December 31,
                                                            ------------------------------
                                                                 2001            2000
                                                            --------------  --------------
<S>                                                         <C>             <C>
Property and equipment:
Computer equipment and software .........................      $   13,838      $   10,508
Furniture and fixtures ..................................           1,659           2,427
Leasehold improvements ..................................           1,471           1,323
                                                               ----------      ----------
Total property and equipment ............................          16,968          14,258
</TABLE>

                                      F-15

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
<S>                                                            <C>            <C>
Less: Accumulated depreciation and amortization .........          (8,466)        (4,844)
                                                               ----------     ----------
                                                               $    8,502     $    9,414
                                                               ==========     ==========
</TABLE>

During year ended December 31, 2001, in conjunction with the restructuring plan,
the Company recorded a purchase and an impairment $20.4 million of leasehold
improvements relating to the new facility the Company did not occupy (see Note
9).

<TABLE>
<S>                                                            <C>             <C>
Accrued liabilities:
Accrued payroll and related benefits ....................      $    4,544      $    7,734
Other accrued liabilities ...............................           5,756           4,655
                                                               ----------      ----------
Total ...................................................      $   10,300      $   12,389
                                                               ==========      ==========
</TABLE>

7.   INVESTMENTS:

     The Company maintains an investment portfolio to support current operations
and to take advantage of investment opportunities. All investments are
classified as available-for-sale and carried at fair value, which is determined
based on quoted market prices, with net unrealized gain or loss included in the
"Accumulated Other Comprehensive Loss" in the accompanying consolidated balance
sheet.

     At December 31, 2001 the Company's investments were comprised of the
following (in thousands):

<TABLE>
<CAPTION>
                                                               Amortized      Unrealized      Unrealized
                                                                 Cost            Gains          Losses        Fair Value
                                                            --------------  --------------  --------------  --------------
<S>                                                         <C>             <C>             <C>             <C>
U.S. Treasury notes .....................................      $    5,175               -               -           5,175
U.S. Government agency bonds ............................          24,468               -             (81)         24,387
Corporate bonds .........................................           9,545               4             (31)          9,518
Commercial paper ........................................           2,897               -               -           2,897
                                                               ----------      ----------      ----------      ----------
Total ...................................................      $   42,085               4            (112)     $   41,977
                                                               ==========      ==========      ==========      ==========

Reported as:
Short-term investments                                                                                         $   16,230
Long-term investments                                                                                              25,747
                                                                                                               ----------
                                                                                                               $   41,977
                                                                                                               ==========
</TABLE>

     Realized gains and losses on the sale of investments for the period ended
December 31, 2001 were not material.

     At December 31, 2001, the Company's investments will mature as follows (in
thousands):

<TABLE>
<CAPTION>
                               Maturity                                 Maturity in
                             Less than 1     Maturity      Maturity     excess of 5    Total Fair
                                 year       1-3 years     4-5 years        years         Value
                             -----------    ---------    ------------   -----------    ----------
<S>                        <C>              <C>          <C>            <C>            <C>
U.S. Treasury notes            $ 5,175             -                -             -     $ 5,175
Government agency bonds          2,001        22,386                -             -     $24,387
Corporate bonds                  6,157         3,361                -             -       9,518
Commercial paper                 2,897             -                -             -       2,897
                               -------       -------     ------------   -----------     -------
Total                          $16,230       $25,747     $          -   $         -     $41,977
                               =======       =======     ============   ===========     =======
</TABLE>

     At December 31, 2000, the Company's short-term investments of $8.7 million
consisted of primarily U.S. government notes and bonds. There were no long-term
investments at December 31, 2000.

8.   DEBT:

     In July 1999, the Company entered into a loan and security agreement with a
bank, which provides for borrowings for purchases of property and equipment of
up to $2.0 million, and borrowings for cash management purposes of up to
$250,000. Amounts borrowed under the agreement bore interest at the bank's prime
rate plus 0.75% (9.25% at December 31, 1999). Borrowings for purchases of
property and equipment

                                      F-16

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

were payable in 36 equal installments beginning in January 2000, which was
repaid in the second quarter of 2000.

     In October 1999, the Company's Canadian subsidiary entered into a revolving
line of credit under which it can borrow up to $600,000 in Canadian dollars. The
revolving line of credit, secured by a letter of credit from the Company's
primary bank, bears interest at the lender's prime rate plus 0.5% per annum. The
line of credit was not utilized during 2001 and was cancelled in October 2001.

     In November 2000, in connection with the SpeechFront acquisition, the
Company assumed certain capital leases of approximately $ 45,500. These leases
bore interest at rates ranging from 17% to 22% and were paid off in February
2001.

9.   RESTRUCTURING:

     In April 2001, the Company's Board of Directors approved a restructuring
plan that would align the Company's expenses with revised anticipated demand and
create a more efficient organization. In connection with the restructuring plan,
the Company recorded a restructuring charge of $34.1 million for lease loss and
severance costs and an asset impairment charge of $20.4 million on tenant
improvement (see Note 10).

     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, comprised of a sublease loss, broker commissions and other
facility costs. To determine the sublease loss, the loss after the Company's
cost recovery efforts from subleasing the building, certain assumptions were
made related to the (1) time period over which the building will remain vacant
(2) sublease terms (3) sublease rates. The lease loss is an estimate under SFAS
No. 5 "Accounting for Contingencies" and represents the low end of the range and
will be adjusted in the future upon triggering events (change in estimate of
time to sublease, actual sublease rates, etc.). The Company has estimated that
the high end of the lease loss could be $55 million if operating lease rental
rates continue to decrease in these markets or should it take longer than
expected to find a suitable tenant to sublease the facility.

     The Company recorded $1.5 million in costs associated with severance and
related benefits. The Company reduced its headcount by approximately 80
employees, with reductions ranging between 10% and 20% across all functional
areas and affecting several locations. The Company expects to save an estimated
$8.0 million annually of salary and related benefits as a result of this
reduction in headcount. In addition, the real estate restructuring plan is
expected to lower facilities expenses which would have been incurred had the
Company occupied the new leased facility.

     The restructuring charges for the year ending December 31, 2001 is as
follows (in millions):

<TABLE>
<CAPTION>
                                                                             Severance and
                                                                                Related           Total
                                                              Lease Loss       Benefits       Restructuring
                                                            --------------  ---------------  ---------------
<S>                                                         <C>             <C>              <C>
Total charge for the year ending December 31, 2001 ......             32.6             1.5            34.1
</TABLE>

                                      F-17

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
<S>                                                         <C>             <C>              <C>
Amount utilized in the year ending December 31, 2001..                (3.6)           (1.4)           (5.0)
                                                               -----------     -----------     -----------

Accrual balance at December 31, 2001 .................         $      29.0     $       0.1     $      29.1
                                                               ===========     ===========     ===========
</TABLE>

     Total cash outlay for the restructuring plan is expected to be $34.1
million, of which $5.0 million was paid through December 31, 2001 and the $29.1
million remain accrued at December 31, 2001. We expect $8.9 million of the lease
loss to be paid out over the next twelve months, and the remaining $20.1 million
to be paid out over the remaining life of the lease of approximately 10 years.
We expect the remaining $100,000 of employee severance and related benefits
accrual to be paid out by March 31, 2002.

     In January 2002, the Company announced a restructuring plan that would
reduce its workforce by approximately 10%. These charges are being recorded
primarily to realign the sales organization, to align the Company's cost
structure with changing market conditions and to create a more efficient
organization (See Note 17).

10.  ASSET IMPAIRMENTS:

     The Company assesses the impairments of long-lived assets, including
identifiable intangibles, in accordance with the provisions of SFAS No. 121
Accounting for the Impairment of Long Lived Assets and for Long Lived Assets to
be Disposed Of.

     In connection with the restructuring plan, the Company decided not to
occupy its new headquarters facility and recorded an asset impairment charge of
$20.9 million on related tenant improvements during the quarter ended June 30,
2001. Included in the $20.9 million asset impairment charge was approximately
$900,000 for leasehold improvements under construction. During the quarter ended
December 31, 2001, the Company decreased this estimate by approximately
$475,000.

     In connection with our SpeechFront acquisition in November 2000, we
allocated purchase price to goodwill and workforce of $5.5 million. During the
quarter ending December 31, 2001, we reviewed the existing business conditions
and determined that the voice instant messaging system technologies under
development during 2001 were not aligned to the Company's revised strategy and
will not be utilized. As a result, the Company has decided to cease its
development of instant messaging system technologies and impaired the remaining
asset balance as of December 31, 2001, which has resulted in a charge of $3.2
million.

     During the year, the Company recorded $7 million related to purchased text
to speech technology. For the period ending December 31, 2001, the Company
amortized $1.2 million to research and development as the product was being
developed into Nuance's text to speech product offering. During the quarter
ending December 31, 2001, the Company reviewed the current value of these
intangible assets based on an analysis which considered existing business
conditions and economic declines including the overall declines in industry
growth rates that have negatively impacted expected future revenue. Based on
consideration of these factors, the Company performed an evaluation of the
recoverability of this asset using undiscounted cash flows. This analysis
indicated that the asset was impaired, accordingly, such asset was written down
by $4.4 million to estimated fair value based on estimated discounted future
cash flows.

                                      F-18

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

11.  COMMITMENTS AND CONTINGENCIES:

Facilities

     The Company leases its facilities under non-cancelable operating leases
with various expiration dates through July 2012. Future minimum lease payments
under these agreements, including the Company's new facilities lease, as of
December 31, 2001, are as follows (in thousands):

                       Fiscal Year                           Operating Lease
---------------------------------------------------------   -----------------
2002 ....................................................      $    9,658
2003 ....................................................           9,727
2004 ....................................................           9,253
2005 ....................................................           8,477
2006 ....................................................           8,778
Thereafter ..............................................          52,494
                                                               ----------
Total minimum lease payments ............................      $   98,387
                                                               ==========

In May 2000, the Company entered into a lease for its new headquarters facility.
The lease has an eleven-year term, which began in August 2001, and provides for
monthly rent payments starting at approximately $600,000. An $12.0 million
certificate of deposit secures a letter of credit required by the landlord for a
rent deposit. In conjunction with the restructuring plan (see Note 9), the
Company decided not to occupy this new leased facility and has recorded a lease
loss of $32.6 million related to future lease commitments, net of expected
sublease income. The future minimum lease payment table referenced above does
not include estimated sublease income.

     Rent expense for the years ended December 31, 2001, 2000, and 1999 was
approximately $2.8 million, $1.9 million and $1.2 million, respectively.

Royalties

     During 2001, we entered into an agreement with a third-party that gives us
non-exclusive intellectual property rights to text to speech software code. We
paid $7.0 million for this purchased technology which has been capitalized. The
agreement includes a royalty clause in which Nuance will pay 5% of all net
revenue attributable to sublicenses of this technology to the third party. The
term of the royalty payments is 8 years.

Legal

     In March 2001, the first of a number of stockholder complaints was filed in
the United States District Court for the Northern District of California against
the Company and certain of its officers. Those lawsuits have been consolidated
and an amended complaint has been filed on behalf of a purported class of people
who purchased our 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 are seeking unspecified damages.
We believe that these allegations are without merit and we are defending the
litigation vigorously. In response to our motion to dismiss, the court has
ordered the plaintiffs to file 2 new, amended complaint. An unfavorable
resolution of this litigation could have a material adverse effect on our
business, results of operations, or financial condition.

     In June and July 2001, putative shareholder derivative actions were filed
in California state court alleging breaches of fiduciary duty and insider
trading by various of our directors and officers. While we are named as a
nominal defendant, the lawsuits do not appear to seek any recovery against us.
Proceedings in these actions have been stayed.

     In August 2001, the first of a number of complaints was filed in federal
district court for the Southern District of New York on behalf of a purported
class of persons who purchased Nuance stock between April 12, 2000 and December
6, 2000. The complaint generally alleges that various investment bank
underwriters engaged in improper and undisclosed activities related to the
allocation of shares in our initial public offering of securities. The
complaints bring claims for violation of several provisions of the federal
securities laws against those underwriters, and also against us and some of our
directors and officers. Similar lawsuits concerning more than 300 other
companies' initial public offerings have been filed in 2001. We believe that the
allegations against us are without merit and intend to defend the litigation
vigorously.

     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
the Company's consolidated financial position, results of operations, or cash
flows.

12.  STOCKHOLDERS' EQUITY:

                           Convertible Preferred Stock

     As of December 31, 2001, the Company had no preferred stock outstanding.
All outstanding shares of convertible preferred stock were converted to the
equivalent number of shares of the Company's common stock upon the consummation
of the Company's initial public offering in April 2000.

                  Series B Convertible Preferred Stock Warrant

     In April 1996, the Company entered into a series of equipment leases with
an aggregate credit limit of $800,000. In connection with these leases, the
Company issued a warrant to purchase 31,256 shares of Series B convertible
preferred stock for $0.96 per share. The warrant was exercised in October 2000
using the net exercise method, resulting in the issuance of 31,021 shares of
common stock.

                  Series D Convertible Preferred Stock Warrant

                                      F-19

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     On May 26, 1998, in connection with a revenue transaction with a
shareholder of Series D convertible preferred stock, the Company issued a
warrant to purchase 200,000 shares of Series D convertible preferred stock for
$5.00 per share. The warrant was exercised in February 2000 for 200,000
shares of the Company's common stock. In accordance with Emerging Issues Task
Force 96-18, the Company estimated the fair value of the warrant to be
approximately $248,000. The fair value was determined by utilizing a
Black-Scholes option pricing model at each of the measurement dates. Measurement
dates were determined to be the date that the warrants vested which was upon
payment of the purchase order by the customer. The following assumptions were
used in the Black-Scholes option pricing model: risk-free interest rate of 5.5%;
expected dividend yields of zero; expected volatility factor of the market price
of the common stock of 50%; and an expected life of the warrant of 1.25 years
from the vesting date.

     The fair value of the warrant of $248,000 was amortized as the Company
recognized revenue under the related arrangement. The Company amortized $124,000
against license revenue in both 1999 and 1998.

                                  Common Stock

     During 2000 and 1999, the Company issued 9,860 and 6,423 shares of common
stock respectively, in consideration for services performed by consultants and
other non-employees. The expense related to these services was calculated by
using the fair value of the common shares on the dates of issuance, ranging from
$6.75 to $15.00 per share, and has been included in operating expenses in the
accompanying consolidated statements of operations.

     In April 2000, the Company completed its initial public offering of 5.2
million shares of common stock at $17 per share. The Company received net
proceeds of approximately $80.3 million, net of offering expenses of
approximately $7.7 million. In connection with the offering, 19,925,986 shares
of preferred stock were automatically converted into an identical number of
shares of common stock.

     In connection with the initial public offering, the holder of a warrant to
purchase 200,000 shares of Series D at $5.00 per share exercised the warrant and
received 200,000 shares of common stock.

     In October 2000, the Company completed a follow-on offering of 1.3 million
shares of common stock at $121 per share. The Company received net proceeds of
approximately $143.2 million, net of offering expenses of approximately $8.8
million.

                                     Warrant

     On December 4, 2000, the Company issued to a customer a warrant to purchase
100,000 shares of common stock at an exercise price of $138.50 per share subject
to certain anti-dilution adjustments. The warrant is exercisable at the option
of the holder, in whole or part, at any time between January 17, 2001 and August
2002. In January 2001, the Company valued the warrant at $526,000, utilizing the
Black-Scholes valuation model using the following assumptions; risk-free
interest rate of 5.5% expected dividend yields of zero, expected life of 1.5
years, and expected volatility of 80%. The warrant is recorded within "Other
Assets" and is being amortized over 20 months. For the year ending December 31,
2001, $320,000 of

                                      F-20

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATION FINANCIAL STATEMENTS (CONTINUED)

amortization was recorded as non-cash compensation expense. During the year, we
performed services of $72,000 for this customer and reduced the non-cash
compensation expense for the period by this amount.

                                  2000 Stock Plan

     In February 2000, the Board of Directors and stockholders approved the 2000
Stock Plan. The 2000 Stock Plan, which became effective as of the Company's IPO
on April 12, 2000, assumed the remaining shares reserved under the 1998 Stock
Plan. Accordingly, no future grants will be made under the 1998 Stock Plan.
Under the 2000 Stock Plan, the Board of Directors may grant options to purchase
the Company's common stock to employees, directors, or consultants at an
exercise price of not less than 100% of the fair value of the Company's common
stock at the date of grant, as determined by the Board of Directors. The 2000
Stock plan will terminate automatically in January 2010, unless terminated
earlier by the Company's Board of Directors. Options issued under the 2000 Stock
Plan have a term of ten years from the date of grant and generally vest 25%
after one year, then ratably over the remaining three years. The number of
shares reserved under the 2000 Stock Plan will automatically be increased each
year, beginning on January 1, 2001, in an amount equal to the lesser of (a)
4,000,000 shares, (b) 6% of the Company's shares outstanding on the last day of
the preceding fiscal year, or (c) a lesser amount determined by the Board of
Directors.

                        1994 and 1998 Stock Option Plans

     On September 1, 1999, the 1994 Flexible Stock Incentive Plan was
terminated. Upon termination of the plan, all unissued options were cancelled.
In August 1998, the Board of Directors approved the 1998 Stock Plan, which
terminated upon the Company's initial public offering on April 13, 2000. As a
result of the termination, the shares remaining available for grant under the
1998 Stock Plan were transferred to the Company's 2000 Stock Plan. Options
issued under the 1994 Flexible Stock Plan and 1998 Stock Plan have a term of ten
years from the date of grant and generally vest 25% after one year, then ratably
over the remaining three years. Due to the terminations of the 1994 Flexible
Incentive Plans and 1998 Stock Plan, options issued to employees which expire or
become unexercisable will not be available for future distribution under the
both Plans.

     On March 1, 2002, Nuance filed a tender offer document with the SEC for an
employee Stock Exchange Program. Employees under the 1998 Stock Plan and 2000
Stock Plan with stock options at an exercise price of $15.00 or greater are
eligible to exchange unexercised options for new options, which the Company will
grant under the 2000 Stock Plan (see Note 17).

                          Employee Stock Purchase Plan

     In February 2000, the Board of Directors and stockholders approved the 2000
Employee Stock Purchase Plan, or the Purchase Plan. The Company reserved a total
of 1,000,000 shares of common stock for issuance under this plan, which became
effective as of the Company's initial public offering on April 13, 2000. The
Purchase Plan is administered over offering periods of 24 months each, with each
offering period divided into four consecutive six-month purchase periods
beginning November 1 and May 1 of each year. Eligible employees can contribute
up to 15% of their compensation each pay period for the purchase of common
stock, not to exceed 2,000 shares per six-month period. On the last business day
of each purchase period, shares of common stock are purchased with the
employee's payroll deductions accumulated during the six months, at a purchase
price per share of 85% of the market price of the common stock on the employee's
entry date into the applicable offering period or the last day of the applicable
offering period, whichever is lower.

     The number of shares reserved under the Purchase Plan will automatically be
increased each year, beginning on January 1, 2001, in an amount equal to the
lesser of (a) 1,500,000 shares, (b) 2% of the Company's shares outstanding on
the last day of the preceding fiscal year, or (c) any lesser amount determined
by the Board of Directors.

     During 2001 and 2000, approximately 459,000 shares and 158,000 shares
were issued under this plan, respectively, representing in employee
contributions of approximately $4.0 million and $2.9 million, respectively. As
of December 31, 2001, approximately 1,026,322 shares were available for issuance
under the Purchase Plan.

     Option activity under the Stock Option Plans is as follows (in thousands,
except per share data):

<TABLE>
<CAPTION>
                                                                 Shares
                                                             Available for    Outstanding     Weighted Average
                                                                 Grant          Options        Exercise Price
                                                            ---------------  --------------  ------------------
<S>                                                         <C>              <C>             <C>
December 31, 1998 .......................................             772            3,259                1.29
    Authorized ..........................................           6,500               --                  --
    Options granted .....................................          (3,062)           3,062                7.93
    Options exercised ...................................              --             (484)               0.59
    Options cancelled ...................................             108             (108)               2.10
</TABLE>

                                      F-21

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


<TABLE>
<S>                                                            <C>             <C>             <C>
     Terminated options .................................            (125)             --              --
                                                               -----------     ----------      ----------
December 31, 1999 .......................................           4,193           5,729      $     4.88
     Options granted ....................................          (3,493)          3,493           53.84
     Options exercised ..................................              --          (2,371)           3.04
     Options cancelled ..................................             206            (206)          12.06
     Terminated options .................................             (74)             --              --
                                                               ----------      ----------      ----------
December 31, 2000 .......................................             832           6,645      $    31.01
     Authorized .........................................           2,430              --              --
     Options granted ....................................          (3,355)          3,355           18.00
     Options exercised ..................................              --            (649)           6.35
     Options cancelled ..................................           1,170          (1,170)          41.78
     Terminated options .................................            (618)             --              --
                                                               ----------      ----------      ----------
December 31, 2001 .......................................             459           8,181      $    26.07
                                                               ==========      ==========      ==========
</TABLE>

     As of December 31, 2001, the Company had reserved 9,666,243 shares of its
common stock for future issuance.

     The following table summarizes the stock options outstanding and
exercisable as of December 31, 2001:

<TABLE>
<CAPTION>
                                                      Options Outstanding                         Options Exercisable
                                     ----------------------------------------------------  ----------------------------------
                                                                                               Number
                                                           Weighted          Weighted        Exercisable        Weighted
                                         Amount at          Average           Average          As of             Average
                                       December 31,        Remaining         Exercise        December 31,       Exercise
    Range of Contractual Price             2001          Contract Life         Price            2001              Price
----------------------------------   ----------------  ----------------  ----------------  ----------------  ----------------
                                      (in thousands)                                        (in thousands)
<S>                                  <C>               <C>               <C>               <C>               <C>
$         0.00 -   7.99                     932               4.9            $    3.82            589          $      3.01
          8.00 -  14.99                   4,263               8.2                10.24            863                 8.68
         15.00 -  69.99                   2,061               8.0                31.41            589                26.30
         70.00 - 175.00                     925               8.2               109.53            289               110.37
                                      ---------         ---------            ---------      ---------            ---------
$         0.00 - 175.00                   8,181               7.8            $   26.07          2,330            $   24.32
                                      =========         =========            =========      =========            =========
</TABLE>


                                      F-22

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

          In July 2001, an employee was terminated effective September 2001. The
employee was allowed to continue to vest in his stock options which resulted in
a pre tax non-cash compensation charge of $216,000 in accordance with the FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation."

                                      F-23

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


          The weighted average fair value of stock options granted during 2001,
2000 and 1999 was $27.71, $44.95 and $7.93, respectively. The fair value of each
option grant was estimated on the date of grant using the Black-Scholes option
pricing model with the following assumptions used for grants in 2001, 2000 and
1999: risk-free interest rate of 5.0% in 2001, 5.9% in 2000 and 5.1% to 7.7% in
1999; expected dividend yields of zero; expected lives of 3 years beyond grant
date; and expected volatility of 141% in 2001, 133% in 2000 and 50% in 1999.
Because the Black-Scholes option valuation model requires the input of
subjective assumptions, the resulting pro forma compensation cost may not be
representative of that to be expected in future periods.

          The weighted average fair value of purchase rights granted pursuant
to the Employee Stock Purchase Plan was $5.32 and $9.90 for the year 2001 and
2000, respectively. The fair value of each purchase right was estimated using
the Black-Scholes option pricing model with the following assumptions used for
2001: risk-free interest rate of 2.0%; expected dividend yields of zero;
expected life of 0.5 years beyond purchase date; and expected volatility of 79%.
Because the Black-Scholes option valuation model requires the input of
subjective assumptions, the resulting pro forma compensation cost may not be
representative of that to be expected in future periods.

          The Company records stock compensation in accordance with Accounting
Principles Board Opinion 25, "Accounting for Stock Issued to Employees." Had
compensation cost for the stock option plans and the Employee Stock Purchase
Plan been determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net loss would have been $124.9 million, $61.5
million and $19.1 million for the years ended December 31, 2001, 2000 and 1999,
respectively. Net loss per share would have been $(3.85), $(2.71) and $(6.53)
for the years ending December 31, 2001, 2000 and 1999, respectively.

                           Deferred Stock Compensation

     In connection with the grant of stock options prior to our initial public
offering, the Company recorded deferred stock compensation of approximately $8.7
million within stockholders' equity, representing the difference between the
estimated fair value of the common stock for accounting purposes and the option
exercise price of these options at the date of grant. This amount is presented
as a reduction of stockholders' equity and will be amortized over the vesting
period of the applicable options in a manner consistent with Financial
Accounting Standards Board Interpretation No. 28. The Company recorded
amortization of deferred stock compensation of $2.0 million, $4.3 million and
$310,000 in the years ending December 31, 2001, 2000 and 1999, respectively,
relating to approximately 3,152,000 stock options granted at a weighted average
exercise price of $8.58. For the year ending December 31, 2001, we reversed
approximately $999,000 of deferred stock compensation and additional
paid-in-capital, which represented the accumulated amortization of deferred
stock compensation relating to employees terminated under the restructuring
plan.

          In connection with the SpeechFront acquisition, the Company recorded
deferred compensation of $4.1 million (Note 3). Approximately $3.1 million and
$580,000 were amortized in the years ending December 31, 2001 and 2000,
respectively, related to these deferred compensation amounts.

          The Company expects to amortize $1.3 million, $209,000 and $10,000 of
non-cash compensation in 2002, 2003 and 2004, respectively.

13.       401(K) PLAN:

          The Company has a defined contribution savings plan under Section
401(k) of the Internal Revenue Code. The plan provides for tax-deferred salary
deductions and after-tax employee contributions. The Company does not make
contributions to the plan.

14.       INCOME TAXES:

          Nuance accounts for income taxes pursuant to SFAS No. 109, "Accounting
for Income Taxes." SFAS No. 109 provides for an asset and liability approach to
accounting for income taxes under which deferred income taxes are provided based
upon enacted tax laws and rates applicable to the periods in which taxes become
payable. As of December 31, 2001 and 2000, significant components of the
Company's current net deferred income tax assets were as follows (in thousands):

                                                          December 31
                                                 -----------------------------
                                                      2001           2000
                                                 -------------  --------------
Deferred Tax Assets:
    Net operating loss carryforwards...........   $ 57,184       $ 24,569
    Tax Credit Carryforwards ..................      2,722          2,582
    Asset impairment on purchased technology...      2,280             --
    Accruals and reserves .....................     17,630          3,180
                                                  --------       --------
    Gross deferred tax assets .................     79,816         30,331
    Valuation Allowance .......................    (79,468)       (30,221)
                                                  --------       --------
    Net Deferred Tax Asset ....................   $    348       $    110
                                                  ========       ========

                                      F-24

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

          As of December 31, 2001 and 2000, the net deferred tax asset consists
of foreign subsidiary temporary differences on accruals and reserves. As of
December 31, 2001 and 2000 the Company had no significant deferred tax
liabilities.

          As of December 31, 2001, the Company has net cumulative operating loss
carryforwards for federal and state income tax reporting purposes of
approximately $134.0 million and $62.0 million, respectively. The federal net
operating loss carryforwards expire on various dates through 2021, while the
state net operating loss carryforwards expire at various dates through 2011. The
Company also has federal and state tax credit carryforwards for income tax
purposes of approximately $1.6 million and $1.1 million, respectively. The
federal tax credit carryforwards expire on various dates through 2021, while the
state tax credits carryforward indefinitely. Under current tax law, net
operating loss and credit carryforwards available to offset future income in any
given year may be limited upon the occurrence of certain events, including
significant changes in ownership interests.

          Our income taxes payable for federal and state purposes has been
reduced, and the deferred tax assets increased, by the tax benefits associated
with taxable dispositions of employee stock options. When an employee exercises
a stock option issued under a nonqualified plan or has a disqualifying
disposition related to a qualified plan, we receive an income tax benefit
calculated as the difference between the fair market value of the stock issued
at the time of the exercise and the option price, tax effected. A portion of our
valuation allowance relates to the equity benefit of our net operating losses.
We had approximately $10.5 million, $18.9 million and $122,000 of taxable
dispositions of employee stock options for the years ended December 31, 2001,
2000 and 1999, respectively. A portion of the valuation allowance, when reduced,
will be credited directly to stockholders' equity. These benefits amounted to
$3.7 million, $6.6 million and $43,000 for the years ended December 31, 2001,
2000 and 1999, respectively.

          The provision for income taxes consists of the following components
(in thousands):


                                                        December 31,
                                            ------------------------------------
                                               2001         2000         1999
                                            ----------   ----------   ----------
Current
    Federal .............................          --           --           --
    State ...............................          --           --           --
    Foreign .............................         651          460           22
                                            ---------    ---------    ---------
         Total ..........................         651          460           --
                                            ---------    ---------    ---------
Deferred
    Federal .............................          --           --           --
    State ...............................          --           --           --
    Foreign .............................        (238)        (110)          --
                                            ---------    ---------    ---------
         Total ..........................        (238)        (110)          --
                                            ---------    ---------    ---------
         Total provision ................   $     413    $     350           22
                                            =========    =========    =========

          The Company recorded foreign income tax provisions for the years ended
December 31, 2001, 2000 and 1999 of $413,000, $350,000 and $22,000 respectively.
Included in the foreign current tax provision in the accompanying Consolidated
Statement of Operations, for the period ending December 31, 2001 is $161,000 of
foreign withholding taxes.

          Income before provision for income taxes consisted of (in millions):

                                                        December 31,
                                            ------------------------------------
                                               2001         2000         1999
                                            ----------   ----------   ----------
United States ...........................   $(111,230)   $ (24,082)   $ (18,878)
Foreign .................................       1,439          958          426
                                            ---------    ---------    ---------
                                            $(109,791)   $ (23,124)   $ (18,452)
                                            =========    =========    =========

          The actual provision for income taxes differs from the statutory U.S.
federal income tax rate as follows (in thousands):

                                      F-25

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
<CAPTION>
                                                                         December 31,
                                                             -----------------------------------
                                                                2001         2000         1999
                                                             ---------    ---------    ---------
<S>                                                          <C>          <C>          <C>
Provision at U.S. statutory rate of 35% ..................   $(38,427)    $ (8,076)    $ (6,466)
State income taxes, net of federal benefit ...............     (6,325)      (1,551)      (1,202)
Change in valuation allowance ............................     45,565        9,450        6,881
Effect of foreign income tax at various rates ............         89          322          166
Research and development tax credit ......................         47        1,208          675
Deferred stock compensation ..............................       (703)      (1,777)        (126)
Other ....................................................        167          774           94
                                                             --------     --------     --------
     Total ...............................................   $    413     $    350           22
                                                             ========     ========     ========
</TABLE>

          The change in valuation allowance for the periods ending December 31,
2001, 2000 and 1999 exclude $3.7 million, $6.6 million, and $43,000,
respectively, related to the tax benefit on employee stock option exercises.

15.  SEGMENT REPORTING:

          Effective January 1, 1998, the Company adopted the provisions of SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes standards for the way companies report information
about operating segments in financial statements. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Operating segments are defined as components of an enterprise 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 has two operating segments: licenses and services and
maintenance. Revenue and cost of revenue for the segments are identical to those
presented on the accompanying consolidated statements of operations. The Company
does not track expenses nor derive profit or loss based on these segments. The
Company also does not track assets by segments.

          Sales of licenses and services and maintenance through December 31,
2001 occurred through resellers and direct sales representatives located in the
Company's headquarters in Menlo Park, California, and in other locations. These
sales were supported through the Menlo Park location. The Company does not
separately report costs by region internally.

          International revenues are based on the country in which the end-user
is located. The following is a summary of international license and service and
maintenance revenue by geographic region:

<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                             -----------------------------------
                                                                2001         2000         1999
                                                             ---------    ---------    ---------
<S>                                                          <C>          <C>          <C>
License Revenue
    United States ........................................   $ 12,331     $ 19,410     $ 10,565
    Europe ...............................................      3,205        7,391          954
    Asia .................................................      1,296        1,293          316
    Australia ............................................      1,132        5,292          103
    Canada ...............................................      1,130        2,793          938
    Latin America ........................................      1,665        1,372          737
                                                             --------      --------    --------
      Total ..............................................   $ 20,759      $ 37,551    $ 13,613
                                                             ========      ========    ========
</TABLE>

                                      F-26

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Service and maintenance Revenue
    United States ..........................   $10,576      $ 8,166      $ 4,785
    Europe .................................     3,415        2,990          619
    Asia ...................................       924          591          195
    Australia ..............................       998          996           38
    Canada .................................     1,153          533          203
    Latin America ..........................     1,400          991          114
                                               -------      -------      -------
      Total ..... ..........................   $18,466      $14,267      $ 5,954
                                               =======      =======      =======

                                                   December 31,
                                              ----------------------
                                                 2001        2000
                                              ----------  ----------
Long-Lived Assets:
    United States ..........................    $6,512      $ 7,359
    Europe .................................        63           45
    Asia ...................................       248           --
    Australia ..............................        18            8
    Canada .................................     3,045        7,219
    Latin America ..........................         9           --
                                                ------      -------
      Total ...... .........................    $9,895      $14,631
                                                ======      =======

16.     RELATED PARTY:

        Fidelity, one of the Company's stockholders, is one of the Company's
customers. Revenues generated from this customer were approximately $237,000,
$592,000 and $3.8 million for the years ending December 31, 2001, 2000 and 1999.

        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. In addition, certain
members of the Company's Board of Directors serve as directors or principals of
entities that are investors in the Company.


17.     SUBSEQUENT EVENTS:

        On January 24, 2002, the Company announced a restructuring plan that
would reduce its workforce by approximately 10%. These charges are being
recorded primarily to realign the sales organization and the Company's cost
structure with changing market conditions to create a more efficient
organization. A restructuring charge, which primarily consists of payroll and
related expenses in connection with headcount reduction and a lease loss on a
facility in Hong Kong, will be recorded in the quarter ending March 31, 2002.

        On March 1, 2002, the Company announced a voluntary stock option
exchange program for all its employees. Under the program, employees are given
the opportunity to elect to cancel outstanding stock options at an exercise
price of $15.00 or greater under the 1998 Stock Plan and 2000 Stock Plan held by
them in exchange for new options to be granted under the 2000 Stock Plan at a
future date at the then current fair market value. The new options will be
granted no earlier than the first business day that is six months and one day
after the cancellation date of the exchanged options. The exercise price per
share of the new options will be 100% of the fair market value on the date of
grant, as determined by the closing price of the Company's common stock reported
by Nasdaq National Market for the last market trading day prior to the

                                      F-27

<PAGE>

                   NUANCE COMMUNICATIONS, INC. & SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

date of grant. These elections were made by March 29, 2002 and were required to
include all options granted during the prior six-month period. The exchange
program is not made available to the Company's executive officers, directors,
consultants and former employees.

                                      F-28

<PAGE>

                                   SCHEDULE II

                           NUANCE COMMUNICATIONS, INC.

       SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 2001

<TABLE>
<CAPTION>
                                                                     Balance at                                   Balance at
                                                                     Beginning     Charged to                       End of
                                                                     of Period      Expenses        Deduction       Period
                                                                    ------------   -----------     -----------    -----------
                                                                                         (in thousands)
<S>                                                                 <C>            <C>             <C>            <C>
YEAR ENDED DECEMBER 31, 1999 Allowance for Doubtful Accounts .....      356            221               6            571
YEAR ENDED DECEMBER 31, 2000 Allowance for Doubtful Accounts .....      571          1,464             212          1,823
YEAR ENDED DECEMBER 31, 2001 Allowance for Doubtful Accounts .....    1,823            521           1,032          1,312
</TABLE>

                                      F-29

<PAGE>

                                  EXHIBIT INDEX

         Exhibit
         Number                             Description
       ----------       --------------------------------------------------------
         3.1(1)         Restated Certificate of Incorporation of Registrant, as
                        currently in effect.

         3.2(1)         Bylaws of Registrant, as amended, as currently in
                        effect.

         4.1(1)         Form of Registrant's Common Stock Certificate.

         4.2(1)         Amended and Restated Investors' Rights Agreement, dated
                        as of October 1, 1999, among the Registrant and the
                        parties named therein.

         4.3(1)         Warrant to Purchase Stock dated April 1, 1996 issued to
                        Phoenix Leasing.

         4.4(5)         Warrant to Purchase Stock dated December 4, 2000 issued
                        to OnStar Corporation.

         4.5(5)         Amendment to the Amended and Restated Investors' Rights
                        Agreement, dated as of October 1, 1999, among the
                        Registrant and the parties named therein.

         4.6(5)         Exchange Agreement dated November 10, 2000 between
                        Registrant, 1448451 Ontario, Inc., Shawn Griffin,
                        William Love and Warren Gallagher.

         10.1(1)        Form of Indemnification Agreement entered into by
                        Registrant with each of its directors and executive
                        officers.

         10.2(1)        1994 Flexible Stock Incentive Plan.

         10.3(1)        1998 Stock Plan.

         10.4(1)        2000 Stock Plan.

         10.5(2)        2000 Employee Stock Purchase Plan and related
                        subscription agreement.

         10.6(1)        Lease Agreement dated May 27, 1997, and related
                        agreements by and between Registrant and Lincoln Menlo
                        IV & V Associates Limited.

         10.7(1)        Form of Stock Option Agreement, as amended, between
                        Registrant and each executive officer other than Brian
                        Danella, Paul Scott and Donna Allen Taylor.

         10.8(1)        Assignment and Assumption Agreement, and related
                        agreements by and between Registrant and CBT Systems
                        USA, Ltd.

         10.9(1)        Memorandum of Agreement of Lease, 2000 Peel Street,
                        Suite 900, Montreal, Quebec, dated January 1, 2000, by
                        and between Registrant and Cite De L'Ile Development
                        Inc.

        10.10(1)        Loan and Security Agreement dated June 23, 1999,
                        between Registrant and Silicon Valley Bank.


<PAGE>

         Exhibit
         Number                           Description
    ---------------     --------------------------------------------------------
       10.11(1)(*)      License Agreement dated December 20, 1994, by and
                        between Registrant and SRI International.

        10.12(1)        Form of Stock Option Agreement entered into between
                        Registrant and Brian Danella, Paul Scott and Donna Allen
                        Taylor.

        10.13(1)        Amendment dated August 23, 1995 to License Agreement
                        dated December 20, 1994 by and between Registrant and
                        SRI International.

        10.14(3)        Lease Agreement dated May 5, 2000 and related agreements
                        by and between Registrant and Pacific Shares Development
                        LLC.

        10.15(4)        Addendum dated August 9, 2000 to Memorandum of Lease
                        Agreement dated January 1, 2000, by and between
                        Registrant and Societe en Commandite Duke-Wellington.

       10.16(5)(*)      Value-Added Reseller Agreement dated August 31, 2000,
                        by and between Registrant and Nortel Networks
                        Limited.

          11.1          Statement of computation of net loss per share (included
                        in Note 2 to Notes to Financial Statements).

          21.1          Subsidiaries of the Registrant.

          23.1          Consent of Arthur Andersen LLP, Independent Public
                        Accountants

          24.1          Power of Attorney (see page 41)

          99.1          Letter to Commission Pursuant to Temporary Note 3T.

_________________________

(1) Incorporated by reference to the Registrant's Registration Statement on
    Form S-1 (File No. 333-96217) as declared effective by the Securities and
    Exchange Commission on April 12, 2000.

(2) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8 filed on Form S-8 filed on May 2, 2000.

(3) Incorporated by reference to the Registrant's Form 10-Q for the period ended
    June 30, 2000 filed on August 14, 2000.

(4) Incorporated by reference to the Registrant's Registration Statement on Form
    S-1 (File No. 333-45128) as declared effective by the Securities and
    Exchange Commission on September 26, 2000.

(5) Incorporated by reference to the Registrant's Form 10-K for the year ended
    December 31, 2000 filed on March 30, 2001.

(*) Confidential treatment has been requested for portions of this exhibit.