----

----

**FORM            10-K**

xAnnual Report Pursuant to Section            13 or 15 (d) of the Securities            Exchange Act of 1934

For the fiscal            year ended December 31, 2007 or

oTransition Report Pursuant to            Section 13 or 15 (d) of the Securities            Exchange Act of 1934

For the            transition period from ___________ to _________________

*COMMISSION            FILE NO. 000-24547*

**SCIENTIFIC            LEARNING CORPORATION**(Exact name of registrant as specified in its charter)
|                                                                                                         |   |                                                        |
|--------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------|
| DELAWARE                                                                                                     |   | 94-3234458                                                  |
| (State or other                        jurisdiction of                        incorporation or organization) |   | (IRS                        Employer Identification Number) |
|                                                                                                         |   |                                                        |
|                                                                                                         |   |                                                        |
| 300                        FRANK H. OGAWA PLAZA, SUITE 600                                                   |
| OAKLAND, CA                        94612-2040                                                                |
| (Address of principal                        executive offices, including zip code)                          |
|                                                                                                         |
| 510-444-3500                                                                                                 |
| (Registrant’s                        telephone number, including area code)                            |
|                                                                                         |   |                                                                 |
|----------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|
| **Securities                        registered pursuant to Section 12 (b) of the Act:**      |
| **Title of Each                        Class     **                 |   | **Name of Each                        Exchange on which Registered** |
| Common Stock, par value                        $0.001 per share NASDAQ Global Market         |
|                                                                                         |
| **Securities                        registered pursuant to Section 12 (g) of the Act: NONE** |

Indicate by check mark if the            registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities            Act. Yes: o No:            x

Indicate by check mark if the            registrant is not required to file reports pursuant to Section 13 or Section 15(d) of            the Act. Yes: o No:            x

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: o

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. o

Indicate by check mark whether            the registrant is a large accelerated filer, an accelerated filer or a            non-accelerated filer. (See definition of “accelerated filer and large            accelerated filer” in Rule 12b-2 of the Exchange Act).

Large accelerated            filer o     Accelerated filer            o     Non-accelerated filer            x

----

Indicate by check mark whether            the Registrant is a shell company (as defined Rule 12b-2 of the Act).            Yes: o No: x

The aggregate market value of            the voting and non-voting common equity held by non-affiliates of the Registrant, based            upon the closing sale price of the Common Stock on June 30, 2007 as reported on the            Nasdaq National Market was approximately $34,080,830. Shares of Common Stock held by            each director and executive officer and persons who owned 5% or more of the            Registrant’s outstanding Common Stock on that date have been excluded in that            such persons may be deemed to be affiliates. This determination of affiliate status is            not necessarily a conclusive determination for other purposes.

As of January 31, 2008 the            Registrant had outstanding 17,316,851 shares of Common Stock.

**DOCUMENTS            INCORPORATED BY REFERENCE**

Portions of the Proxy Statement            for the Registrant’s 2008 Annual Meeting of Stockholders are incorporated by            reference in Part III.

Page 2

----

----

**TABLE OF            CONTENTS**

|                            |   |                                                                                                                                                             |   |                            |
|---------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|
|                            |   |                                                                                                                                                             |   | PAGE                        NO. |
| PART                        I   |        |                                                                                                                                                                  |   |                            |
|                            |   |                                                                                                                                                             |   |                            |
| Item                        1.  |        | Business                                                                                                                                                         |   | 4                               |
| Item                        1A. |        | Risk                        Factors                                                                                                                              |   | 21                              |
| Item                        1B. |        | Unresolved                        Staff Comments                                                                                                                 |   | 26                              |
| Item                        2.  |        | Properties                                                                                                                                                       |   | 26                              |
| Item                        3.  |        | Legal                        Proceedings                                                                                                                         |   | 26                              |
| Item                        4.  |        | Submission                        of Matters to a Vote of Security Holders                                                                                       |   | 27                              |
|                            |   |                                                                                                                                                             |   |                            |
| PART II                         |   |                                                                                                                                                             |   |                            |
|                            |   |                                                                                                                                                             |   |                            |
| Item                        5.  |        | Market                        for Registrant’s Common Equity, Related Stockholder Matters and                        Issuer Purchases of Equity Securities |   | 30                              |
| Item                        6.  |        | Selected                        Financial Data                                                                                                                   |   | 32                              |
| Item                        7.  |        | Management’s                        Discussion and Analysis of Financial Condition and Results of                        Operations                        |   | 33                              |
| Item                        7A. |        | Quantitative                        and Qualitative Disclosures about Market Risk                                                                                |   | 41                              |
| Item                        8.  |        | Financial                        Statements and Supplementary Data                                                                                               |   | 42                              |
| Item                        9.  |        | Changes                        in and Disagreements with Accountants on Accounting and Financial                        Disclosure                               |   | 64                              |
| Item                        9A. |        | Controls                        and Procedures                                                                                                                   |   | 64                              |
| Item                        9B. |        | Other                        Information                                                                                                                         |   | 65                              |
|                            |   |                                                                                                                                                             |   |                            |
| PART                        III |        |                                                                                                                                                                  |   |                            |
|                            |   |                                                                                                                                                             |   |                            |
| Item                        10. |        | Directors                        and Executive Officers of the Registrant                                                                                        |   | 66                              |
| Item                        11. |        | Executive                        Compensation                                                                                                                    |   | 66                              |
| Item                        12. |        | Security                        Ownership of Certain Beneficial Owners and Management and Related                        Stockholder Matters                     |   | 66                              |
| Item                        13. |        | Certain                        Relationships and Related Transactions                                                                                            |   | 66                              |
| Item                        14. |        | Principal                        Accountant Fees and Services                                                                                                    |   | 66                              |
|                            |   |                                                                                                                                                             |   |                            |
| PART                        IV  |        |                                                                                                                                                                  |   |                            |
|                            |   |                                                                                                                                                             |   |                            |
| Item                        15. |        | Exhibits                        and Financial Statements                                                                                                         |   | 67                              |
|                            |   |                                                                                                                                                             |   |
| SIGNATURES                      |        |                                                                                                                                                             | 71     |

Page 3

----

**PART            I**

|                               |         |
|------------------------------------|--------------|
| **ITEM                        1.** | **BUSINESS** |

**Overview**

We create educational software            that accelerates learning by improving the processing efficiency of the brain. Based on            more than 30 years of neuroscience and cognitive research, the *Fast            ForWord*® family of products provides struggling readers with            computer-delivered exercises that build the cognitive skills required to read and learn            effectively.

Our products are marketed            primarily to K-12 schools in the United States. While we recommend our *Fast            ForWord* products as a reading intervention solution for struggling, at-risk, and            special education students, schools successfully use *Fast ForWord* products for            students with a wide range of abilities and accomplishments to improve their academic            performance.

The ability to read effectively            is essential for success in school and in life. Federal education policy has long            emphasized the importance of reading; the No Child Left Behind Act of 2002 calls for            all students to read at grade level by 2014. According to the United States Department            of Education (“USDE”), in 2007, 33% of fourth graders in the United States            had reading scores below basic and 67% were not proficient in reading. Among students            eligible for free or reduced-price lunches, the USDE found that 83% of fourth graders            were not proficient in reading. According to the USDE, between 1992 and 2007, there was            only a modest improvement in the proportion of fourth graders reading below the basic            level, despite a national focus on reading and significant and increased federal            funding.

Since our inception, learners            have used our *Fast ForWord* products over 1.1 million times, and almost 5,200            schools have purchased at least $10,000 of our *Fast ForWord* product licenses and            services.

The Scientific            Learning® family of products is distinguished by its basis in            independent and peer-reviewed scientific research, specifically in neuroscience. The            understanding that the organization of the brain can be modified throughout life            through experience - the concept of brain plasticity - led us to create a novel            approach to learning. This approach focuses on increasing learning capacity by            improving basic cognitive skills through the rigorous and systematic application of            neuroscience principles. Our approach uses computer technology because it affords the            only practical way to effectively and consistently deliver individualized training to a            large number of students simultaneously.

Our *Fast ForWord* family            includes 11 major software products that share this common neuroscience approach,            implemented in a variety of reading intervention contexts - early literacy development,            foundational language skills, linking spoken language and print, reading skills for            grade levels K-5 and adolescent intervention.

Our focus on science continues            in our emphasis on generating rigorous proof that our products produce substantial            improvements for different types of struggling readers in a variety of settings.            Through December 31, 2007, over 145 efficacy studies, including the results from more            than 32,000 aggregate participants, demonstrate the academic gains achieved through the            *Fast ForWord* products. These studies show gains for students at all K-12 grade            levels, for at-risk students, special education students, English language learners,            Title One students, and a variety of other demographic groups. Gains have been            demonstrated throughout the United States and in eight other countries. Studies show            that these gains endure over time.

To assist educators in getting            the best results from their *Fast ForWord* implementations, we offer a            web-delivered data analysis and reporting tool that uses sophisticated algorithms to            provide diagnostic and prescriptive information and intervention strategies. This            allows educators to track student progress and move students appropriately through the            product sequence. To achieve the best results with our products, it is important that            educators adhere to our protocols for product use. To support and encourage these best            practices in the use of our products, we provide a variety of on-site, web-based and            telephone-based services and support.

On January 7, 2008, we completed            the acquisition of substantially all of the assets of Soliloquy Learning, including the            Reading Assistant product, for $10.7 million in cash. The Scientific Learning Reading            AssistantTM combines advanced speech recognition technology with scientifically            based courseware to help students strengthen fluency, vocabulary and comprehension to            become proficient life-long readers.

Page 4

----

**Growth            Strategy**

Our strategic goal is to have            our products become widely accepted by educators as a solution that dramatically            improves and sustains achievement patterns to meet the needs of a broad spectrum of            learners across a variety of academic subjects.

Critical elements of our            strategy include:

|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | **Broadening                        Educator Awareness of Our Products.** We intend to increase awareness of                        our products, including their impact on reading and learning and the                        research behind them, through a variety of marketing techniques, including                        an increased number of brain science events that we sponsor or                        co-sponsor.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Establishing                        Rigorously Proven Student Results as an Important Criterion in the                        Selection of Educational Products.** Educators select products for their                        students based on many factors. We believe that we have demonstrated our                        products’ positive impact on student achievement with an                        exceptionally high degree of scientific rigor. Our marketing strategy is                        designed to focus educators on our results, the depth of the science                        validating those results, and the importance of those results to their                        decision-making process.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Focusing Our                        Sales Efforts on Key School Districts**. We plan on continuing to target                        those school districts that are struggling with academic under-achievement,                        have high levels of funding and are headed by strong leaders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Increasing Sales                        Capacity and Productivity.** We intend to increase our selling resources,                        including improving our sales infrastructure and adding additional tools                        and training programs for our sales force to shorten sales cycles and to                        increase the number of transactions valued at over $100,000. We have                        increased our sales force by over 50% since 2004 and plan substantial                        additional increases this year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Emphasizing                        Post-Sales Support.** We believe that effective implementation of our                        products in compliance with our protocols is important to obtaining the                        best student results. To help schools follow best practices in their                        implementations, we plan to continue to emphasize post-sales support,                        including implementation services and results monitoring, and to continue                        to explore innovative and cost-effective ways to provide these                        services.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Improving and                        Expanding Our Products**. We continue to look at ways to improve our                        product lines to enhance ease of use and product effectiveness. We                        introduced the Reading Progress Indicator assessment in June 2007. This                        product is designed to provide customers with a rapid and convenient way to                        measure a student’s reading skills before and after use of our                        *Fast ForWord* products. We introduced shortened daily protocols for                        all of our *Fast ForWord* products and now have consistent protocols                        across all our *Fast ForWord* products. The new, shortened protocols                        are designed for use 30 minutes per day, over a longer overall time period.                        The limited availability of time and computers in schools is an obstacle to                        use of our products. By shortening the protocols, we believe that these new                        protocols will offer our customers valuable additional                        flexibility. |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Identifying and                        Expanding into Other New Product Areas.** We continue to identify and                        evaluate potential new applications for our neuroscience-based technology.                        These include additional products to be marketed specifically for average                        and gifted students, English language learners, test preparation and                        improving mathematics skills. While we do not currently have any of these                        products in development, we may pursue such expansion organically, through                        acquisitions, or through technology or product licensing                        agreements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   | Ø | **Increasing Our                        Global Presence, Particularly in Asia.** We believe that the global                        demand to learn English is significant, particularly in India and China. As                        of December 31, 2007, we had 24 value-added resellers, or VARs, and were                        selling in 42 countries outside the US and Canada, and we plan to increase                        that number.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

Page 5

----

**Subsequent Event: Acquisition            of Reading Assistant**

On January 7, 2008 we completed            the acquisition of substantially all of the assets of the Soliloquy Learning business,            including the Reading Assistant product, from JTT Holdings (d/b/a Soliloquy Learning)            for $10.7 million in cash. Reading Assistant is a unique software tool that combines            advanced speech verification technology with scientifically-based interventions to help            elementary and secondary students strengthen their reading fluency, vocabulary and            comprehension in order to become proficient, life-long readers.

We acquired the Reading            Assistant product in order to serve a broader range of students, to broaden our            offering for English language learners for the US K-12 market as well as the            international market, and to further leverage our growing direct sales organization            with complementary product offerings. The National Reading Panel has identified five            major components of reading and literacy: phonemic awareness, phonics, fluency,            vocabulary and comprehension. Our Fast ForWord family of products addresses all of            these components, but is particularly strong in phonemic awareness and phonics. The            Reading Assistant product adds strength in fluency, vocabulary and comprehension,            thereby allowing us to address a broader range of student needs.

Soliloquy Learning was            established in 2000, and the Reading Assistant was introduced in 2002. The Reading            Assistant has been licensed to more than 800 elementary, middle and high schools at an            average price of $6,000 to $7,000 per site. We estimate that in the twelve months            ending December 31, 2007, Soliloquy Learning had approximately $1.9 million in revenue,            85% gross margins and a $2.8 million net loss (unaudited).

The Reading Assistant uses the            Carnegie Mellon University Sphinx speech recognition engine, which is publicly            available. Using this engine, the Soliloquy Learning team developed additional            proprietary technology specific to the needs of children and the education environment,            which is protected by one issued and seven pending patents.

Reading fluency is the ability            of a student to read quickly enough to garner meaning from a text, and is reported to            have a high correlation with overall reading proficiency. However, to become a fluent            reader, students must frequently read aloud and receive timely feedback and assistance            with their reading. Providing effective fluency training for all students is a            challenge in the classroom because teachers do not have enough resources and/or time to            give the consistent and rigorous one-on-one attention a child needs to improve his or            her reading fluency. Reading Assistant addresses this problem by acting as a personal            tutor. The program listens as a student reads aloud, monitoring for signs of difficulty            and providing immediate feedback and assistance when a child is challenged by a            word.

Students at all grade levels can            use the Reading Assistant. There are currently two content libraries of stories            available for the Reading Assistant, one for elementary school students and one for            secondary school students. To use the Reading Assistant, a student sits at a computer            station with headphones and an attached microphone. The student is presented with text            and as they read the text the computer will correct important mistakes and provide            feedback. The student can also ask for assistance in pronouncing a word or getting the            meaning of a word. Since the student is reading from a predetermined set of content,            the technology is actually performing speech verification versus the more complex task            of speech recognition.

Research on the efficacy of this            solution has been sponsored through grants from the National Institute of Child Health            and Human Development. The Florida Center for Reading Research reviewed the research on            the Reading Assistant solution, reporting on a study where students in the experimental            group showed statistically significant growth in reading fluency after using the            Reading Assistant compared to the control group. The report cited strengths of repeated            reading with emphasis on vocabulary and comprehension, rich and robust vocabulary            instruction and support, and immediate corrective feedback. They observed no            significant weaknesses. The Center also stated that the Reading Assistant is aligned            with current reading research.

Customers are using Reading            Assistant in a variety of environments including computer labs and classrooms.            Typically school sites have used the product at least 10 to 15 minutes a day, three            days a week. The teachers and administrators like the fact that students can practice            their reading in a nonthreatening environment listening or reading aloud to the            computer without fellow students or adults listening.

In addition to the Reading            Assistant product, we have added 19 staff from the Reading Assistant team. They will            remain in Waltham, Massachusetts and will be responsible for continuing to build and            maintain the speech verification technology system as well as developing additional            content.

Page 6

----

We believe that teachers,            schools and districts will want a steady stream of fresh content for the Reading            Assistant for students to use in building their reading fluency across all grades and            content areas, and therefore developing additional content will be a priority. The            addition of the Reading Assistant also brings new opportunities to develop new speech            recognition products that can directly link to our Fast ForWord Language and Fast            ForWord Reading products. In addition, we plan to integrate the Reading Assistant with            our Progress Tracker reporting platform to provide a single platform across our product            portfolio.

Reading Assistant will be sold            through our existing sales channels. We plan to integrate the Reading Assistant into            our marketing efforts, including our Brain Events. We expect to sell Reading Assistant            both separately and in bundles with our *Fast ForWord* products.

The majority of Soliloquy            Learning’s business came from sales to K-12 public schools, however they also had            an OEM business they used to fund development. Reading Assistant will compete in the            same supplemental and interventional education market as *Fast ForWord* products.            We also may encounter competition from these OEMs who will be selling products based on            similar technology.

**Markets**

Our products are available            worldwide to educational institutions, speech and language clinics, and learning and            tutorial centers. Since our inception through December 31, 2007, learners have used our            *Fast ForWord* products over 1.1 million times, an increase of 35% over year-end            2006.

*United States K-12            Market*

Our sales are concentrated in            K-12 schools in the United States, which in 2007 were estimated to serve approximately            55.8 million students. In each of the last three fiscal years, the U.S. K-12 sector has            represented more than 90% of our revenue. Almost 5,200 schools have purchased at least            $10,000 of our *Fast ForWord* product licenses and services, compared to 4,500 at            the end of 2006. While our installed base is growing, these 5,200 schools represent a            small fraction of the nearly 125,000 K-12 schools in the United States.

We market our products primarily            as a reading intervention solution, to be used as an interventional or remedial            supplement to existing curriculum materials for struggling, at-risk, English language            learners (“ELL”), and special education students, at both the elementary            and secondary school levels to improve reading and learning. Despite a national focus            on reading and increased federal funding to improve reading proficiency and school            district accountability, independent evaluations of student performance have            demonstrated little improvement in reading results. According to the USDE, in 2005, 33%            of fourth graders in the United States had below basic reading scores and 67% were not            proficient in reading, and between 1992 and 2007, there was only a modest improvement            in the proportion of fourth graders performing at the “below basic” level.            Among students eligible for free or reduced-price lunches, the USDE found that 83% of            fourth graders were not proficient in reading.

Sales of our products are            included in the growing supplemental education materials segment of the overall            education materials market. Simba Information’s *Publishing for the PreK-12            Market 2007 – 2008 (April 2007)* estimates that:

|   |     |                                                                                                                                                                     |
|--------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | The total market for                        K-12 instructional materials is $8.58 billion, growing at 4.2%                                                               |
|   |     |                                                                                                                                                                     |
|        | Ø | The supplemental                        materials segment of that market is $4.29 billion                                                                                |
|   |     |                                                                                                                                                                     |
|        | Ø | The fastest growing                        supplemental market, technology based electronic courseware, is $856                        million and expected to grow 9.4% |

We do not compete in the            separate basal materials market (a $3.5 billion market, according to Simba), which            consists primarily of textbook programs that include student editions, teacher editions            and companion materials to teach particular scope and sequence of a subject area for a            span of grades. We also do not compete in the market for formative, summative or            clinical assessments, estimated by Simba to be $1.22 billion in 2007, or in the market            for school library and reference products.

The educational materials market            is expected to continue to grow, driven by several factors:

Page 7

----

|   |     |                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | Increasing                        **enrollment** of pre-K-12 students, projected by the National Center                        for Education Statistics of the U.S. Department of Education to grow from                        55.8 million students in 2007 to 59.8 million students in 2016.                                                                                                     |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                |
|        | Ø | Performance and                        educator **accountability** requirements of federal legislation,                        including the No Child Left Behind Act of 2002, and persistent achievement                        gaps based primarily on income and ethnicity which are driving the use and                        growth of programs addressing the needs of struggling readers.   |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                |
|        | Ø | Increase in current                        **expenditures** per student. Current expenditures per pupil in constant                        2004/05 dollars increased 23% from 1991/92 to 2003/04. From 2003/04 to                        2016/17, current expenditures in constant 2004/05 dollars per pupil are                        projected to increase 30 percent, to approximately $11,000. |

The pre-K-12 education materials            market includes approximately 14,000 public school districts, 97,000 public schools and            28,000 private schools. Purchasing decisions for *Fast ForWord* products are            primarily made by district level administrators.

*No Child Left Behind Act of            2002*

The Elementary and Secondary            Education Act of 2001, commonly known as the No Child Left Behind Act            (“NCLB”), concentrates on increased accountability in the public school            system. The bill focuses on reducing the achievement gap between students of different            ethnic backgrounds and ensuring that every child can read at his or her grade level.            The primary influence of NCLB was to make schools and district more accountable for            performance through testing and reporting of student progress at the student sub-group            level – English Language Learners, Title 1 Students and Special Needs students            are all measured within their sub-groups to ensure performance is being achieved. As a            result, schools are demanding proven, research-based reading interventions that can            bring these subgroups to grade level proficiency quickly.

Because of our ongoing            commitment to proven, research-based reading interventions, we continue to be ideally            positioned to offer schools compelling solutions to bring all students up to grade            level proficiency quickly. Our family of products is based on more than 30 years of            neuroscience and cognitive research the results of which are supported by independent            academic researchers and school districts, as well as by our founding scientists and            our company’s own studies.

The No Child Left Behind Act is            scheduled for reauthorization after the 2008 presidential election. Some aspects of No            Child Left Behind, in particular the emphasis on testing by sub-group and the            consequences of failing to meet specified achievement criteria, have been            controversial. We believe that while there may be some changes to No Child Left Behind,            these changes will not decrease the need to improve reading performance, the market for            our products or the federal funding supporting elementary and secondary            education.

*Accountability*

Parents and policy makers are            exerting greater pressure to hold teachers and administrators accountable for student            performance. School report cards, sanctions for lack of learner improvement, financial            incentives, school vouchers, extended day programs, enhanced intervention services,            professional development for teachers, and supplementary educational services            alternatives are some of the techniques used by states and the federal government to            increase local educator accountability and student performance. The *Fast ForWord*            products help schools respond to these accountability pressures in a variety of ways,            including:

|        |     |                                                                                                                                                                                                                                                      |
|--------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | Our products can                        improve academic achievement in students for whom other approaches have                        failed.                                                                                                            |
|   |     |                                                                                                                                                                                                                                                      |
|        | Ø | Our products can be                        used to increase the scores of children who are “on the bubble”                        (just below a desired score on an achievement test).                                                        |
|   |     |                                                                                                                                                                                                                                                      |
|        | Ø | Educators can use                        Progress Tracker to track the progress of students by demographic group,                        responding to the requirement to achieve Adequate Yearly Progress for all                        defined groups. |

Page 8

----

*Funding            Sources*

Funding for educational            materials comes from a variety of federal, state and local sources. According to the            U.S. Census Bureau, in school year 2004/2005, 47% of district funding was from state            sources, 44% from local sources and 9% from federal sources. The federal government            spent $36.8 billion on elementary and secondary schools in 2007, up from $15 billion in            2000. Some funding sources are allocated for specific uses, such as improving reading            performance, depending on the policy objectives of the funding source.

Federal funds are a critical            resource to help school districts address the needs of the most challenged learners.            The primary federal support for education dates back to 1965 with the introduction of            the Elementary and Secondary Education Act. We believe that a significant proportion of            our sales are funded by two key federal sources that support struggling readers. Title            One supplements funding for schools with low income students; IDEA provides funding for            special education students. These programs are projected to total $25.4 billion for            fiscal year 2008 compared to $16.1 billion in 2001, an increase of 58%.

*Other Markets*

In addition to selling to K-12            schools, we also sell to and through private practice professionals and learning            centers. These speech and language and other professionals recommend the use of our            products to appropriate clients and then supervise the use of the software, often in            connection with their other services. In 2007, approximately 600 non-school            professionals and entities in the United States and Canada used our products. While            this business is a small proportion of our overall business and has been essentially            flat over the last several years, the private practice professionals nevertheless            remain significant to us. They were our first market, and many have extensive knowledge            about our products and their use that can be valuable for us and our customers. These            professionals sometimes provide contract services to schools and from time to time            recommend our products for students in those schools.

Sales to countries other than            the United States and Canada are a small but growing part of our business. We are            developing a network of value added representatives to serve these markets. Since our            inception, international participants have used our products more than 11,800 times.            During 2007, *Fast ForWord* products were marketed to customers in 42 countries,            up from 29 in 2006. As of December 31, 2007, we were represented by 24 value-added            representatives, up from 21 at year end 2006. Research studies of the results of            *Fast ForWord* users in Australia, Germany, Singapore, India, Ireland and the            United Kingdom have demonstrated the efficacy of our products. International revenues            represented approximately 2% of our total revenues in 2007.

Our strategy for international            markets thus far has been conservative, so that we do not divert resources from our            U.S. K-12 market, but we believe the potential opportunity is significant. Outside the            United States and Canada, our products are used in three primary applications: in            tutoring and learning centers to strengthen academic skills, by clinical professionals            with relatively impaired children, and to assist in the acquisition of English as a            second language. English has become the second language of choice in most countries,            with approximately 340 million people speaking English worldwide. About one-fourth to            one-third of the population worldwide now understand and speak English to some degree,            and English is the international language of business, travel, and diplomacy. While our            products do not provide all the components necessary to teach English to non-native            speakers, they have been demonstrated to be extremely effective in assisting in English            language instruction, through building the necessary underlying cognitive, acoustic            processing, phonological and other skills needed to learn and speak English            fluently.

We continue to explore and            evaluate other potential markets where our products can help struggling learners,            including correctional institutions and tutoring centers.

**Products**

Our *Fast ForWord* family            of products consists of award-winning software that combines neuroscience, cognitive            science and computer technology to change the neurological patterns in students’            brains. Our products build learning capacity by systematically and rigorously applying            proven neuroscience principles to develop the cognitive skills required to read and            learn effectively, using exercises based on language and reading skills. The results            from our products are fast, effective and enduring; results have been demonstrated            through brain imaging studies, changes in achievement on standardized reading tests and            more than 145 efficacy studies.

Page 9

----

*Cognitive Skills            Development*

Reading and learning require a            variety of foundational cognitive skills, all functioning together. The *Fast            ForWord* products build learning capacity by developing the prerequisite skills that            enable students to take greater advantage of their reading and other academic            instruction and improve their reading proficiency. *Fast ForWord* products do this            by building these cognitive skills, including memory, attention, processing and            sequencing (we refer to these as Learning MAPs).

*Memory.* Working memory is            the aspect of memory that allows one to keep information available while thinking about            meanings and relationships, and is used in sentence and paragraph comprehension,            remembering instructions and reasoning. The *Fast ForWord* exercises            systematically vary the amount of information that must be retained to successfully            complete the exercise task, using individually adaptive methods to gradually expand the            working memory demands of the task.

*Attention.* Attention is            the ability to focus on tasks and ignore distractions. Every exercise in our product            family requires selective and focused attention in order to advance. Specific vigilance            tasks require sustained attention over progressively longer time frames, building the            attentional skills needed in all reading and learning.

*Processing.* Processing            means the ability to address information such as images and sounds quickly enough to            discriminate their differences. Processing skills are an essential prerequisite for            phonemic awareness (the ability to distinguish among and manipulate the smallest sounds            in language that can change meaning) and reading. Our exercises build processing rate            and accuracy in the skills addressed by the exercises. For example, exercises in our            *Fast ForWord* Language to Reading and Literacy Advanced products focus on the            accuracy and rate of processing for letter-sound correspondence, leading to the            automaticity in those skills needed for reading.

*Sequencing.* Sequencing            refers to the ability to quickly and accurately determine the identity of specific            stimuli and the order in which the stimuli occur. This ability is supported by both            working and longer-term memory, attention, and processing. Sequencing of auditory,            language and written information is critical for the accurate understanding of meaning.            The *Fast ForWord* exercises systematically and individually adapt the complexity            of the sequencing tasks needed to develop phonemic awareness, word fluency, oral and            reading comprehension, and other critical cognitive operations.

*Neuroscience-Based Learning            Principles*

The *Fast ForWord* products            apply learning principles that have been established through neuroscience and cognitive            research as being critical to learning new tasks and establishing rapid change in brain            function: frequency and intensity, adaptivity, simultaneous development, and timely            motivation. In our marketing, we refer to our application of these principles as            *F.A.S.T. Power LearningTM*.

*Frequency and Intensity:*            The cortex of the human brain contains millions of neurons arranged in regions that            represent our sensory systems, control our motor systems and provide for higher-order            associative interactions. These regions contain networks of neurons that connect within            and between regions. These functional networks develop and maintain their connections            through a process that is driven by neural activity. The stronger the neural activity,            the stronger the network becomes. As a result, completing a series of learning tasks in            frequent, intense sessions is needed to make the changes in brain functioning that            enhance learning. Our product use protocols call for customers to use the products five            days a week, between 30 and 100 minutes (depending on the product) per day, providing            the frequency and intensity needed. The *Fast ForWord* products also contain            substantially more learning activities per 50 minute session than do other            computer-based reading intervention products, providing more intense neural activity            and therefore greater effectiveness.

*Adaptivity:* The            mechanisms of brain plasticity are best engaged in learning a new task when new            populations or new areas of neurons are engaged. Continually adjusting the learning            tasks to become progressively more difficult provides better cortical activation for            learning. The *Fast ForWord* products use sophisticated algorithms to analyze            student learning data using a complex set of rules. These algorithms regulate the            products’ speech modification rules and otherwise adjust content exposure to            advance the individual student through the products at a rate specifically tailored to            that student. The products adjust content exposure in a variety of ways. For example,            many of the exercises automatically adjust the specific content presented to the            student so that the student can make correct responses approximately 80% of the time            for each discrete skill. This adjustment is designed to keep cortical

Page            10

----

activation up and to keep the            exercises challenging and engaging, while allowing the student to experience a feeling            of accomplishment and to avoid the frequent failure that can discourage a            student’s learning.

*Simultaneous Development:*            Complex behaviors require the coincident and sequential engagement of multiple cortical            systems. The *Fast ForWord* products simultaneously develop both major and            supporting cognitive skills for enduring learning improvements. While each exercise is            designed to develop underlying cognitive skills such as memory, attention, processing            and sequencing, it also focuses on a specific set of reading or language            tasks.

*Timely Motivation:* A            critical factor in strengthening neural connections, and therefore maximizing critical            learning changes, is the input from the neuromodulatory reward systems that are            activated by meaningful consequences of behavior. These reward systems need to be            activated within tens of milliseconds of the neural synaptic activity to maximize the            potential for synaptic strengthening. In the *Fast ForWord* exercises, learners            are rewarded for a correct answer quickly, within this critical time frame, and on            their first attempt only, in order to drive learning behavior. To keep students active            and engaged, the products also feature a bonus point system and the delivery of special            animations that signify milestones as students progress.

*Products in the Fast ForWord            Family*

Since 1997, when we introduced the            first *Fast ForWord* product, our product family has expanded to 11 major software            offerings. During 2007, our *Fast ForWord* family of products accounted for 67% of            revenue. The software products function with a wide variety of hardware and software            configurations and are designed to work with the computer technology widely available            in schools.

|                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|----------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                  |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                  |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| **Product**                                                                      |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                             |   | **Language Series                        Products**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *Fast ForWord*Language Basics                                                    |   | *Fast ForWord*                        Language Basics targets early literacy development, building visual                        attention, auditory discrimination and sustained auditory attention, using                        exercises that improve sound sequencing skills, fine motor skills, hand-eye                        coordination, pattern recognition and color and shape                        identification.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *Fast ForWord*Language                                                           |   | Our first product,                        *Fast ForWord* Language builds learning capacity using exercises that                        specifically focus on oral language comprehension and listening, including                        phonological awareness (the understanding that words are composed of sounds                        and the ability to identify and manipulate the sounds of language),                        listening accuracy and comprehension, working memory, and familiarity with                        language structures. The *Fast ForWord* Language product uses                        acoustically modified speech, which stretches and emphasizes particular                        sounds in an adaptive manner, to help children learn to quickly isolate and                        recognize individual speech sounds, an underlying skill critical to                        reading. |
|                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *Fast ForWord*Language toReading                                                 |   | *Fast ForWord*                        Language to Reading software builds learning capacity through improving                        cognitive skills while helping students make the link between spoken and                        written language, using exercises that focus on listening comprehension,                        sound-letter recognition, phonological awareness, beginning word                        recognition and English language conventions.                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *Fast ForWord                        to*Literacy                                 |   | The *Fast                        ForWord* to Literacy product is specifically designed for adolescents                        and adults who lack reading proficiency. Its content and exercises are                        similar to those in the Fast ForWord Language product, but have been                        adapted to maximize impact for adolescents and English language learners                        based on actual learning results from those groups. Using graphics,                        characters and themes appealing to adolescents, the product progressively                        increases the demand on cognitive skills. This product replaces our earlier                        *Fast ForWord* Middle & High product.                                                                                                                                                                    |
|                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *Fast ForWord*                        to                        LiteracyAdvanced |   | *Fast ForWord*                        to Literacy Advanced software includes content and exercises similar to                        those in the *Fast ForWord* Language to Reading software. Like the                        Literacy product, the content has been tuned to maximize impact using                        actual learning results, and the user interface is designed to appeal to                        adolescents. The product includes age-targeted exercises that emphasize                        phonemic awareness, decoding, word recognition, sequential and inferential                        comprehension and the ability to sequence multi-step                        instructions.                                                                                                                                                                                                              |

Page            11

----

**Reading Series            Products**

The *Fast ForWord* to Reading            series of products builds learning capacity through developing cognitive skills using            exercises focused on critical reading abilities. The Reading Series exercises focus on            phonemic awareness, phonics and decoding, spelling, vocabulary, fluency and            comprehension. The content of each product is correlated to the reading standards for            the end of the grade level indicated by the product number. (Reading Prep is correlated            to kindergarten.) However, the increasingly demanding cognitive complexity of the            products can take the learner well beyond that grade level.

|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                      |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                      |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Product**                                          |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *Fast ForWord*                        toReading Prep |   | The *Fast                        ForWord* to Reading Prep product builds learning capacity through                        exercises that prepare the student for reading, focusing on phonemic                        identification, categorization and blending, letter names, sound and letter                        correspondence, rapid letter/word recognition, and oral                        vocabulary.                                                                                                                                                                                                                                  |
|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *Fast ForWord*                        toReading 1    |   | The *Fast                        ForWord* to Reading 1 product builds learning capacity while introducing                        familiarity with print. The exercises emphasize sound-letter                        correspondence, rapid letter-word comprehension, high-frequency words and                        beginning print comprehension.                                                                                                                                                                                                                                                                                                 |
|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *Fast ForWord*                        toReading 2    |   | *Fast ForWord*                        to Reading 2 software builds learning capacity through exercises that build                        a spectrum of reading skills, focusing on comprehension at the sentence and                        paragraph level, vocabulary, spelling, punctuation and capitalization. The                        product continues work in phonics and decoding and introduces morphological                        structures such as prefixes and suffixes. Morphology relates to the use of                        words, letters, and letter combinations that change the meaning of a                        word. |
|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *Fast ForWord*                        toReading 3    |   | The *Fast                        ForWord* to Reading 3 product builds learning capacity by continuing to                        improve cognitive skills through exercises that focus on increasing                        fluency. The exercises focus on semantic, syntactic, phonological and                        morphological categories, phonics, spelling and comprehension. Sentences in                        the exercise incorporate a high level of syntactic complexity. Syntax                        relates to how grammatical markers and words are combined to make                        meaningful sentences.               |
|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *Fast ForWord*                        toReading 4    |   | *Fast ForWord*                        to Reading 4 software builds learning capacity by improving cognitive                        skills in the context of a focus on text interpretation. The exercises                        focus on comprehension and vocabulary, and build word skills relating to                        compound works, prefixes and homophones.                                                                                                                                                                                                                                                                            |
|                                                 |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *Fast ForWord*                        toReading 5    |   | The *Fast                        ForWord* to Reading 5 product builds learning capacity by improving                        cognitive skills while strengthening advanced comprehension strategies. The                        exercises carry a significant working memory load, as they build                        vocabulary, improve critical thinking and abstract reasoning, improve                        composition skills, and focus on accuracy, fluency and                        comprehension.                                                                                                                                     |

Page 12

----

|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|-------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                           |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|                                           |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| **Product**                               |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|                                           |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                      |   | **Internet-Based                        Tools**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| *Progress                        Tracker* |   | Progress Tracker,                        our Internet-based data analysis and reporting tool, analyzes student                        learning results to provide diagnostic and prescriptive intervention                        information and allows educators to track and report their students’                        learning progress. It also provides information aligning the *Fast                        ForWord* products to basal reading programs and correlating the products                        to state standards. Progress Tracker generates status flags using                        sophisticated algorithms to analyze student learning data with a complex                        set of rules partially based on past data patterns. These status flags                        alert the educator when intervention is necessary for a student, and                        suggest to the educator when to move the student to a lower or higher level                        product or to complete product use. Progress Tracker provides detailed                        reports at the student, classroom, school, and district level, and can be                        reported by subgroup, providing a tool for educators to analyze their                        progress towards the Annual Yearly Progress requirements mandated by No                        Child Left Behind. Customers can configure the system to send automatic                        emails to parents, teachers, administrators or others to provide easy                        periodic updates. Progress Tracker also provides the ability to collect                        behavioral survey data from teachers and parents prior to and after product                        use. |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                      |   | In June 2007, we                        added Reading Progress Indicator to our Progress Tracker system. Reading                        Progress Indicator is a reliable and valid assessment of a student’s                        reading skills. It is designed to be quick and convenient to administer                        before and after *Fast ForWord* product use, to rapidly demonstrate                        the effectiveness of our products.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

*Product            Effectiveness*

Research by our school district            customers, independent academics and our own scientists has demonstrated that *Fast            ForWord* products improve language and reading skills across a broad spectrum of            demographic groups, and we continue to accumulate outcomes data from students in            classrooms across the country. To date, more than 145 research studies, including the            results from more than 32,000 aggregate participants, demonstrate the academic gains            achieved through the *Fast ForWord* products. Published studies show outcomes from            more than 455 learning organizations.

As of December 31, 2007, research            substantiating the outcomes that can be achieved through using the *Fast ForWord*            products includes:

|                                                                                                                                                                                                                                                                           |   |                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                              |   |                                                                                                                                                                                                                                                                     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                |        |                                                                                                                                                                                                                                                                                                                                                                           |        |                                                                                                                                                                                   |        |                                                                                                                                                                                                                                                                          |
| **By                        region**                                                                                                                                                                                                                                           |   | **Skills**                                                                                                                                                                                                                                                                                                                                                                |   | **Students**                                                                                                                                                                      |   | **Other**                                                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                |   |                                                                                                                                                                                                                                                                                                                                                                           |   |                                                                                                                                                                                   |   |                                                                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                                                                           |   |                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                              |   |                                                                                                                                                                                                                                                                     |
| **Northeast (38                        reports)**Connecticut,                        Delaware, Maryland,                        Massachusetts, New                        Jersey, New York,                        Pennsylvania, Rhode                        Island, Virginia |   | **State                        Assessments                        (39 reports)**BLT, DIBELS, DRP,                        DSTP, EOG, FCAT,                        ISAT, ITBS, LEAP,                        MCAS, MCT, MSA,                        OAT, OPT, SAT-9,                        TAAS, TAKS,                        TCAP, Terra Nova,                        TPRI |   | **At-Risk                        Learners                        (16 reports)**Oral Language,                        Phoneme Awareness,                        30 Minute Protocol |   | **Brain Plasticity                        is well-founded in research.** More than 30,000 articles relating to                        research on “Brain Plasticity” for the years 1967-2007 have                        been indexed by scholar.google.com. |

Page            13

----

|                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                       |        |                                                                                                                                                                                                                                                                                         |        |                                                                                                                                                                                                                                                                                                                                                             |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **By                        region**                                                                                                                                                                                                                                                                  |   | **Skills**                                                                                                                                                                                                                                                                              |   | **Students**                                                                                                                                                                                                                                                                                                                                                |   | **Other**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                                                                                                                                                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| **South (22                        reports)**Alabama, Arkansas,                        Florida, Georgia,                        Louisiana,                        Mississippi, North                        Carolina, South                        Carolina, Tennessee                                |   | **Reading                        Skills                        (119 reports)**Phoneme Awareness,                        Reading                        Comprehension,                        Vocabulary, Fluency,                        Listening                        Comprehension |   | **Title I                        Schools                        (28 reports)**Reading achievement                        results for                        elementary, middle                        and secondary                        schools                                                                                                          |   | **Independent                        reviews substantiate the research basis of the *Fast ForWord*                        products.** Independent reviews of the *Fast ForWord* research have                        been published by the USDE’s What Works Clearinghouse, the Metiri                        Group, the Florida Center for Reading Research and the Milken Family                        Foundation.                                                                                                                          |
|                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| **Midwest (30                        reports)**Illinois, Indiana,                        Kentucky, Michigan,                        Minnesota, Missouri,                        Ohio, South Dakota,                        Wisconsin                                                                  |   | **Cognitive                        Skills                        (11 reports)**Memory, Attention,                        Processing,                        Sequencing                                                                                                                  |   | **English                        Language                        Learners (7 reports)**Reading skills and                        achievement for                        elementary, middle                        and secondary                        schools                                                                                              |   | ***Fast                        ForWord* product effectiveness research continues to grow.** Research                        demonstrating the positive impact of *Fast ForWord* software has                        resulted in more than 145 research reports based on data from more than                        32,000 students at 455 schools.                                                                                                                                                                                                   |
|                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| **West (44                        reports)**Alaska, Arizona,                        Arkansas, California,                        Idaho, Kansas,                        Montana, New                        Mexico, Oklahoma,                        Texas, Washington,                        Wyoming |   | **Longitudinal                        Studies (4 reports)**State Assessments,                        Oral Language,                        Reading Skills                                                                                                                               |   | **Special                        Education                        Recipients                        (22 reports)**Dyslexia,                        Autism/PDD,                        Attention Deficit                        Disorder, Language                        Impairments,                        Developmentally                        Delayed |   | **Substantial &                        ongoing research impact by contributing scientists.** Scientists directly                        involved in the development of the *Fast ForWord* products have                        authored or co-authored more than 435 articles and book chapters in the                        fields of brain plasticity, neuropsychology and cognitive development. This                        foundational research has been cited more than 4,200 times in the                        scientific literature. |
|                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| **International                        Studies (8 reports)**Australia, Canada,                        Germany, India,                        Ireland, Singapore,                        United Kingdom                                                                                                |   | **Language                        Skills                        (33 reports)**Language Arts, Oral                        Language, Listening,                        Speaking, Syntax,                        Oral Grammar, Oral                        Vocabulary                      |   | **Other                        Populations                        (14 reports)**Gifted & Talented,                        Native Americans,                        Young Adults,                        Adjudicated                                                                                                                                     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                       |        |                                                                                                                                                                                                                                                                                         |        |                                                                                                                                                                                                                                                                                                                                                             |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

Highlights of this research            include:

|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|--------|----------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | Twenty-five studies                        involving more than 2,600 children have demonstrated *Fast ForWord*                        efficacy using well-controlled experimental or quasi-experimental study                        conditions and reliable and valid performance measures, including studies                        that use randomized control groups.                                                                                                                                                                                                                                                                                                                                     |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | Ø | The What Works                        Clearinghouse, established by the U.S. Department of Education’s                        Institute of Education Sciences, has reviewed the research on the effect of                        the Fast ForWord products on English Language Learners and Beginning                        Readers. Based upon studies that meet the What Works Clearinghouse’s                        high standards, the Clearinghouse has determined that the Fast ForWord                        products have positive effects.                                                                                                                                            |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | Ø | The underlying basis                        for these achievement gains is demonstrated by a Stanford University study                        published in 2003 in the *Proceedings of the National Academy of                        Sciences.* This study confirmed that after using the *Fast ForWord*                        Language product, students on average experienced significant changes in                        brain activation patterns as shown by functional magnetic resonance                        imaging. On average, the *Fast ForWord* participants also showed                        significant gains on measures of language and reading                        performance. |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | Ø | In an effort to                        determine the cause of the phonological deficit frequently seen in children                        with developmental dyslexia, researchers from Harvard, MIT, Dartmouth,                        Rutgers, and Stanford investigated differences in the cortical activity of                        typical reading children and children with                                                                                                                                                                                                                                                                                                                          |

Page            14

----

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | developmental                        dyslexia as they processed rapidly changing sounds. The results were                        published in *Restorative Neurology and Neuroscience* in 2007 and                        demonstrated that typical reading children process slowly and rapidly                        changing sounds in different cortical regions, while children with                        developmental dyslexia process them in the same region. Children with                        developmental dyslexia who underwent remediation with Fast ForWord products                        increased their language and reading skills, and the way they processed                        rapidly changing sounds changed, becoming more similar to that of typical                        readers. |

*Implementation*

We market the *Fast            ForWord* products primarily as an intervention solution, and our customers most            frequently use the products with students who are struggling. However, some customers            use the *Fast ForWord* software with all of their students. We provide our            customers with a placement chart that, based on a students grade level, achievement,            and demographics, recommends which product the student should use. We suggest that            students use two *Fast ForWord* products per year.

Neuroscience teaches us that to            facilitate the brain changes that lead to enhanced learning, the student needs to            complete a set of learning tasks in a frequent, intense timeframe. To provide that            intensity and frequency, we have established product use protocols for our *Fast            ForWord* products that call for customers to use the products five days a week,            between 30 and 90 minutes per day, for a period of generally between four and twelve            weeks (depending on the student and the product). It can be challenging for educators            to dedicate that much time to *Fast ForWord* use out of a limited and already            crowded school day. *Fast ForWord* implementation also competes with other            software applications for the limited number of school computers. To address this            challenge in 2007 we introduced protocols for all of our products designed for use 30            minutes per day. We believe the addition of this shorter daily protocol will offer our            customers valuable additional flexibility.

Our products are most frequently            used in a computer lab setting, either a lab entirely devoted to *Fast ForWord*            product use or a lab shared with other applications. A lab setting is likely to provide            the appropriate kind of quiet focused atmosphere that is best for *Fast ForWord*            use. Some customers have effectively used the products, especially the Reading series            products, in regular classrooms. We expect that the 30 minute protocols will facilitate            use in regular classrooms.

We encourage our customers to            use the products with as many students as their scheduling and computer resources            permit. In 2007, our customers with full site licenses to the Gateway Edition products            averaged 103 students per school using the products, up from 98 in 2006.

*License Terms*

We license our products in a            variety of configurations to meet the customer’s needs. Schools typically            purchase site or workstation licenses, which are available either as a perpetual            license or for a limited term. Most customers also purchase implementation services,            which we believe are important to encourage successful use of the products. Our            approximate license package list prices range from approximately $10,000 to $85,000 per            site, depending on the number of products, the number of workstations, the duration of            the license and the volume purchased.

Products licensed for            administration by private practice professionals are generally purchased on a per            product per student basis. Our Language and Reading series products presently list for            between $500 and $900 per product per student. The private practice professional            charges separately for his or her services. Hospitals, clinics and learning centers            purchase both per-product per-student licenses and site or workstation licenses,            depending on their size and needs.

**Fast ForWord Services and            Support**

We believe that the training and            implementation support provided by our service personnel is important to achieving            appropriate product use in schools, where a limited school day and competing priorities            makes it challenging for educators to devote the time and resources needed for a solid            implementation. The *Fast ForWord* products employ science and research unfamiliar            to many educators, and understanding these principles is key to successful and            sustained implementations. Our service professionals are highly trained and skilled at            building the necessary knowledge and best practices. In 2007, services, support and            Progress Tracker accounted for 33% of revenue, compared to 27% in 2006 and 25% in 2005.            As of December 31, 2007, our service and support organization

Page            15

----

included 58 employees            supplemented by 34 independent contractors who provide on-site customer training,            consulting and technical services.

*Services*

To facilitate effective            implementation, we offer on-site product training, technical installation,            implementation management, consulting, and professional development services. To help            our customers obtain the best possible student achievement results, our product            training and professional development sessions provide an extensive hands-on            introduction to our products, “best practices” implementation strategies,            and an introduction to the science behind our products. We also offer implementation            management services, which provide administrators a detailed overview of the            implementation at each of their schools, and consulting on data analysis and            interpretation, intervention and motivation strategies, connecting with classroom            teachers and other topics of interest to the customer.

We host national and regional            Circle of Learning user conferences and a spectrum of forums, workshops, and seminars            for customers and prospective customers. At these gatherings, speakers provide            information on advances in neuroscience and learning, and current customers offer            actual case studies on how our products impact student achievement. These sessions also            provide our customers with opportunities to network and develop informal support            relationships.

*Support*

For customers who purchase our            support services, we provide progress monitoring, software technical update releases,            and extensive telephone, email and web-based support. Our progress monitoring services            provide customers on-going remote monitoring of their students’ progress by our            staff, with periodic out-bound telephone contact tailored to the customer’s level            of implementation success. Our Customer Connect Website provides extensive            implementation and technical resources, together with Web-based seminars. In our annual            independent customer surveys, customers using *Fast ForWord* products gave            excellent ratings to the support they received and the professionalism of our support            team.

In 2006, we moved our basic            support services from the outside vendor that we had used for many years to our own We            Care support center located in Tucson, Arizona. We made this change to enhance our            service levels, increase the integration between support personnel and our technical            organization, and contain costs. We believe this move has met these objectives. At year            end 2007 we had 20 support professionals, compared to 15 at year end 2006.

**Warranty**

We generally provide a warranty            that our software products operate substantially as described in the manuals and guides            that accompany the software for a period of 90 days. The warranty excludes damage from            misuse, accident, and certain other circumstances. To date, we have not experienced any            significant warranty expense.

**Sales and            Marketing**

We sell to our principal market,            K-12 school districts throughout the United States, primarily using a direct sales            force. During the past two years, an important part of our strategy has been to            increase the size as well as the productivity of our direct sales force. In 2007, our            average number of field sales representatives was 49, an increase of approximately 17%            over 2006. We plan to continue to increase our field sales force. (We calculate the            annual average of field representatives by averaging the number of representatives at            the end of each quarter.)

Our field sales personnel            typically are experienced professionals with backgrounds in selling technology-based            curriculum products to the K-12 market. Most bring strong relationships with educators            built over many years. We support our sales representatives with a strong field sales            management team with extensive experience in this market and with strategic            consultants, who frequently are retired school district superintendents and other            senior district administrators, and who have extensive experience and relationships in            K-12 education. To reach smaller and rural schools, to a limited extent we also sell            our products through school consortiums and regional service centers.

We believe large booked sales            are an important indicator of mainstream education industry acceptance and an important            factor in reaching our goal of increasing sales force productivity. In 2007 we            continued to focus our sales force on multi-site sales. As a result, in the second            quarter of 2007, we closed the second largest transaction in our

Page            16

----

history with Duval County Public            schools. As a result of this transaction and other transactions closed this year and in            prior years, revenues from Duval County for 2007 were more than 10% of our revenues for            the year.

A critical component of our            marketing strategy is our brain science events. These are Company-sponsored or            cosponsored events that provide us with a significant period of time in which to            explain our neuroscience approach and achievement results, and have been particularly            effective selling opportunities. We also conduct direct marketing campaigns and            participate in selected trade shows. In our marketing, we emphasize the unique            characteristics of our solution, our neuroscience research basis, and our proven impact            on student achievement.

We sell to clinical            professionals and learning centers principally through direct marketing (mail, web and            telesales) and conferences (both industry conferences and an annual forum we conduct            ourselves).

We are also building a network            of independent value-added representatives outside North America. As of December 31,            2007, we had relationships with 24 representatives, compared to 21 at year end 2006. To            date, booked sales outside North America have not been significant. We are building            this channel to capitalize on the growing demand for English fluency around the world.            We believe that *Fast ForWord* products offer unique value in quickly            “rewiring” the brain for English. We also believe the international market            has large potential growth opportunities, and we are positioning to take advantage of            these in the future.

**Competition**

Districts and schools employ a            wide variety of learning intervention programs and methods for their struggling            students. The market for supplemental and interventional educational products is            fragmented and competitive, with no single company or product with a dominant market            share. We presently have a small share of the reading intervention supplemental            market.

The critical factor for K-12            school districts is the perceived ability of the product to further the            district’s instructional goals. Attributes that influence the district’s            assessment of this factor include the ability to deliver measurable improvements in            student achievement, cost, reputation, existing relationships with customers,            completeness of the product offering, ability to provide effective and efficient            product implementation, and ability to work with the other components of the school            curriculum. We believe that generally we compete favorably on the basis of these            factors.

Our patented products are highly            differentiated by their neuroscience basis and their focus on the development of            learning capacity through improving cognitive skills. While we therefore have little            direct competition, we do compete vigorously for available funding against other            companies offering educational software and other language and reading programs, as            well as with providers of traditional methods of teaching language and reading. Many of            the companies providing these competitive offerings are much larger than us, are more            established in the school market than we are, offer a broader range of products to            schools, and have greater financial, technical, marketing and distribution resources            than we do. Competitors may enter our market segment and offer actual or claimed            results similar to those achieved by our products. In addition, although the            traditional approaches to language and reading are fundamentally different from the            approach we take, the traditional methods are more widely known and accepted and,            therefore, represent significant competition for available funds.

**Product Development; New            Products**

The markets in which we compete            are characterized by frequent product introductions and evolving educational standards            and approaches. Our future success will depend in part on our ability to continue to            enhance and update our existing products or to develop and successfully introduce new            products.

Our research and development            expenses were approximately $4.5 million for the year ended December 31, 2007, and $4.1            million and $3.9 million for the years ended December 31, 2006 and, 2005, respectively.            As of December 31, 2007, 22 of our employees were engaged in research and development            activities, which include both product development and outcomes research.

*Development            Strategy*

Over the past several years, our            development efforts have focused on broadening our product solution and making our            products more effective and easier to use in the school environment. Since introducing            the first *Fast ForWord*

Page            17

----

product, we have broadened our            product line to include 11 neuroscience-based intervention products, and a robust suite            of Internet-based information tools and introduced a major new architecture for our            major products.

**Major Product            Introductions**

|                                                                                                                                                                                                                                                         |   |                                   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|
|                                                                                                                                                                                                                                                              |
| **Product**                                                                                                                                                                                                                                                  |   | **Launch                        year** |
|                                                                                                                                                                                                                                                              |   |                                        |
| *Fast ForWord*                        Language                                                                                                                                                                                                               |   | 1997                                   |
| *Fast ForWord*                        Language to Reading                                                                                                                                                                                                    |   | 1998                                   |
| *Away We Go!*                        product family (predecessors to *Fast ForWord* Language Basics and                        *Fast ForWord* to Reading Prep)                                                                                               |   | 1999                                   |
| *Fast ForWord*                        Middle and High School (predecessor to *Fast ForWord* to                        Literacy)                                                                                                                              |   | 1999                                   |
| *Fast ForWord*                        to Reading 3 (originally *Fast ForWord* Reading)                                                                                                                                                                       |   | 2000                                   |
| Progress                        Tracker                                                                                                                                                                                                                      |   | 2001                                   |
| *Fast ForWord*                        Gateway Edition (new architecture of our major products that improved ease                        of use, added additional student content and provided additional Internet                        based capabilities) |   | 2003                                   |
| *Fast ForWord*                        to Reading 4                                                                                                                                                                                                           |   | 2003                                   |
| *Fast ForWord*                        to Reading 1                                                                                                                                                                                                           |   | 2004                                   |
| *Fast ForWord*                        to Reading 2                                                                                                                                                                                                           |   | 2004                                   |
| *Fast ForWord*                        Language Basics                                                                                                                                                                                                        |   | 2005                                   |
| *Fast ForWord*                        to Reading Prep                                                                                                                                                                                                        |   | 2005                                   |
| *Fast ForWord*                        to Reading 5                                                                                                                                                                                                           |   | 2005                                   |
| *Fast ForWord*                        to Literacy                                                                                                                                                                                                            |   | 2006                                   |
| *Fast ForWord*                        to Literacy Advanced                                                                                                                                                                                                   |   | 2006                                   |
| Reading Progress                        Indicator addition to Progress Tracker                                                                                                                                                                               |   | 2007                                   |
|                                                                                                                                                                                                                                                              |

Our products rely on            market-tested technology and uniform platforms and are developed in a shared authoring            environment, so that customers can easily broaden their *Fast ForWord*            implementations, as well as move students easily among our products.

A critical component of our            process for enhancing our products and developing new products is our analysis of the            data uploaded to us through our Progress Tracker tool. This data is a unique and            valuable resource. Analyzing the patterns among groups of participants allows us to            understand, in detail, how students generally progress, where students have difficulty,            where intervention might be appropriate, and how these patterns differ by demographic            group. We can also identify trends in product use and efficacy that can help us develop            product improvements for specific sub-groups of learners.

*Reading Progress            Indicator*

In June 2007, we introduced the            Reading Progress Indicator assessment as a new component in our Progress Tracker data            system offering. Reading Progress Indicator is designed to provide customers with a            rapid and convenient way to measure students’ reading skills before and after            *Fast ForWord* product use. The Reading Progress Indicator assessment was            developed with and licensed from an independent third party, Bookette Software            Company.

Reading Progress Indicator is            designed to be a reliable and validated assessment of a student’s reading skills            that is correlated to nationally recognized normed assessments. Reading Progress            Indicator will show an overall reading score in the form of grade equivalents, normal            curve equivalents and percentiles. When a customer has licensed Progress Tracker with            Reading Progress Indicator, the assessment will be launched for each student when the            student begins and completes use of the *Fast ForWord* product. The assessment            will include two forms for each of four grade level tests.

*Product            Enhancements*

Our strategy is to devote much            of our current development resources to three major product enhancement            projects:

|        |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | *Updated                        Technology*: We are in the process of updating our products using a new                        development platform, which will allow us to make our user interfaces more                        appealing to students, permit better integration between our products and                        newer operating systems, and give us the capability of delivering our                        products over a web portal. Our two newest products, *Fast ForWord* to                        Literacy and *Fast ForWord* |

Page            18

----

|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |     | to Literacy Advanced                        were created using the Flash authoring environment for multi-media                        applications, and we have begun the process of converting all of our major                        products to Flash.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | Ø | *Major New                        Editions of Fast ForWord Language and Fast ForWord**Language to                        Reading*: We have also begun major new editions of our two oldest                        products, *Fast ForWord* Language and *Fast ForWord* Language to                        Reading. In this process, we are mining our student results database to                        find adjustments that will increase the efficiency and effectiveness of the                        products, updating the graphical interface and converting the authoring                        environment to Flash.                                                                                                                                                                                        |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | Ø | *Enhancements in                        Customer Use*: We are currently doing research to see if we can develop                        protocols for use of our *Fast ForWord* products that would be                        effective if used less than 5 days a week. If these protocols can be                        developed and found effective it could possible open additional markets                        such as learning centers or after school use, and make for easier                        implementations. We are working on a placement tool based on the Reading                        Progress Indicator assessment that will recommend a starting and a learning                        path for an individual student based on their achievement and other                        factors. |

We have not announced any            release dates for product upgrades and enhancements and we plan to charge for new            products or upgrades, where applicable.

*New Products*

We continue to evaluate            potential new applications for our neuroscience-based technology, and have identified a            number of potential development areas, including additional products to be marketed            specifically for average and gifted students, English language learners, test            preparation and improving mathematics skills. While studies have shown that the current            *Fast ForWord* products improve the math performance of learners by developing the            foundational skills of memory, attention processing and sequencing, there are other            cognitive skills also critical to math proficiency. We are in the early stages of            evaluating these potential product areas and have not reached any decision with respect            to whether to proceed in a particular area.

Unexpected challenges could make            these and other potential development projects longer or more expensive than planned.            In addition, new technology products usually contain bugs that are not discovered in            the testing process, and tend to be more challenging to implement when they are first            introduced, especially in the diverse and challenging K-12 technology environment. We            cannot guarantee that we will meet our intended introduction schedule for future            products, or that future products will be free of technical issues or that they will be            well received in the market.

**Intellectual            Property**

Our intellectual property            strategy addresses both product technology and product concepts. Our policy is to            protect our proprietary rights in our products and technology through a combination of            patents, trademarks, copyrights, trade secret laws, confidentiality procedures, and            contractual provisions.

At December 31, 2007, we held            the rights to 79 issued patents and 30 pending applications. These include 55 issued            U.S. patents and 20 pending U.S. applications that we own or co-own. We also held seven            issued patents from other countries and had nine applications pending abroad. We were            the exclusive licensee under 11 issued U.S. patents, six issued foreign patents, and            one pending foreign patent applications. The U.S. patents expire between 2014 and            2019.

We also have ten U.S. trademark            registrations, including registrations for marks including “*Fast            ForWord*,” our most important trademark.

The 18 patents and applications            that we license are owned by the Regents of the University of California, or the            Regents, and Rutgers, the State University of New Jersey, and relate to the basic            speech and sound modification and adaptive technology developed at those institutions.            In 2007, approximately 78% of our product booked sales was derived from selling            products that use the licensed inventions. This license is exclusive and extends for            the life of the University patents, which expire in 2014, subject to the right of the            Regents to terminate in case of default and our right to terminate at any time upon 60            days written notice. If we were to lose our rights under this license, it would            materially harm our business. This license requires payment of royalties based upon            cumulative net booked sales of our products, subject to certain minimum royalty            amounts. In 2006 and each year thereafter, the minimum

Page            19

----

royalty payment is $150,000. In            2007, 2006 and 2005, we had approximately $1,028,000, $868,000, and $1,048,000,            respectively in royalty expense under the license.

*Posit Science            Corporation*

In September 2003, we            transferred certain of our technology to Posit Science Corporation, or PSC, for use in            the healthcare field. The initial focus of PSC is on products to combat age-related            cognitive decline and to enhance cognitive abilities as people age. The transaction            included a license of the patents we own and certain software we developed, a            sublicense of the patents we license from the universities, and the sale of some            research-related assets. All of the rights licensed to PSC are limited to a specified            healthcare field and most of the licenses are exclusive in that field. For these            rights, PSC paid us a one-time initial fee, issued us shares in PSC and has an ongoing            royalty obligation. PSC has also agreed to cross-license any patents issued to PSC. We            retain all rights to our technology outside of the specified healthcare            field.

Dr. Michael M. Merzenich, who is            one of our founders, directors, significant stockholders and a former officer of ours,            is also a founder, director, significant stockholder and officer of PSC.

**Seasonality**

Our quarterly booked sales and            revenue fluctuate seasonally, reflecting a number of factors including school            purchasing practices, budget cycles and instructional periods. Historically, our booked            sales have been lowest in the first quarter of the year and highest in the second            quarter of the year.

**Backlog**

Our deferred revenue was            approximately $23.0 million as of December 31, 2007, and $19.2 million as of December            31, 2006. These deferred revenues are primarily composed of the portion of multi-year            sales, term-based sales, support and Progress Tracker sales not yet recognized as            revenue, and professional development and technical services that have not yet been            performed. Approximately $17.4 million of our deferred revenue as of December 31, 2007            is expected to be recognized within the next 12 months.

**Employees**

As of December 31, 2007 we had            215 full-time equivalent employees, compared to 197 at December 31, 2006. None of our            employees is represented by a union or subject to collective bargaining            agreements.

Page            20

----

|                                |                                    |
|-------------------------------------|-----------------------------------------|
| **ITEM                        1A.** | **RISK                        FACTORS** |

**RISK            FACTORS**

*The following factors as well            as other information contained in this report should be considered in making any            investment decision related to our common stock. If any of the following risks actually            occurs, our business, financial condition and results of operations could be materially            and adversely affected and the trading price of our common stock could            decline.*

**To grow our business, we need            to increase acceptance of our products among K-12 education purchasers. Failure to do            so would materially and adversely impact our revenue, profitability and growth            prospects.**

We believe that to date most            educators who have used *Fast ForWord* products are “early adopters.”            Early adopters make up a relatively small proportion of our K-12 market, so in order to            grow our revenue and profit, we need to increase our reach beyond early adopters to            more conservative customers. We believe that our ability to grow acceptance of our            products in the conservative K-12 education market will depend largely on the critical            factors discussed below.

Our *Fast ForWord* products            use an approach that differs from the approaches that schools have traditionally used            to address reading problems. In particular, our products develop the brain to process            more efficiently, are based on neuroscience research and focus on building cognitive            skills. All of these concepts may be unfamiliar to educators. K-12 educational            practices are slow to change, and it can be difficult to convince educators of the            value of a substantially different approach.

In order to obtain the best            student results from using our product, schools must follow a recommended protocol for            *Fast ForWord* use, which requires at least 30 minutes per day out of a limited            and already crowded school day. Our recommendation that schools follow a prescribed            protocol in using our products may limit the number of schools willing to purchase from            us. In addition, if our products are not used in accordance with the protocol, they may            not produce the expected student results, which may lead to customer dissatisfaction            and decreased revenue.

Our products are generally            implemented in a computer lab with a lab coach or teacher rather than in the classroom            with the students’ regular classroom teachers. To reach a broader group of            customers, encourage additional sales from existing customers and improve student            achievement results, we need to better engage classroom teachers in the products’            implementation, in an effective and efficient manner.

We encourage our customers to            purchase significant levels of on-site service because we believe that these services            enable more effective product use and lead to stronger student achievement gains. If we            are unable to continue to convince customers to purchase these levels of service,            customers may experience more difficulty with their implementations.

If we are unable to convince our            market of the value of our significantly different approach and otherwise overcome the            challenges identified above, our revenue and growth prospects could be materially and            adversely impacted and our profit could decline.

**Our sales cycle tends to be            long and somewhat unpredictable, which may result in delayed or lost revenue, which            could materially and adversely impact our revenue and profitability.**

Like other companies in the            instructional market, our sales to K-12 schools are affected by school purchasing            cycles and procedures, which can be quite bureaucratic. The cost of some of our K-12            license packages requires multiple levels of approval in a political environment, which            results in a time-consuming sales cycle that can be difficult to predict. When a            district decides to finance its license purchase, the time required to obtain necessary            approvals can be extended even further. In addition, sales to schools are subject to            budgeting constraints, which may require schools to find available discretionary funds,            obtain grants or wait until subsequent budget cycles. As a result, our sales cycle            generally takes months, and in some cases, can take a year or longer. Therefore, we may            devote significant time and energy to a particular customer sale over the course of            many months, and then not make the sale when expected or at all. This can result in            lost opportunities that can materially and adversely impact our revenue and            profit.

Page            21

----

**It is difficult to accurately            forecast our future financial results. This may cause us to fail to achieve the            financial performance anticipated by investors and financial analysts, which could            cause the price of our stock to decline.**

Our revenue and net income or            loss are difficult to predict and may fluctuate substantially from quarter to quarter            and from year to year. We started operations in February 1996 and through 2002 incurred            significant operating losses. In both 2006 and 2007, we had an operating loss and            modest net income. At December 31, 2007, we had an accumulated deficit of $76.7 million            from inception.

A significant proportion of our            customers’ purchases are made within the last two weeks of each quarter. We            therefore have limited visibility on revenue for the quarter until the end of the            quarter. If a customer unexpectedly postpones or cancels an expected purchase due to            changes in the customer’s objectives, priorities, budget or personnel, we may            experience an unexpected shortfall that cannot be made up in the quarter. The effect of            the concentration of sales at the end of the quarter is compounded by the fact that our            various license and service packages have substantially differing revenue recognition            periods. Even when the amount and timing of a transaction can be accurately projected,            it may be difficult to predict which license package a customer will            purchase.

In addition, our sales strategy            emphasizes district-level, multi-site transactions. The receipt or implementation of a            single large order, or conversely its loss or delay, can significantly impact the level            of sales booked and revenue recognized in a given quarter.

Our expense levels are based on            our expectations of future revenue and are primarily fixed in the short term. We may            not be able to adjust spending in a timely manner to compensate for any unexpected            revenue shortfall, which could cause our net income to fluctuate            unexpectedly.

Failure to achieve the financial            results expected by investors and financial analysts in a given quarter could cause an            immediate and significant decline in the trading price of our common stock.

**We may not achieve the            benefits we expect from our acquisition of the Reading Assistant product, which could            have a material adverse effect on our business, financial and operating            results.**

Our goals in acquiring the            Reading Assistant product are to provide additional products to serve a broader range            of students, to broaden our offering for English language learners for the US K-12            market as well as the international market, and to further leverage our growing direct            sales organization with additional complementary and effective products for sale. To            fully realize the anticipated benefits from the acquisition, we will face a number of            post-transaction challenges:

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | We must                        significantly increase the volume of sales over the level historically                        achieved by Soliloquy. In addition, if our understanding about the Reading                        Assistant product, its ease of use, efficacy, and acceptability to                        educators is not correct, it will be more challenging to reach our expected                        sales volume. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | • | We must successfully                        retain critical management and technical personnel who have joined us from                        the Soliloquy business.                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | • | We may experience                        unanticipated difficulties in further developing the Reading Assistant                        product. If so, development of product improvements and new products built                        on the Reading Assistant platform may be more costly and may take more time                        than we expect.                                                                               |

**We rely on studies of student            performance results to demonstrate the effectiveness of our products. If the validity            of these studies or the conclusions that we draw from them are challenged, our            reputation could be harmed and our business prospects and financial results could be            materially and adversely affected.**

We rely heavily on statistical            studies of student results on assessments to demonstrate that our products lead to            improved student achievement. Reliance on these studies to support our claims about the            effectiveness of our products involves risks, including the following:

Page            22

----

|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | •     | The results of                        studies depend on schools’ appropriately implementing the products                        and adhering to the product protocol. If a school does not do so, the study                        may not show that our products produce substantial student                        improvements.                                                                                                                                                                                                                                                                                               |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | **•** | Some studies on                        which we rely may be challenged because the studies use a limited sample                        size, lack a randomly selected control group, include assistance or                        participation from us or our scientists, or have other design                        characteristics that are not optimal. These challenges may assert that                        these studies are not sufficiently rigorous or free from bias, and may lead                        to criticism of the validity of the studies and the conclusions that we                        draw from them. |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | •     | Schools studying the                        effectiveness of our products use the product with different types of                        students and use different assessments, sometimes making it difficult to                        aggregate or compare results.                                                                                                                                                                                                                                                                                                                                                                 |

Our sales and marketing efforts,            as well as our reputation, could be adversely impacted if the studies upon which we            rely to demonstrate the effectiveness of our products, or the conclusions we draw from            those studies, are seen to be insufficient.

**If our products contain            errors or if customer access to our web-delivered products is disrupted, we could lose            new sales and be subject to significant liability claims.**

Because our software products            are complex, they may contain undetected errors or defects, known as bugs. Bugs can be            detected at any point in a product’s life cycle, but are more common when a new            product is introduced or when new versions are released. In the past, we have            encountered unexpected bugs in our products shortly after release. We expect that,            despite our testing, errors will be found in new products and product enhancements in            the future. Significant errors in our products could lead to:

|   |   |                                                                               |
|--------|--------|------------------------------------------------------------------------------------|
|   | • | delays in or loss of                        market acceptance of our products;     |
|   |   |                                                                               |
|   | • | diversion of our                        resources;                                 |
|   |   |                                                                               |
|   | • | a lower rate of                        expansion purchases from current customers; |
|   |   |                                                                               |
|   | • | injury to our                        reputation; and                               |
|   |   |                                                                               |
|   | • | increased service                        expenses or payment of damages.           |

Our Progress Tracker data tool            and the Web-enabled version of the Reading Assistant product both rely on the World            Wide Web in order to function. Unanticipated problems affecting our network systems            could cause interruptions or delays in the delivery of that product. The servers that            support Progress Tracker are currently located in a third-party co-location facility in            Sacramento, California. While we believe that the services provided by this facility            are robust, interruptions in customer access could be caused by the occurrence of a            natural disaster, power loss, vandalism or other telecommunications problems. We have            experienced problems due to power loss in the past, and we will continue to be exposed            to the risk of access failure in the future.

If our products do not work            properly, or if there are problems with customer access to Progress Tracker or the            Web-enabled version of Reading Assistant, we may be required to issue credits,            customers may elect not to renew their support or access contracts or not to purchase            additional licenses, we may lose sales to potential customers and we may be subject to            liability claims. We cannot be certain that the limitations of liability set forth in            our agreements would be enforceable or would otherwise protect us from liability for            damages. A material liability claim against us, regardless of its merit or its outcome,            could result in substantial costs, significantly harm our business reputation and            divert management’s attention from our operations.

**We will be required to comply            with the auditors’ attestation requirement of Sarbanes-Oxley Section 404 starting            in fiscal 2008 or fiscal 2009. If we or our auditors determine that our internal            controls over financial reporting are not effective or if we are unable to comply with            the auditors’ attestation requirement when we are required to do so, such            ineffective controls or non-compliance could have a materially adverse effect on            us.**

Page            23

----

Under Sarbanes-Oxley Section            404, as implemented by the SEC and PCAOB, we were required to provide an initial            management assessment on our internal control over financial reporting for fiscal 2007            and we have complied with that requirement in this Form 10-K.

Under current rules, we will be            required to provide an auditors’ attestation on our internal controls for fiscal            2008. However, the SEC has recently proposed extending the deadline for that            requirement so that, as long as we are a non-accelerated filer measured at June 30,            2008, we would not be required to comply with the auditor’s attestation            requirement until fiscal 2009. We cannot assure you that, in the course of completing            the work to satisfy the auditors’ attestation requirement, we or our auditors            will not detect a material weakness in our internal control over financial reporting or            that we can satisfactorily comply with the attestation requirement.

**Claims relating to data            collection from our user base may subject us to liabilities and additional            expense.**

Schools and clinicians that use            our products frequently use students’ names to register them in our products and            enter into our database academic, diagnostic and/or demographic information about the            students. In addition, the results of student use of our products are uploaded to our            database. We have designed our system to safeguard this personally-identifiable            information, but the protection of such information is an area of increasing public            concern and significant government regulation, including but not limited to the            Children’s Online Privacy Protection Act. If our privacy protection measures            prove to be ineffective, we could be subject to liability claims for unauthorized            access to or misuses of personally-identifiable information stored in our database. We            may also face additional expenses to analyze and comply with increasing regulation in            this area.

**Sales of our products depend            on the availability of government funding for public school reading intervention            purchases, which is variable and outside the control of both us and our direct            customers. If such funding becomes less available, our public school customers may be            unable to purchase our products and services on a scale or at prices that we            anticipate, which would materially and adversely impact our revenue and net            income.**

United States public schools are            funded primarily through state and local tax revenues, which are devoted primarily to            school building costs, teacher salaries and general operating expenses. Public schools            also receive funding from the federal government through a variety of federal programs,            many of which target children who are poor and/or are struggling academically. Federal            funds typically are restricted to specified uses.

We believe that the funding for            a substantial portion of our K-12 sales comes from federal funding, in particular IDEA            (special education) and Title One funding. The current federal budget deficit and            competing federal priorities may impact the availability of federal education funding.            A cutback in federal education funding could have a materially adverse impact on our            revenue.

State and local school funding            can be significantly impacted by fluctuations in tax revenues due to changing economic            conditions. States are forecasting shortfalls in their tax revenues for fiscal 2009,            because of the existing housing slump and a potential recession in the nationwide            economy. While education spending remains an important priority for states, it faces            competition from demands for relief for homeowners, transportation spending and rising            health care costs. An economic downturn leading to a significant reduction in state tax            revenues could have a materially adverse impact on our revenue.

The availability of funding for            instructional products like ours can also be affected by unpredictable events, such as            increases in energy costs or damage due to severe weather. We believe that severe            storms and spiking energy costs adversely impacted our sales in 2005. Unpredictable            events of similar magnitude could adversely impact our revenue in the            future.

**We compete for sales with            companies that have longer histories and greater resources than we do. We may not be            able to compete effectively in the education market.**

The market in which we operate            is very competitive. While our products are highly differentiated by their neuroscience            basis and their focus on improving brain processing efficiency and developing cognitive            skills, we nevertheless compete vigorously for the funding available to schools. We            compete not only against other software-based reading intervention products but also            against print and service-based offerings from other companies and against traditional            methods of teaching language and reading. Many of the companies providing these            competitive offerings are much larger than we are, are more established in the school            market than we are, offer a broader range

Page            24

----

of products to schools, and have            greater financial, technical, marketing and distribution resources than we do.            Encouraged by the No Child Left Behind Act, new competitors may enter our market            segment and offer actual or claimed results similar to those achieved by our products.            In addition, although traditional approaches to language and reading are fundamentally            different from our approach, the traditional methods are more widely known and accepted            and, therefore, represent significant competition for available funds.

**If we lose key personnel or            are unable to hire additional qualified personnel as necessary, we may not be able to            achieve our business goals, which could materially and adversely affect our financial            results and share price.**

We depend on the performance of            our senior management, sales, marketing, development, research, educational, finance            and other administrative personnel with extensive experience in our industry and with            our Company. The loss of key personnel could harm our ability to execute our business            strategy, which could adversely affect our financial results and share price. In            addition, we believe that our future success will depend in large part on our continued            ability to identify, hire, retain and motivate highly skilled employees who are in            great demand. We cannot assure you that we will be able to do so.

**Our current liquidity            resources may not be sufficient to meet our needs.**

We believe that cash flow from            operations will be our primary source of funding for our operations during 2008 and the            next several years. In 2007 and 2006, we generated $6.1 million and $4.3 million,            respectively, in cash from operating activities. We ended 2007 with $21.2 million in            cash and cash equivalents. We expended $10.7 million in cash in connection with the            acquisition of the Reading Assistant product line.

In addition, we have a line of            credit with Comerica Bank totaling $5.0 million, which expires on December 30, 2008. At            December 31, 2007 no borrowings were outstanding and we were in compliance with the            covenants of that line.

Funding our liquidity needs out            of cash flow from operations will require us to achieve certain levels of booked sales            and expenses. If we are unable to achieve sufficient levels of cash flow from            operations, or are unable to obtain waivers or amendments from Comerica in the event we            do not comply with our covenants, we would be required either to obtain debt or equity            financing from other sources, or to reduce expenses. Reducing our expenses could            adversely affect our operations by reducing the resources available for sales,            marketing, research or development efforts. We cannot assure you that we will be able            to secure additional debt or equity financing on acceptable terms, if at            all.

**If we are unable to maintain            our access to the intellectual property rights that we license from third parties, our            sales and net income will be materially and adversely affected.**

Our most important products are            based on licensed inventions owned by the University of California and Rutgers, the            State University of New Jersey. In 2007, we generated approximately 78% of our booked            sales from products that use this licensed technology. If we were to lose our rights            under these licenses (whether through expiration of our exclusive license period,            expiration of the underlying patent’s exclusivity, invalidity or unenforceability            of the underlying patents, a breach by us of the terms of the license agreements or            otherwise), such a loss of these licensed rights or a requirement that we must            re-negotiate these licenses could materially harm our booked sales, our revenue and our            net income.

**If we are unable to            adequately protect our intellectual property rights or if we infringe on the rights of            others, we could become subject to significant liabilities, need to seek licenses or            lose our rights to sell our products.**

Our ability to compete            effectively depends in part on whether we are able to maintain the proprietary aspects            of our technology and to operate without infringing on the proprietary rights of            others. It is possible that our issued patents will not offer sufficient protection            against competitors with similar technology, that our trademarks will be challenged or            infringed by competitors, or that our pending patent applications will not result in            the issuance of patents. Issued patents can prove to be invalid or unenforceable as a            result of a variety of reasons, including deficiencies in prosecution. As a result of            potential deficiencies during the prosecution of certain patents to which we have            rights, it is possible that these patents may be subject to a claim of unenforceability            or invalidity. If others are able to develop similar products due to the expiration,            unenforceability or invalidity of the underlying patents, the resulting competition            could materially harm our booked sales, revenue and net income. The Company

Page            25

----

historically has not registered            its copyrights in the United States, which may make it difficult to collect damages            from a third party that may be infringing a Company copyright. The degree of future            protection for our proprietary rights is also uncertain for products or product            improvements in early-stage development, because it is difficult to predict from            early-stage development efforts which product(s) will ultimately be marketed or what            form the ultimately marketed product(s) will take.

In addition, we could become            party to patent or trademark infringement claims, litigation or interference            proceedings. These proceedings could result from claims that we are violating the            rights of others or may be necessary to enforce our own rights. Any such proceedings            would result in substantial expense and significant diversion of management effort, and            the outcome of any such proceedings cannot be accurately predicted. An adverse            determination in such proceedings could subject us to significant liabilities or            require us to seek licenses from third parties, which may not be available on            commercially reasonable terms or at all. In addition, competitors may design around our            technology or develop competing technologies. Intellectual property rights may also be            unavailable or limited in some foreign countries, which could make it easier for            competitors to capture or increase their market share with respect to related            technologies.

We generally require the            execution of a written licensing agreement, which restricts the use and copying of our            software products. However, if unauthorized copying or misuse were to occur to a            substantial degree, our sales could be adversely affected.

**Our common stock is thinly            traded and its price is volatile.**

Our common stock presently            trades on the Nasdaq Global Market, and our trading volume is low. For example, for the            last three months of 2007, our average daily trading volume was approximately 43,000            shares. The market price of our common stock has been highly volatile since we became            publicly traded and could continue to be subject to wide fluctuations.

**The ownership of our common            stock is concentrated.**

At December 31, 2007, Trigran            Investments owned approximately 24% of our outstanding stock, and our executive            officers and directors held approximately 15% of the outstanding stock. As a result,            these stockholders are able to exercise significant influence over all matters            requiring stockholder approval, including the election of directors and approval of            significant corporate transactions, and may have interests that diverge from those of            other stockholders. This concentration of ownership may also delay, prevent or deter a            change in control of our company.

|                                |                                                 |
|-------------------------------------|------------------------------------------------------|
| **ITEM                        1B.** | **UNRESOLVED STAFF                        COMMENTS** |

Not applicable

|                               |           |
|------------------------------------|----------------|
| **ITEM                        2.** | **PROPERTIES** |

We lease approximately 30,500            square feet of office space in Oakland, California for our headquarters under a lease            that expires in December 2013. The lease includes two five-year options to extend the            term of the lease. We also lease approximately 2,500 square feet of office space in            Tucson, Arizona for our support center under a lease that expires in 2009. In early            2008, we entered into a new lease for our Reading Assistant operations in Waltham,            Massachusetts for approximately 6,000 square feet that expires in September 2011. We            are currently evaluating our space requirements in Tucson, Arizona and may lease            additional space in that area. We believe our other facilities are sufficient for our            operations currently and should be adequate to meet our needs for at least the next two            years.

|                               |                                         |
|------------------------------------|----------------------------------------------|
| **ITEM                        3.** | **LEGAL                        PROCEEDINGS** |

Litigation with Former Sales            Representative

On January 23, 2008, Robert G.            (Jerry) Smith, a former account manager in Florida, filed a complaint against us in US            District Court for the Middle District of Florida. The lawsuit claims breach of            contract for unpaid wages of approximately $423,000. Smith alleges that he is owed            additional commission relating to large sale transaction in the second quarter of 2007.            We are in the early stages of this proceeding. Discovery has not yet            started.

Page            26

----

Litigation with School            District Customer

On October 22, 2007, we were            sued by the Christina School District (the “District”) in the US District            Court for the District of Delaware. The District had previously been sued by investors            who are the assignees of the lessor under a Master Lease Purchase Agreement (the            “Lease Agreement”) entered into by the District in 2003. The District            ceased making payments under the Lease Agreement and the investors have claimed that            the District breached the Lease Agreement. The District filed a third party complaint            against us, claiming that we must refund amounts paid to us by the District for            training and consulting under our contracts with the District. Because the District            decided not to use our products, it did not therefore use all of the services specified            in the contract. The third party complaint alleges unjust enrichment against us. The            District states that the amount it is seeking is approximately $220,000. We have filed            a motion to dismiss the complaint, which has not yet been decided.

We believe that these claims are            not meritorious and that we do not have any significant liability to these claimants..            We therefore do not believe that the resolution of these matters will have a material            adverse effect on our financial position or results of operations.

|                              |                                                                           |
|-----------------------------------|--------------------------------------------------------------------------------|
| **ITEM                        4** | **SUBMISSION OF                        MATTERS TO A VOTE OF SECURITY HOLDERS** |

None

Page            27

----

**EXECUTIVE            OFFICERS**

The following table sets forth            various information concerning our executive officers, as of March 10, 2008:

|                                          |   |   |   |                                                                                    |
|-----------------------------------------------|--------|--------|--------|-----------------------------------------------------------------------------------------|
| NAME                                          |   | AGE    |   | POSITION                                                                                |
|                                               |   |        |   |                                                                                         |
|                                          |
| Robert C.                        Bowen        |   | 66     |   | Chairman and Chief                        Executive Officer                             |
|                                          |   |   |   |                                                                                    |
| D. Andrew                        Myers        |   | 36     |   | President and Chief                        Operating Officer                            |
|                                          |   |   |   |                                                                                    |
| Linda L.                        Carloni       |   | 54     |   | Vice President,                        General Counsel and Corporate Secretary          |
|                                          |   |   |   |                                                                                    |
| Glenn G.                        Chapin        |   | 52     |   | Vice President,                        Sales                                            |
|                                          |   |   |   |                                                                                    |
| Jane A.                        Freeman        |   | 54     |   | Executive Vice                        President, Chief Financial Officer, and Treasurer |
|                                          |   |   |   |                                                                                    |
|                                          |   |   |   |                                                                                    |
| Dr. William M.                        Jenkins |   | 57     |   | Sr. Vice President,                        Product Development                          |
|                                          |   |   |   |                                                                                    |
| Jessica                        Lindl          |   | 34     |   | Vice President,                        Marketing                                        |
|                                          |   |   |   |                                                                                    |
| Gillian A.                        McCormack   |   | 52     |   | Vice President,                        Operations                                       |

***Robert C. Bowen***            joined us as Chairman and Chief Executive Officer in June 2002. From 1989 to 2001, he            served as a senior executive and officer of National Computer Systems, a provider of            educational assessment and administrative software and services. His last assignment            there, from 1995 to 2001, was as President of NCS Education, a leading provider of            enterprise software for K-12 school districts. NCS was acquired by Pearson, PLC, in            2000. After retiring from NCS in 2001, Mr. Bowen consulted for various businesses in            education until joining us. Previously, Mr. Bowen held senior executive positions with            other leading education and publishing companies, including seventeen years with            McGraw-Hill. Early in his career, Mr. Bowen was a high school math teacher, a coach,            and a school district administrator. Mr. Bowen received his bachelor’s and            master’s degrees from the University of Tennessee, Chattanooga.

***D. Andrew Myers***            joined us as President and Chief Operating Officer in January 2008. Prior to joining            us, Mr. Myers worked at Pearson Education since 1997. His last position was as Senior            Vice President, Digital Product Development for Pearson Curriculum, where he was            responsible for integrating the technology teams from six preceding business units into            a digital development group of 275 employees. From August 2004 to March 2007, Mr. Myers            was the Chief Operations Officer for Pearson Digital Learning, where he was responsible            for setting product, financial, technical and operational strategies for that            580-employee business unit. From 2002 to 2004, Mr. Myers served as Vice President Sales            for Pearson Digital Learning. Mr. Myers started with Pearson as a sales representative            in 1996. Pearson Education is the education division of Pearson PLC, an international            media company. Mr. Myers holds an MBA from the Haas School of Business at the            University of California Berkeley and a BA in finance from the University of            Utah.

***Linda L. Carloni***            joined the Company as General Counsel in October 1999, became our Secretary in March            2000 and was appointed Vice President in June 2000. Before joining us, Ms. Carloni was            a founder and Vice President of Alere Medical Incorporated, a healthcare services            start-up. Earlier in her career, Ms. Carloni worked in technology transfer for the            University of California, was the general counsel of Nellcor Incorporated, a medical            device company, and was an associate and a partner at the Cooley Godward law firm. She            received her bachelor’s degree in political science from Case Western Reserve            University and her law degree from Boalt Hall School of Law at the University of            California, Berkeley.

***Glenn G. Chapin***            joined the Company in April 2001 as Vice President of K-12 Sales. Mr. Chapin brings to            his role with us more than 25 years experience working with schools to implement            technology based curriculum and management systems that impact teaching and student            learning. From 1995 to 2001, Mr. Chapin held sales executive positions at            CompassLearning, completing his service there as the Southern Region Vice President.            Prior to his post at CompassLearning, Mr. Chapin held sales executive positions at            National Computer Systems, where he held positions of increasing responsibility over a            15 year period, from serving as the Midwest territory sales representative and            rising

Page            28

----

to Southern Region Sales VP            prior to his departure. Mr. Chapin is a graduate of St. John Fischer College in            Rochester, New York where he received his Bachelor of Science degree in Business            Administration.

***Jane A. Freeman***            joined us as Vice President, Finance and Treasurer in August 1999 and was named Chief            Financial Officer in January 2000. She was appointed Senior Vice President in January            2004 and Executive Vice President in December 2007. She also served as our Vice            President Business Development from August 1999 until June 2000. Prior to joining us,            Ms. Freeman spent 20 years in the investment business. From 1988 through 1998, she was            employed by Rockefeller & Co., a global investment firm, where she led the global            asset allocation process, managed the US Small Cap equity product and served on the            Management Committee of the firm. She is a director of four mutual funds managed by            Harding Loevner LLP. Ms. Freeman holds a B.A. in mathematics and chemistry and an            M.B.A. (with distinction) from Cornell University and a License in Applied Economics            from the University of Louvain in Belgium.

***Dr. William M.            Jenkins*** was appointed Senior Vice President, Product Development in November            2000. Dr. Jenkins is a founder and served as our Vice President, Product Development            from June 1997 until November 2000. From March 1996 to June 1997, Dr. Jenkins was our            Vice President, Research and Development. From 1990 to 1996, Dr. Jenkins was an Adjunct            Associate Professor at the University of California, San Francisco. Dr. Jenkins is the            principal developer of our current software products. Dr. Jenkins holds a B.S. in            Psychology, an M.A. in Psychobiology and a Ph.D. in Psychobiology from Florida State            University, with additional post-doctoral training from UCSF.

***Jessica Lindl***            joined us as Vice President of Marketing in March 2007. Prior to joining us, Ms. Lindl            served as Vice President of Marketing and Product Management for Riverdeep, a leading            developer of educational software. Ms. Lindl held marketing management positions of            increasing responsibility at Riverdeep and The Learning Company, which was acquired by            Riverdeep, from 2001 through 2006. Prior to her tenure at Riverdeep, Ms. Lindl served            as the Director of Product Management for Simplexis, an e-procurement provider for the            K-12 market, in 2000 and 2001 and as part of the sales management team for AT&T in            San Francisco from 1995 to 1998. Ms. Lindl holds a bachelor’s degree in economics            and international studies from Miami University in Oxford, Ohio and an MBA from the            Haas School of Business at the University of California, Berkeley.

***Gillian A.            McCormack*** joined us as Vice President, Operations in October 2002. Prior to            joining us, Ms. McCormack had served as vice president of professional and technical            services for NCS Learn (Pearson Education) beginning in 2000. From 1994 through 2000,            she was the vice president of customer support for NovaNET, an E-learning company.            Earlier in her career, Ms. McCormack worked in management and field positions at            Jostens Learning, an educational software company. Ms. McCormack began her career as an            elementary and middle school teacher and was a master of teacher training in Tucson,            Arizona. She holds a bachelor of science in elementary education and a bachelor of            science in special education and learning disabled K-12 from the University of            Arizona.

Page            29

----

**ITEM 5.             MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED            STOCKHOLDER MATTERS**

(a) Market Information.            Our common stock currently is, and during all of 2006 and 2007 was, traded on the            NASDAQ Global Market under the symbol “SCIL”. (In 2006, the name of the            market was changed from the NASDAQ National Market to the NASDAQ Global            Market.)

The following table sets forth,            for the periods indicated, the closing high and low sales prices per share of our            common stock as reported on the NASDAQ Global Market.

|                                  |   |   |   |   |   |   |   |
|---------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| 2006                                  |   | High   |   | Low    |   |
| First                        Quarter  |   | $      | 5.96   |   | $      | 4.28   |   |
| Second                        Quarter |   | $      | 5.20   |   | $      | 3.91   |   |
| Third                        Quarter  |   | $      | 5.25   |   | $      | 3.82   |   |
| Fourth                        Quarter |   | $      | 6.09   |   | $      | 4.44   |   |
|                                  |   |   |   |   |   |   |   |
| 2007                                  |   | High   |   | Low    |   |
| First                        Quarter  |   |   | 7.72   |   |   | 5.28   |   |
| Second                        Quarter |   |   | 7.71   |   |   | 6.23   |   |
| Third                        Quarter  |   |   | 7.95   |   |   | 5.19   |   |
| Fourth                        Quarter |   |   | 6.49   |   |   | 4.98   |   |

Holders. As of January            31, 2008, the approximate number of stockholders of record of our common stock was            112.

Dividend Policy. We have            never declared or paid cash dividends on our common stock, and we do not anticipate            paying any cash dividends in the foreseeable future. Our current Loan and Security            Agreement with Comerica Bank provides that we may not pay any dividends other than            stock dividends during the term of the Agreement.

Securities Authorized for            Issuance under Equity Compensation Plans. For information regarding securities            authorized for issuance under equity compensation plans, see Item 12.

Performance Measurement            Comparison.

The following chart compares the            cumulative total stockholder return of Scientific Learning Common Stock for the five            years ended December 31, 2007 with the cumulative total return during the same period            of (i) the NASDAQ Composite Market Index and (ii) a Scientific Learning constructed            peer group index. The companies in the peer group index were selected on the basis of            similarity in the nature of their business. At December 31, 2007, the peer group            included Plato Learning, Inc., Princeton Review, Renaissance Learning Inc., and            Scholastic Corporation.

Over the last five years, the            peer group has changed from time to time because of acquisitions, changes in business,            and other changes affecting peer group companies. This table shows these            changes:

|                                                 |   |                                                                                                                                                      |
|------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
| Members of Peer                        Group         |   | Tenure in Peer                        Group                                                                                                               |
|                                                      |   |                                                                                                                                                           |
| Excelligence                                         |   | Removed from peer                        group after September 30, 2006 after it stopped trading.                                                         |
|                                                 |   |                                                                                                                                                      |
| Lightspan,                        Inc.               |   | Removed from peer                        group during 2003 upon its acquisition                                                                           |
|                                                 |   |                                                                                                                                                      |
| Riverdeep                                            |   | Removed from peer                        group during 2002 because its stock was moved from the Nasdaq to the Irish                        Stock Exchange |
|                                                 |   |                                                                                                                                                      |
| Smart                        Force                   |   | Removed from peer                        group during 2002 upon its acquisition                                                                           |
|                                                 |   |                                                                                                                                                      |
| Student                        Advantage             |   | Removed from peer                        group during 2002 when in the process of negotiating its sale                                                    |
|                                                 |   |                                                                                                                                                      |
| Sylvan Learning                        Systems, Inc. |   | Removed from peer                        group during 2003 because it changed the nature of its business.                                                 |

Page            30

----

The comparison assumes $100 was            invested on December 31, 2002 in Scientific Learning Common Stock and in each of the            foregoing indices. It also assumes reinvestment of dividends. The stock price            performance shown in the graph below should not be considered indicative of potential            future stock price performance.

Recent Sales of Unregistered            Securities; Use of Proceeds from Registered Securities. Not applicable

(b) Not applicable

(c) Not applicable

Page            31

----

|                               |                                               |
|------------------------------------|----------------------------------------------------|
| **ITEM                        6.** | **SELECTED                        FINANCIAL DATA** |

In thousands, except per share            amounts

|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
|-------------------------------------------------------------------------------------|--------|----------------------------------------------------|---------|----------|--------|----------|--------|----------|---------|----------|--------|---------|--------|--------|---------|--------|
|                                                                                |   | **Year Ended December                        31,** |    |
|                                                                                |   | **2007**                                           |    | **2006** |   | **2005** |   | **2004** |    | **2003** |   |
|                                                                                |   |                                                    |    |          |   |          |   |          |    |          |   |
| **Statement of                        Operations Data:**                            |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Revenues:                                                                           |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Products                                                                            |   | $                                                  | 31,023  |     | $      | 29,966   |   | $        | 30,263  |     | $      | 22,802  |   | $      | 24,491  |   |
| Service and                        support                                          |   |                                               | 15,030  |     |   | 11,032   |   |     | 10,056  |     |   | 8,174   |   |   | 5,425   |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Total                        revenues                                               |   |                                               | 46,053  |     |   | 40,998   |   |     | 40,319  |     |   | 30,976  |   |   | 29,916  |   |
| Cost of                        revenues:                                            |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Products                                                                            |   |                                               | 1,680   |     |   | 1,638    |   |     | 2,018   |     |   | 1,775   |   |   | 2,127   |   |
| Service and                        support                                          |   |                                               | 8,539   |     |   | 7,897    |   |     | 5,637   |     |   | 4,981   |   |   | 3,872   |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Total cost of                        revenues                                       |   |                                               | 10,219  |     |   | 9,535    |   |     | 7,655   |     |   | 6,756   |   |   | 5,999   |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Gross                        profit                                                 |   |                                               | 35,834  |     |   | 31,463   |   |     | 32,664  |     |   | 24,220  |   |   | 23,917  |   |
|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Operating                        expenses:                                          |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Sales and                        marketing                                          |   |                                               | 24,868  |     |   | 21,073   |   |     | 17,619  |     |   | 16,087  |   |   | 12,961  |   |
| Research and                        development                                     |   |                                               | 4,500   |     |   | 4,129    |   |     | 3,896   |     |   | 3,555   |   |   | 3,500   |   |
| General and                        administrative                                   |   |                                               | 7,660   |     |   | 6,643    |   |     | 5,841   |     |   | 5,313   |   |   | 4,529   |   |
| Restructuring                                                                       |   |                                               | — |     |   | —  |   |     | — |     |   | — |   |   | (7      | )      |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Total operating                        expenses                                     |   |                                               | 37,028  |     |   | 31,845   |   |     | 27,356  |     |   | 24,955  |   |   | 20,983  |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| **Operating income                        (loss)**                                  |   |                                               | (1,194  | )        |   | (382     | )      |     | 5,308   |     |   | (735    | )      |   | 2,934   |   |
| Other income from                        related party                              |   |                                               | 247     |     |   | 150      |   |     | 50      |     |   | 99      |   |   | 448     |   |
| Interest income                        (expense), net                               |   |                                               | 1,019   |     |   | 643      |   |     | 421     |     |   | (100    | )      |   | (1,209  | )      |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Net income (loss)                        before income tax                          |   |                                               | 72      |     |   | 411      |   |     | 5,779   |     |   | (736    | )      |   | 2,173   |   |
| Income tax provision                        (benefit)                               |   |                                               | (1,082  | )        |   | 203      |   |     | 182     |     |   | (43     | )      |   | 43      |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Net income                        (loss)                                            |   | $                                                  | 1,154   |     | $      | 208      |   | $        | 5,597   |     | $      | (693    | )      | $      | 2,130   |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Basic net income                        (loss) per share                            |   | $                                                  | 0.07    |     | $      | 0.01     |   | $        | 0.33    |     | $      | (0.04   | )      | $      | 0.13    |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Shares used in                        computing basic net income (loss) per share   |   |                                               | 17,161  |     |   | 16,846   |   |     | 16,715  |     |   | 16,408  |   |   | 16,007  |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Diluted net income                        (loss) per share                          |   | $                                                  | 0.06    |     | $      | 0.01     |   | $        | 0.31    |     | $      | (0.04   | )      | $      | 0.13    |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
| Shares used in                        computing diluted net income (loss) per share |   |                                               | 18,297  |     |   | 17,740   |   |     | 18,023  |     |   | 16,408  |   |   | 16,908  |   |
|                                                                                |   |                                                    |         |     |        |          |   |          |         |     |        |         |   |        |         |   |
|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| **Balance Sheet                        Data:**                                      |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
|                                                                                |   |                                               |    |     |   |     |   |     |    |     |   |    |   |   |    |   |
| Cash and cash                        equivalents                                    |   | $                                                  | 21,179  |     | $      | 16,364   |   | $        | 9,022   |     | $      | 10,281  |   | $      | 3,648   |   |
| Short-term                        investments                                       |   |                                               | — |     |   | —  |   |     | 3,043   |     |   | — |   |   | — |   |
| Working                        capital                                              |   |                                               | 7,862   |     |   | 3,951    |   |     | 2,842   |     |   | (3,986  | )      |   | (11,331 | )      |
| Total                        assets                                                 |   |                                               | 33,803  |     |   | 26,283   |   |     | 18,734  |     |   | 22,958  |   |   | 15,597  |   |
| Stockholders’                        equity (deficit) (1)                     |   |                                               | 5,820   |     |   | 1,017    |   |     | (1,835  | )        |   | (8,111  | )      |   | (8,544  | )      |

|   |                                                                       |
|--------|----------------------------------------------------------------------------|
| (1)    | We have paid no cash                        dividends since our inception. |

Page            32

----

**ITEM            7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF            FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS**

**Overview**

We develop and distribute the            *Fast ForWord* family of software. Our patented products build learning capacity            by rigorously and systematically applying neuroscience-based learning principles to            improve the fundamental cognitive skills required to read and learn. Extensive outcomes            research by independent researchers, our founding scientists, school districts and our            company demonstrates the rapid and lasting gains achieved through *Fast ForWord*            participation. Our products are marketed primarily to K-12 schools in the US, to whom            we sell through a direct sales force. To facilitate the use of our products, we offer a            variety of on-site and remote professional and technical services, as well as phone,            email and web-based support. Since our inception, learners have used our *Fast            ForWord* products over one million times and approximately 5,200 schools have            purchased at least $10,000 of our *Fast ForWord* product licenses and services. As            of December 31, 2007 we had 215 full-time equivalent employees, compared to 197 at            December 31, 2006.

On January 7, 2008, we completed            the acquisition of substantially all of the assets of Soliloquy Learning, including the            Reading Assistant product, for $10.7 million in cash. The Scientific Learning Reading            Assistant combines advanced speech recognition technology with scientifically based            courseware to help students strengthen fluency, vocabulary and comprehension to become            proficient life-long readers.

**Business            Highlights**

We market our *Fast            ForWord* products primarily as a reading intervention solution for struggling,            at-risk, English Language Learners, and special education students. Approximately 70%            of the estimated 55 million public and private school K-12 students in the United            States test as not proficient in reading. While our installed base is growing, the            approximately 5,200 schools that have purchased at least $10,000 of our product            licenses and services represent a small fraction of the approximately 125,000 K-12            schools in the US.

Federal education funds are a            critical resource in helping school districts address the needs of the most challenged            learners. We believe that a significant proportion of our sales are funded by federal            sources, particularly Title One and IDEA (special education) grants. In fiscal 2008,            these programs are projected to total $25.4 billion. States are forecasting shortfalls            in their taxation revenues for fiscal 2009 because of the existing housing slump and a            potential recession in the nationwide economy. Such shortfalls would have an impact on            education spending, although it is likely that education would remain among the top            priorities.

Sales of our products are            included in the growing supplemental education materials segment of the overall            education materials market. Simba Information’s *Publishing for the PreK-12            Market 2007 – 2008 (April 2007)* estimates that:

|   |     |                                                                                                                                                                     |
|--------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Ø | The total market for                        K-12 instructional materials is $8.58 billion, growing at 4.2%                                                               |
|   |     |                                                                                                                                                                     |
|   | Ø | The supplemental                        materials segment of that market is $4.29 billion                                                                                |
|   |     |                                                                                                                                                                     |
|   | Ø | The fastest growing                        supplemental market, technology based electronic courseware, is $856                        million and expected to grow 9.4% |

**Company            Highlights**

In 2007 total revenue increased            by 12% compared to 2006. This compares to an increase of 2% in 2006 compared to 2005.            We attribute our revenue increase primarily to:

|   |   |                                                                                                                                                                                           |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Our improved sales                        capacity resulting from additional sales representatives hired in 2006 who                        became productive in 2007.                         |
|   |   |                                                                                                                                                                                           |
|   | • | A continued focus                        within our sales organization on quickly closing transactions over                        $100,000, and on increasing the size of these transactions. |

Booked sales increased 16% in            2007 compared to 2006. Revenue increased at a slower rate than booked sales because in            2007 our sales mix contained a greater proportion of multiple year service and support            offerings, where a significant amount of revenue is to be recognized in future periods,            as compared to previous years. (For more explanation of booked sales, see Booked Sales            and Selling Activity, below.)

We also experienced continued            growth in our international sales, which increased 62% in 2007 compared to 2006,            following an increase of 112% in 2006 compared to 2005. In 2007, international sales            comprised approximately 2%

Page            33

----

of total sales, compared to 1.5%            in 2006. We conduct our international business through value-added representatives            (“VARs”). At December 31, 2007 we had 24 VARs selling in 42            countries.

We reported net income of $1.2            million in 2007, compared to net income of $0.2 million in 2006. The increase in net            income is primarily due to an income tax benefit of approximately $1.2 million arising            from the reduction of a portion of our deferred taxation valuation            allowance.

During 2007 we introduced our            Reading Progress Indicator service. While we are pleased with the initial results, the            incremental revenue from this additional offering was not significant in            2007.

We ended 2007 with $21.2 million            in cash and cash equivalents, and had no outstanding debt. We did not make use of our            credit line during 2007. Net cash generated from operating activities was $6.1            million.

In January 2008 we completed the            acquisition of the Soliloquy Reading Assistant product line and substantially all of            the other assets of the Soliloquy Learning business, based in Waltham, Massachusetts,            for cash consideration of $10.7 million. We estimate that as a direct result of this            acquisition our revenue and our operating expenses in 2008 will increase.

**Results of            Operations**

**Revenues**

|                                          |   |                                               |   |         |   |     |   |         |   |     |   |   |   |   |   |   |
|-----------------------------------------------|--------|----------------------------------------------------|--------|--------------|--------|----------|--------|--------------|--------|----------|--------|--------|--------|--------|--------|--------|
|                                          |   | **Year Ended December                        31,** |   |
|                                          |   |                                                    |
| (dollars in                        thousands) |   | **2007**                                           |   | ***Change*** |   | **2006** |   | ***Change*** |   | **2005** |   |
|                                               |        |                                                    |        |              |        |          |        |              |        |          |        |
| Products                                      |   | $                                                  | 31,023 |         | *4*    | *%*      |   | $            | 29,966 |     | *-1*   | *%*    |   | $      | 30,263 |   |
| Service and                        support    |   |                                               | 15,030 |         | *36*   | *%*      |   |         | 11,032 |     | *10*   | *%*    |   |   | 10,056 |   |
|                                               |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |        |        |
| Total                        revenues         |   | $                                                  | 46,053 |         | *12*   | *%*      |   | $            | 40,998 |     | *2*    | *%*    |   | $      | 40,319 |   |
|                                               |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |        |        |

*2007 revenue compared to            2006*: Product revenues, which comprise the majority of our revenue, increased            modestly in 2007 compared to 2006. The growth in product revenues was slower than total            revenues due to lower than expected product sales, and an increase in multiple year            service and support packages which include a lower proportion of product revenue. In            2007 one customer accounted for more than 10% of our total revenue. On average 48% of            booked sales in 2007 were recognized into revenue in the quarter in which the sale            occurred.

Our service and support revenue            increased significantly in 2007 compared to 2006 due to more services delivered and a            higher number of schools on support. At December 31, 2007 we had approximately 32% more            schools on support than at December 31, 2006. The increase in schools on support is            mainly due to our success in selling renewals to our growing installed base.

*2006 revenue compared to            2005*: Product revenue declined in 2006 compared to 2005 because we recognized            approximately $6.5 million less revenue from sales made in prior periods. This decrease            was almost offset by increased revenue recognized on sales booked in 2006. On average            52% of booked sales in 2006 were recognized into revenue in the quarter in which the            sale occurred.

Service and support revenue            increased in 2006 by 10%, primarily due to stronger sales of on-site services,            partially offset by a lower level of revenue recognized from sales made in prior years.            Service and support revenue also reflected the increase in the number of schools            purchasing ongoing Progress Tracker access and support contracts. We had 26% more            customers on support at December 31, 2006 than at December 31, 2005.

*Booked sales and selling            activity*: Booked sales is a non-GAAP financial measure that management uses to            evaluate current selling activity. We believe that booked sales is a useful metric for            investors as well as management because it is the most direct measure of current demand            for our products and services. Booked sales equals the total value (net of allowances)            of software, services and support invoiced in the period. Revenue on a GAAP basis is            recorded for booked sales when all four of the requirements for revenue recognition            have been met; if any of the requirements to recognize revenue are not met, the sale is            booked to deferred revenue. We use booked sales information for resource allocation,            planning, compensation and other management purposes. We believe that revenue is the            most comparable GAAP measure to booked sales. However, booked sales should not be            considered in isolation from revenue, and is not intended to represent a substitute            measure of revenue or any other performance measure calculated under GAAP.

Page            34

----

The following reconciliation            table sets forth our booked sales, revenues and change in deferred revenue for the            twelve months ended December 31, 2007, 2006 and 2005:

|                                                               |   |                                               |   |         |   |     |   |         |   |     |   |   |   |   |   |   |
|--------------------------------------------------------------------|--------|----------------------------------------------------|--------|--------------|--------|----------|--------|--------------|--------|----------|--------|--------|--------|--------|--------|--------|
|                                                               |   | **Year Ended December                        31,** |   |
| (dollars in                        thousands)                      |   | **2007**                                           |   | ***Change*** |   | **2006** |   | ***Change*** |   | **2005** |   |
|                                                                    |
| Booked                        sales                                |   | $                                                  | 49,849 |         | *16*   | *%*      |   | $            | 43,154 |     | *37*   | *%*    |   | $      | 31,538 |   |
| Less                        revenue                                |   |                                               | 46,053 |         | *12*   | *%*      |   |         | 40,998 |     | *2*    | *%*    |   |   | 40,319 |   |
|                                                                    |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |        |        |
| Net                        increase/(decrease) in deferred revenue |   |                                               | 3,796  |         |   |     |   |         | 2,156  |     |   |   |   |   | (8,781 | )      |
|                                                                    |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |        |        |
| Total deferred                        revenue end of period        |   | $                                                  | 22,955 |         | *20*   | *%*      |   | $            | 19,159 |     | *13*   | *%*    |   | $      | 17,003 |   |
|                                                                    |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |        |        |

Booked sales in the K-12 sector,            which accounted for over 91% of booked sales in 2007, increased 14% to $45.6 million            compared to $40.2 million in 2006. Booked sales in the K-12 sector were $28.4 million            in 2005.

We believe that the principal            reasons for the increase in 2007 booked sales are:

|   |   |                                                                                                                                                                                                                                                                                          |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Our improved sales                        capacity resulting from additional sales representatives hired in 2006 who                        became productive in 2007. We had an average of 49 quota bearing sales                        representatives in 2007, compared to 42 in 2006.    |
|   |   |                                                                                                                                                                                                                                                                                          |
|   | • | A continued focus                        within our sales organization on quickly closing transactions over                        $100,000, and on increasing the size of these transactions. Our 2007 sales                        included one transaction for approximately $7.4 million. |

The increase in booked sales in            2007 was smaller than the increase that we experienced in 2006. The large increase in            2006 was mainly because sales in 2005 in several key states had been depressed due to            severe weather conditions, spiking energy prices, and other factors that contributed to            general funding uncertainty.

We believe large booked sales            are an important indicator of mainstream education industry acceptance and an important            factor in reaching our goal of increasing sales force productivity. In 2007 we            continued to focus our sales force on multi-site sales, and we closed 90 transactions            in excess of $100,000 compared to 102 in 2006 and 59 in 2005. Although we closed fewer            large deals in 2007 than in 2006, the average size of these transactions increased            substantially, from approximately $285,000 in 2006 to approximately $349,000 in 2007.            The increase in average transaction size was mainly due to the impact of one            transaction for approximately $7.4 million. For the year ended December 31, 2007, 69%            of our K-12 booked sales were realized from sales over $100,000. For the comparable            periods ending December 31, 2006 and 2005, large booked sales accounted for 67% and 59%            of booked sales respectively.

Large booked sales include            volume discounts but the percentage discount applicable to any given transaction will            vary and the relative percentage of large sales and smaller sales in a given quarter            may fluctuate. Because we discount product license fees but do not discount service and            support fees, product booked sales and revenue are disproportionately affected by            discounting. We cannot predict the size, number and timing of large transactions in the            future.

Booked sales outside the K-12            market (primarily to the adult corrections market, private practice clinicians and            international customers) increased by 40% in 2007 compared to 2006, mainly due to the            impact of a large corrections sale. International sales increased by 62% in 2007            compared to 2006. Non K-12 sales in 2006 were flat relative to 2005.

Although federal, state and            local budget pressures make for an uncertain funding environment for our customers, we            are optimistic about our growth prospects in the K-12 market. However, achieving our            booked sales growth objectives will depend on increasing customer acceptance of our            products, which requires us to continue to focus on improving our products’ ease            of use, their fit with school requirements, and our connection with classroom teachers            and administrators. Our K-12 growth prospects are also influenced by factors outside            our control including the overall level, certainty and allocation of state, local and            federal funding. For a discussion of some of the other important factors that affect            our results, see *Risk Factors.* In addition, the revenue recognized from our            booked sales can be unpredictable. Our various license and service packages have            substantially differing revenue recognition periods, and it is often difficult to            predict which license package a customer will purchase, even when the amount and timing            of a sale can be reasonably projected. See *Management’s Discussion and            Analysis – Application of*

Page            35

----

*Critical Accounting            Policies* for a discussion of our revenue recognition policy. In addition, the            timing of a single large order or its implementation can significantly impact the level            of booked sales and revenue at any given time.

**Gross Profit and Cost of            Revenues**

|                                                               |   |                                               |   |     |   |     |   |   |   |   |
|--------------------------------------------------------------------|--------|----------------------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|
|                                                               |   | **Year Ended December                        31,** |   |
| (dollars in                        thousands)                      |   | **2007**                                           |   | **2006** |   | **2005** |   |
|                                                                    |
| Gross profit on                        products                    |   | $                                                  | 29,343 |     | $      | 28,328   |   | $      | 28,245 |   |
| Gross profit margin                        on products             |   |                                               | 95     | %        |   | 95       | %      |   | 93     | %      |
| Gross profit on                        service and support         |   |                                               | 6,491  |     |   | 3,135    |   |   | 4,419  |   |
| Gross profit margin                        on services and support |   |                                               | 43     | %        |   | 28       | %      |   | 44     | %      |
|                                                                    |        |                                                    |        |          |        |          |        |        |        |        |
| Total gross                        profit                          |   | $                                                  | 35,834 |     | $      | 31,463   |   | $      | 32,664 |   |
| Total gross profit                        margin                   |   |                                               | 78     | %        |   | 77       | %      |   | 81     | %      |
|                                                                    |        |                                                    |        |          |        |          |        |        |        |        |

The overall gross profit margin            improved slightly in 2007 compared to 2006. The increase in gross margin was driven            primarily by increased service and support margins, partially offset by a reduction in            the proportion of higher margin product revenue. Service and support revenue growth of            36%, combined with an 8% increase in service and support costs, resulted in an increase            in the service and support gross margin from 28% to 43%. The main reasons for the            increase in service and support gross margin were higher staff utilization and leverage            from our new Tucson support center. Higher margin product revenues comprised 67% of            total revenues in 2007 compared to 73% in 2006.

The overall gross profit margin            declined in 2006 compared to 2005, as a small improvement in product margin was more            than offset by a substantial decrease in services and support margin. Product margins            improved primarily because capitalized software amortization, which was charged to            product cost of revenue, ceased in June 2006. We also reduced costs by limiting the            quantity of electronic media that we send to customers. Service and support margins            declined from 2005 to 2006 primarily due to our investment in a new support center in            Tucson, Arizona, which replaced an outside vendor. We also hired additional service            staff in anticipation of increased service sales.

**Operating            Expenses**

|                                              |   |                                               |   |       |   |     |   |       |   |     |   |   |   |   |   |   |
|---------------------------------------------------|--------|----------------------------------------------------|--------|------------|--------|----------|--------|------------|--------|----------|--------|--------|--------|--------|--------|--------|
|                                              |   | **Year Ended December                        31,** |   |
| (dollars in                        thousands)     |   | **2007**                                           |   | **Change** |   | **2006** |   | **Change** |   | **2005** |   |
|                                                   |
| Sales and                        marketing        |   | $                                                  | 24,868 |       | *18*   | *%*      |   | $          | 21,073 |     | *20*   | *%*    |   | $      | 17,619 |   |
| Research and                        development   |   |                                               | 4,500  |       | *9*    | *%*      |   |       | 4,129  |     | *6*    | *%*    |   |   | 3,896  |   |
| General and                        administrative |   |                                               | 7,660  |       | *15*   | *%*      |   |       | 6,643  |     | *14*   | *%*    |   |   | 5,841  |   |
|                                                   |        |                                                    |        |            |        |          |        |            |        |          |        |        |        |        |        |        |
| Total operating                        expenses   |   | $                                                  | 37,028 |       | *16*   | *%*      |   | $          | 31,845 |     | *16*   | *%*    |   | $      | 27,356 |   |
|                                                   |        |                                                    |        |            |        |          |        |            |        |          |        |        |        |        |        |        |

*Sales and Marketing*:            Sales and marketing expenses consist principally of salaries and incentive compensation            paid to employees engaged in sales and marketing activities, travel costs, tradeshows,            conferences, and marketing and promotional materials. The increase in sales and            marketing costs in 2007 compared to 2006 is mostly due to higher employee costs, as            headcount has increased by 11% year over year, and also to increased spending on            marketing initiatives such as trade shows and the use of marketing consultants,            partially offset by reduced incentive compensation costs. In 2006, our sales and            marketing expenses increased over 2005, primarily due to increased sales and marketing            staff, more marketing activities and higher commissions reflecting higher booked sales.            Commissions in 2006 were $1.3 million higher than in 2005. At December 31, 2007, we had            51 field-based quota-bearing sales personnel selling to public schools, compared to 44            and 36 at December 31, 2006 and 2005 respectively. We expect our sales and marketing            expenses to increase at a low double digit rate in 2008.

*Research and Development*:            Research and development expenses principally consist of compensation paid to employees            and consultants engaged in research and product development activities and product            testing, together with software and equipment costs. The increased costs for 2007            compared to 2006 are primarily due to higher outsourced development costs. Research and            development expenses increased by 6% in 2006 due primarily to stock compensation            expenses and patent acquisition legal fees. We expect research and development expenses            to almost double in 2008 due to the addition of the Reading Assistant employees and the            amortization of the acquired intangible assets.

Page            36

----

*General and            Administrative:* General and administrative expenses principally consist of salaries            and compensation paid to our executives, accounting staff and other support personnel,            as well as travel expenses for these employees, and outside legal and accounting fees.            The increase in 2007 expenses compared to 2006 is mostly due to the legal, accounting,            printing and travel costs of approximately $688,000 related to our secondary stock            offering. Stock compensation expense was also higher in 2007 than in 2006. These costs            were partially offset by lower expenses for management incentive compensation. General            and administrative expenses increased by 14% in 2006 due primarily to stock            compensation expenses and incentive compensation expenses, partially offset by a            reduction in accounting and legal fees relating to the restatement of financial results            that were expensed in 2005. Accounting and legal fees associated with the restatement            that were expensed in 2005 totaled approximately $380,000*.* We expect general and            administrative expenses to increase modestly in 2008.

**Other Income from Related            Party**

In September 2003, we signed an            agreement with Posit Science Corporation (“PSC”), transferring our patented            technology to PSC for use in the health field. During the twelve months ended December            31, 2007, 2006 and 2005 we recorded $247,000, $150,000, and $50,000 respectively, for            royalties received and services provided to PSC. Amounts received to date and any            future receipts are being reported as other income as we do not consider these            royalties to be part of our recurring operations.

**Interest and Other Income            (Expense), net**

|                                                            |   |                                               |   |         |   |     |   |         |   |     |   |   |   |   |    |   |
|-----------------------------------------------------------------|--------|----------------------------------------------------|--------|--------------|--------|----------|--------|--------------|--------|----------|--------|--------|--------|--------|---------|--------|
|                                                            |   | **Year Ended December                        31,** |   |
| (dollars in                        thousands)                   |   | **2007**                                           |   | ***Change*** |   | **2006** |   | ***Change*** |   | **2005** |   |
|                                                                 |
| Interest on invested                        cash                |   |                                               | 680    |         | *38*   | *%*      |   |         | 494    |     | *104*  | *%*    |   |   | 242     |   |
| Reclassification of                        service revenue      |   |                                               | 332    |         | *132*  | *%*      |   |         | 143    |     | *NA*   |   |   |   | — |   |
| Miscellaneous                                                   |   |                                               | 7      |         | *17*   | *%*      |   |         | 6      |     | *-97*  | *%*    |   |   | 179     |   |
|                                                                 |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |         |        |
| Interest and other                        income (expense), net |   | $                                                  | 1,019  |         | *58*   | *%*      |   | $            | 643    |     | *53*   | *%*    |   | $      | 421     |   |
|                                                                 |        |                                                    |        |              |        |          |        |              |        |          |        |        |        |        |         |        |

In 2007, interest and other            income (expense), net, consisted primarily of interest earned on our invested cash of            $680,000 and a reclassification of $332,000 of service and support revenue relating to            two customers for whom we are no longer performing services. For 2006, interest and            other income (expense), net, consisted primarily of interest earned of $494,000 and a            reclassification of $143,000 of service and support revenue relating to the same two            customers. In 2005, interest and other income (expense), net, comprised mainly interest            earned on our invested cash of $242,000 and interest on officer loans of $170,000. All            officer loans were repaid in full by March 31, 2006.

**Income Tax Provision            (Benefit)**

During the fourth quarter of            2007, we recorded an income tax benefit of approximately $1.1 million. This benefit            included a $1.2 million reduction in our deferred tax asset valuation allowance related            to a portion of our deferred tax assets that will more likely than not be realized,            based on future projected taxable income for fiscal 2008. Prior to the fourth quarter            of 2007, we recorded a full valuation allowance against our deferred tax assets. These            projections were based on one year of projected future taxable income.

As of December 31, 2007, we have            U.S. federal and state net operating loss carryforwards of approximately $61.2 million            and $46.5 million, respectively. The U.S. federal net operating loss carryforwards will            expire at various dates beginning in 2018 through 2027 if not utilized. State net            operating loss carryforwards will expire at various dates beginning in 2012 through            2017.

As of December 31, 2007, we had            U.S. federal and state tax credit carryforwards of approximately $1.2 million and $0.9            million, respectively. The federal credit will expire at various dates beginning in            2011 through 2027, if not utilized. California state research and development credits            can be carried forward indefinitely.

Net operating loss carryforwards            and credit carryforwards reflected above are limited due to ownership changes as            provided in the Internal Revenue Code and similar state provisions.

Page            37

----

**Liquidity and Capital            Resources**

Our cash and cash equivalents            and short-term investments were $21.2 million at December 31, 2007 compared to $16.4            million at December 31, 2006 and $12.1 million at December 31, 2005. At December 31,            2007 there were no borrowings outstanding under our credit line. In January 2008 we            expended $9.7 million of our cash for the acquisition of the assets of Soliloquy            Learning.

Net cash provided by operations            in 2007 was $6.1 million, compared to cash provided by operations of $4.3 million in            2006 and $2.1 million used in operations in 2005. Overall, our receivable collection            experience has remained strong throughout 2007. We collected $51.7 million of            receivables in 2007, compared to $40.3 million of receivables in 2006 and $34.1 million            in 2005.

Net cash used in investing            activities in 2007 was $2.4 million, consisting of net purchases of property and            equipment of $1.1 million, a loan to JTT Holdings of $1.0 million in connection with            the January 2008 acquisition of Soliloquy Learning, and acquisition costs incurred of            $319,000.

During the year ended December            31, 2006, we purchased an enterprise-wide customer relationship management system. As            of December 31, 2007 and 2006, a net book value of $1.4 million and $463,000,            respectively, related to the purchase and subsequent implementation of this system was            included in property and equipment. These costs will be depreciated over the initial            estimated useful life of five years.

Net cash generated by investing            activities in 2006 was $2.4 million, consisting of the maturity of short-term            investments of $3.0 million and officer loan repayments of $0.2 million, partially            offset by property and equipment purchases of $0.8 million.

Net cash generated by investing            activities in 2005 was $0.4 million, consisting of the purchase of $3.0 million of            short-term investments and the purchase of hardware and software for $0.2 million,            which were more than offset by the repayment of $3.6 million of officer            loans.

Net cash generated by financing            activities in 2007, 2006 and 2005 was $1.2 million, $0.6 million, and $0.5 million            respectively. Net cash generated by financing activities in all three years resulted            from the sale of stock upon option exercises and through purchases of stock through the            employee stock purchase plan. There was no borrowing on our credit line in 2007 or            2006.

Because our booked sales tend to            be seasonal, we may have negative cash flows in particular quarters, particularly the            first quarter, when booked sales tend to be substantially lower than in other            quarters.

On June 5, 2007 we amended our            existing revolving line of credit agreement with Comerica Bank. The maximum that can be            borrowed under the agreement is $5.0 million. The line expires on December 2, 2008.            Borrowing under the line of credit bears interest at a floating prime rate, or a fixed            rate of LIBOR plus 2.5%. To secure the line we granted Comerica a security interest in            all of our assets other than our intellectual property. We also agreed with Comerica            that we will not grant a security interest in our intellectual property to any third            party. Borrowings under the line are subject to various covenants. The agreement            includes a letter of credit sublimit not to exceed $1.0 million. At December 31, 2007,            we have an outstanding letter of credit for $206,000. There were no borrowings            outstanding on the line of credit at December 31, 2007 and we were in compliance with            all our covenants.

We expect that cash flow from            operations will continue to be our primary source of funds for the next several years.            Again, this will require us to achieve certain levels of booked sales. If we are unable            to achieve sufficient levels of cash flow from operations, we may seek other sources of            debt or equity financing, or may be required to reduce expenses. Reducing our expenses            could adversely affect our operations by reducing the resources available for sales,            marketing, research or development efforts. We cannot assure you that we will be able            to secure additional debt or equity financing on acceptable terms.

**Off-Balance Sheet            Arrangements**

We have no off-balance sheet            arrangements.

Page            38

----

**Contractual Obligations and            Commitments**

We have a non-cancelable lease            agreement for our corporate office facilities. The minimum lease payment is            approximately $78,000 per month through 2008. After 2008 the base lease payment            increases at a compound annual rate of approximately 5%. The lease expires in December            2013. We also have a lease agreement for our Tucson, Arizona office through April 2009            at an average rent of approximately $4,500 per month for the period subsequent to            January 1, 2007. In early 2008, we entered into a new lease for our Reading Assistant            operations in Waltham, Massachusetts for approximately 6,000 square feet that expires            in September 2011. This lease, as well as the existing Waltham lease that expires on            March 31, 2008, is included in the table under “operating lease            obligations”.

We also make royalty payments to            the institutions who participated in the original research that produced our initial            products. Our minimum royalty payments are $150,000 per year.

The following table summarizes            our obligations at December 31, 2007 and the effects such obligations are expected to            have on our liquidity and cash flow in future periods.

|                                               |   |   |   |   |   |   |   |   |   |                                                              |   |   |   |   |   |   |   |   |   |   |   |
|----------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|-------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| (dollars in                        thousands)      |   | 2008   |   | 2009   |   | 2010   |   | 2011   |   | 2012                        and                        thereafter |   | Total  |   |
|                                                    |        |        |        |        |        |        |        |        |        |                                                                   |        |        |        |
| Contractual                        Obligations:    |   |   |   |   |   |   |   |   |   |                                                              |   |   |   |   |   |   |   |   |   |
| Operating lease                        obligations |   | $      | 1,143  |   | $      | 1,142  |   | $      | 1,171  |                                                              | $      | 1,183  |   |   | $      | 2,312  |   |   | $      | 6,951  |   |
| Purchase                        obligations        |   |   | 150    |   |   | 150    |   |   | 150    |                                                              |   | 150    |   |   |   | 450    |   |   | $      | 1,050  |   |
|                                                    |        |        |        |        |        |        |        |        |        |                                                                   |        |        |        |        |        |        |        |        |        |        |        |
| Total                                              |   | $      | 1,293  |   | $      | 1,292  |   | $      | 1,321  |                                                              | $      | 1,333  |   |   | $      | 2,762  |   |   | $      | 8,001  |   |
|                                                    |        |        |        |        |        |        |        |        |        |                                                                   |        |        |        |        |        |        |        |        |        |        |        |

Our purchase order commitments            at December 31, 2007 are not material

Effective January 1, 2007, we            adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty            in Income Taxes — an interpretation of FASB Statement No. 109.” At December            31, 2007, we had a liability for unrecognized tax benefits and an accrual for the            payment of related interest totaling $25,000, of which approximately $3,000 is expected            to be paid within one year. For the remaining liability, due to the uncertainties            related to these tax matters, we are unable to make a reasonably reliable estimate when            cash settlement with a taxing authority will occur. Refer to Note 10 to the Financial            Statements for additional discussion on unrecognized tax benefits.

**Loans to Current and Former            Officers**

In March 2001 we made full            recourse loans to certain of our officers, in amounts totaling $3.1 million. In 2002            some of these officers left our Company. The notes were secured by shares of our Common            Stock owned by the current and former officers. The loans bore interest at 4.94%.            Principal and interest were due December 31, 2005. During the twelve months ended            December 31, 2005 we received $3.6 million in loan repayments, including interest. At            December 31, 2005 there was a remaining balance due of $297,000. This represented            principal and interest from one of the former officers. During the first quarter of            2006 we received the balance due in the form of cash and stock.

**Application of Critical            Accounting Policies**

Our financial statements are            prepared in accordance with accounting principles generally accepted in the United            States (“GAAP”). These accounting principles require us to make certain            estimates, assumptions and judgments. We believe that the estimates, assumptions and            judgments upon which we rely are reasonable based upon information available to us at            the time. The estimates, assumptions and judgments that we make can affect the reported            amounts of assets and liabilities as of the date of the financial statements, as well            as the reported amounts of revenues and expenses during the periods presented. To the            extent there are material differences between these estimates and actual results, our            financial statements would be affected.

We believe that the estimates,            assumptions and judgments pertaining to revenue recognition and allowance for doubtful            accounts are the most critical assumptions to understand in order to evaluate our            reported financial results. A detailed discussion of our use of estimates, assumptions            and judgments as they relate to these polices is presented below. We have discussed the            application of these critical accounting policies with the Audit Committee of the Board            of Directors.

Page            39

----

*Revenue            Recognition*

We derive revenue from the sale            of licenses to our software and from service and support fees. Software license revenue            is recognized in accordance with AICPA Statement of Position 97-2, “Software            Revenue Recognition,” as amended by Statement of Position 98-9 (SOP 97-2). SOP            97-2 provides specific industry guidance and four basic criteria, which must be met to            recognize revenue. These are: 1) persuasive evidence of an arrangement exists; 2)            delivery of the product has occurred; 3) a fixed or determinable fee; and 4) the            probability that the fee will be collected. The application of SOP 97-2 requires us to            exercise significant judgment related to our specific transactions and transaction            types.

Sales to our school customers            typically include multiple elements (e.g., Fast ForWord software licenses, Progress            Tracker, our Internet-based participant tracking service, support, training,            implementation management, and other services). We recognize revenue using the residual            method, whereby the difference between the total arrangement fee and the total            “vendor specific objective evidence”(“VSOE”) of fair value of            the undelivered elements is recognized as revenue relating to the delivered elements.            VSOE of fair value for each element of an arrangement is based upon the normal pricing            and discounting practices for those products and services when sold separately and, for            support services, is also measured by the renewal price. We are required to exercise            judgment in determining whether VSOE exists for each undelivered element based on            whether our pricing for these elements is sufficiently consistent.

The value of software licenses,            services and support invoiced during a particular period is recorded as deferred            revenue until recognized. All revenue from transactions that include new products that            have not yet been delivered is deferred until the delivery of all products. Deferred            revenue is recognized as revenue as discussed below.

Multiple contracts with the same            customer are generally accounted for as separate arrangements except in cases where            contracts are so closely related that they are effectively part of a single            arrangement.

*Product            revenue*

Product revenue is primarily            derived from the licensing of software and is recognized as follows:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • | Perpetual licenses                        – software licensed on a perpetual basis. Revenue is recognized at                        the later of product delivery date or contract start date using the                        residual method. If VSOE does not exist for all the undelivered elements,                        all revenue is deferred and recognized ratably over the service period if                        the undelivered element is services or when all elements have been                        delivered. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| • | Term licenses                        – software licensed for a specific time period, generally three to                        twelve months. Revenue is recognized ratably over the license                        term.                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| • | Individual                        participant licenses – software licensed for a single participant.                        Revenue is recognized over the average period of use, typically six                        weeks.                                                                                                                                                                                                                                                                                                         |

*Service and support            revenue*

Service and support revenue is            derived from a combination of training, implementation, technical and professional            services, online services and customer support. Training, technical and other            professional services are typically sold on a per day basis. If VSOE exists for all            elements of an arrangement or all elements except software licenses, services revenue            is recognized as performed. If VSOE does not exist for all the elements in an            arrangement except software licenses, service revenue is recognized over the longest            contractual period in an arrangement. Revenue from services sold alone or with support            is recognized as performed.

*Allowance for Doubtful            Accounts*

We maintain an allowance for            doubtful accounts for estimated losses due to the inability of customers to make            payments. We adjust this allowance periodically based on our historical experience of            bad debt write offs, which have been low in recent years. Cancellations and refunds are            allowed in limited circumstances, and such amounts have not been            significant.

Page            40

----

*Income Taxes*

We account for income taxes            using the liability method, which requires the recognition of deferred tax assets or            liabilities for the tax-effected temporary differences between the financial reporting            and tax bases of our assets and liabilities, and for net operating loss and tax credit            carryforwards. Prior to the fourth quarter of 2007, we recorded a full valuation            allowance to reserve for the benefit of our deferred tax assets due to the uncertainty            surrounding our ability to realize these assets.

During the fourth quarter of            2007, we recorded an income tax benefit of $1.1 million. This benefit included a $1.2            million reduction in the valuation allowance related to a portion of our deferred tax            assets that will more likely than not be realized. This determination was primarily            based on projected taxable income. In evaluating our ability to realize our deferred            tax assets we consider all available positive and negative evidence including our past            operating results and our forecast of future taxable income. In determining future            taxable income, we make assumptions to forecast federal and state operating income, the            reversal of temporary differences, and the implementation of any feasible and prudent            tax planning strategies. These assumptions require significant judgment regarding the            forecasts of future taxable income, and are consistent with the forecasts used to            manage our business. We intend to maintain the remaining valuation allowance until            sufficient further positive evidence exists to support further reversals of the            valuation allowance. Our income tax expense recorded in the future will be reduced to            the extent of offsetting decreases in our valuation allowance.

*Stock-Based            Compensation*

Under the fair value recognition            provisions of SFAS No. 123R, we use the Black-Scholes option valuation model to            estimate stock-based compensation expense at the grant date based on the fair value of            the award and recognize the expense ratably over the requisite service period of the            award. Determining the appropriate fair value model and assumptions used in calculating            the fair value of stock-based awards requires judgment, including estimating stock            price volatility, forfeiture rates and expected life.

The estimated expected stock            price volatility decreased from 80% in 2006 to 49% in 2007. Our expected stock price            volatility is based upon our historical experience over the expected life of the            options, and this decrease occurred as a result of historical periods beyond the            expected life of the options containing highly volatile prices being eliminated from            the fiscal 2007 volatility calculation.

In the fourth quarter of 2007 we            changed our estimate of the forfeiture rate from 11% to 3.5%, based on our experience            of actual forfeiture rates. This resulted in incremental stock compensation expense of            approximately $316,000 in the fourth quarter. Stock compensation expense may be            adjusted in the future if actual forfeiture rates differ significantly from our current            estimates.

|                                |                                                                                  |
|-------------------------------------|---------------------------------------------------------------------------------------|
| **ITEM                        7A.** | **QUANTITATIVE AND                        QUALITATIVE DISCLOSURES ABOUT MARKET RISK** |

**Interest Rate            Risk**

Our exposure to market risk for            changes in interest rates relates primarily to the rate of interest that we earn on our            cash and cash equivalents. We did not hold any marketable debt securities at December            31, 2007. A hypothetical increase or decrease in market interest rates by 10% from the            market interest rates at December 31, 2007 would not have a material affect on our            results of operations.

Page            41

----

|                               |                                                                                                                                     |
|------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------|
| **ITEM                        8.** | **FINANCIAL                        STATEMENTS AND SUPPLEMENTARY DATA**                                                                   |
|                               |                                                                                                                                     |
|                               |   Report                        of Ernst & Young LLP, Independent Registered Public Accounting                        Firm |

The Board of Directors and            Stockholders            Scientific Learning Corporation

          We            have audited the accompanying balance sheets of Scientific Learning Corporation as of            December 31, 2007 and 2006 and the related statements of income, stockholders equity            (deficit), and cash flows for each of the three years in the period ended December 31,            2007. Our audits also included the financial statement schedule listed in the index at            Item 15(a)(2). These financial statements and schedule are the responsibility of the            Company’s management. Our responsibility is to express an opinion on these            financial statements and schedule based on our audits.

          We            conducted our audits in accordance with the standards of the Public Company Accounting            Oversight Board (United States). Those standards require that we plan and perform the            audit to obtain reasonable assurance about whether the financial statements are free of            material misstatement. We were not engaged to perform an audit of the Company’s            internal control over financial reporting. Our audits included consideration of            internal control over financial reporting as a basis for designing audit procedures            that are appropriate in the circumstances, but not for the purpose of expressing an            opinion on the effectiveness of the Company’s internal control over financial            reporting. Accordingly, we express no such opinion. An audit also includes examining,            on a test basis, evidence supporting the amounts and disclosures in the financial            statements, assessing the accounting principles used and significant estimates made by            management, and 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 Scientific Learning Corporation as of December 31,            2007 and 2006, and the results of its operations and its cash flows for each of the            three years in the period ended December 31, 2007, in conformity with U.S. generally            accepted accounting principles. Also, in our opinion, the related financial statement            schedule, when considered in relation to the basic financial statements taken as a            whole, presents fairly in all material respects the information set forth            therein.

          As            discussed in Notes 1 and 10 to the financial statements, Scientific Learning            Corporation changed its method of accounting for share based payments as of January 1,            2006 and its method of accounting for uncertain tax positions as of January 1,            2007.

/s/  ERNST & YOUNG            LLP

San Francisco, California            March 10, 2008

Page            42

----

**Scientific            Learning Corporation            Balance Sheets**(In thousands, except share and per share amounts)

|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|--------|--------|--------|---------|--------|--------|
|                                                                                                                                                                                                                                                          |   | **December 31,                        2007** |   | **December 31,                        2006** |   |
|                                                                                                                                                                                                                                                          |   |                                              |   |                                              |   |
| **Assets**                                                                                                                                                                                                                                                    |   |                                         |   |                                         |   |   |   |
| Current                        assets:                                                                                                                                                                                                                        |   |                                         |   |                                         |   |   |   |
| Cash and cash                        equivalents                                                                                                                                                                                                              |   |                                         | $      | 21,179                                       |   |   |   | $      | 16,364  |   |   |
| Accounts receivable,                        net of allowance for doubtful accounts of $96 and $99 at December 31, 2007                        and 2006, respectively                                                                                          |   |                                         |   | 6,155                                        |   |   |   |   | 7,098   |   |   |
| Deferred income                        taxes                                                                                                                                                                                                                  |   |                                         |   | 1,191                                        |   |   |   |   | — |   |   |
| Prepaid expenses and                        other current assets                                                                                                                                                                                              |   |                                         |   | 1,291                                        |   |   |   |   | 971     |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Total current                        assets                                                                                                                                                                                                                   |   |                                         |   | 29,816                                       |   |   |   |   | 24,433  |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Property and equipment,                        net                                                                                                                                                                                                            |   |                                         |   | 1,742                                        |   |   |   |   | 941     |   |   |
| Loan to JTT                        Holdings                                                                                                                                                                                                                   |   |                                         |   | 1,000                                        |   |   |   |   | — |   |   |
| Deferred acquisition                        costs                                                                                                                                                                                                             |   |                                         |   | 319                                          |   |   |   |   | — |   |   |
| Other assets                                                                                                                                                                                                                                                  |   |                                         |   | 926                                          |   |   |   |   | 909     |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |
| **Total                        assets**                                                                                                                                                                                                                       |   |                                         | $      | 33,803                                       |   |   |   | $      | 26,283  |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| **Liabilities and                        stockholders’ equity**                                                                                                                                                                                         |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Current                        liabilities:                                                                                                                                                                                                                   |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Accounts                        payable                                                                                                                                                                                                                       |   |                                         | $      | 716                                          |   |   |   | $      | 607     |   |   |
| Accrued                        liabilities                                                                                                                                                                                                                    |   |                                         |   | 3,859                                        |   |   |   |   | 5,089   |   |   |
| Deferred                        revenue                                                                                                                                                                                                                       |   |                                         |   | 17,379                                       |   |   |   |   | 14,786  |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Total current                        liabilities                                                                                                                                                                                                              |   |                                         |   | 21,954                                       |   |   |   |   | 20,482  |   |   |
| Deferred revenue,                        long-term                                                                                                                                                                                                            |   |                                         |   | 5,576                                        |   |   |   |   | 4,373   |   |   |
| Other                        liabilities                                                                                                                                                                                                                      |   |                                         |   | 453                                          |   |   |   |   | 411     |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Total                        liabilities                                                                                                                                                                                                                      |   |                                         |   | 27,983                                       |   |   |   |   | 25,266  |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Commitments and                        contingencies                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Stockholders’                        equity:                                                                                                                                                                                                            |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Preferred stock, $0.01                        par value; 1,000,000 shares authorized,                        no shares issued or outstanding                                                                                                                  |   |                                         |   | —                                      |   |   |   |   | — |   |   |
| Common stock, $0.01 par                        value; 40,000,000 authorized,17,315,886 and 16,972,333 shares issued and                        outstanding at December 31, 2007 and 2006, respectively, and additional                        paid-in capital |   |                                         |   | 82,558                                       |   |   |   |   | 78,909  |   |   |
| Accumulated                        deficit                                                                                                                                                                                                                    |   |                                         |   | (76,738                                      | )      |   |   |   | (77,892 | )      |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| Total                        stockholders’ equity                                                                                                                                                                                                       |   |                                         |   | 5,820                                        |   |   |   |   | 1,017   |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |   |                                         |   |   |   |   |    |   |   |
| **Total liabilities                        and stockholders’ equity**                                                                                                                                                                                   |   |                                         | $      | 33,803                                       |   |   |   | $      | 26,283  |   |   |
|                                                                                                                                                                                                                                                          |   |                                         |        |                                              |   |   |   |        |         |   |   |

*See accompanying            notes.*

Page            43

----

**Scientific            Learning Corporation            Statements of Income**            (In thousands, except per share amounts)

|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
|------------------------------------------------------------------------------|--------|----------------------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|
|                                                                         |   | **Year Ended December                        31,** |   |
|                                                                         |   |                                                    |   |
|                                                                         |   | **2007**                                           |   | **2006** |   | **2005** |   |
|                                                                         |   |                                                    |   |          |   |          |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| **Revenues:**                                                                |   |                                               |   |     |   |     |   |   |   |   |
| Products                                                                     |   | $                                                  | 31,023 |     | $      | 29,966   |   | $      | 30,263 |   |
| Service and                        support                                   |   |                                               | 15,030 |     |   | 11,032   |   |   | 10,056 |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
| Total                        revenues                                        |   |                                               | 46,053 |     |   | 40,998   |   |   | 40,319 |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| **Cost of                        revenues:**                                 |   |                                               |   |     |   |     |   |   |   |   |
| Cost of                        products                                      |   |                                               | 1,680  |     |   | 1,638    |   |   | 2,018  |   |
| Cost of service and                        support                           |   |                                               | 8,539  |     |   | 7,897    |   |   | 5,637  |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
| Total cost of                        revenues                                |   |                                               | 10,219 |     |   | 9,535    |   |   | 7,655  |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| Gross profit                                                                 |   |                                               | 35,834 |     |   | 31,463   |   |   | 32,664 |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| **Operating                        expenses:**                               |   |                                               |   |     |   |     |   |   |   |   |
| Sales and                        marketing                                   |   |                                               | 24,868 |     |   | 21,073   |   |   | 17,619 |   |
| Research and                        development                              |   |                                               | 4,500  |     |   | 4,129    |   |   | 3,896  |   |
| General and                        administrative                            |   |                                               | 7,660  |     |   | 6,643    |   |   | 5,841  |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| Total operating                        expenses                              |   |                                               | 37,028 |     |   | 31,845   |   |   | 27,356 |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| Operating income                        (loss)                               |   |                                               | (1,194 | )        |   | (382     | )      |   | 5,308  |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| Other income from                        related party                       |   |                                               | 247    |     |   | 150      |   |   | 50     |   |
| Interest and other                        income (expense), net              |   |                                               | 1,019  |     |   | 643      |   |   | 421    |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| Net income before                        income tax                          |   |                                               | 72     |     |   | 411      |   |   | 5,779  |   |
| Income tax provision                        (benefit)                        |   |                                               | (1,082 | )        |   | 203      |   |   | 182    |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
| Net income                                                                   |   | $                                                  | 1,154  |     | $      | 208      |   | $      | 5,597  |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                         |   |                                               |   |     |   |     |   |   |   |   |
| Basic net income per                        share:                           |   | $                                                  | 0.07   |     | $      | 0.01     |   | $      | 0.33   |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
| Shares used in                        computing basic net income per share   |   |                                               | 17,161 |     |   | 16,846   |   |   | 16,715 |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
| Diluted net income per                        share:                         |   | $                                                  | 0.06   |     | $      | 0.01     |   | $      | 0.31   |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |
| Shares used in                        computing diluted net income per share |   |                                               | 18,297 |     |   | 17,740   |   |   | 18,023 |   |
|                                                                         |   |                                                    |        |     |        |          |   |        |        |   |

*See accompanying            notes.*

Page            44

----

**Scientific            Learning Corporation            Statements of Cash Flows**            (In thousands)

|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
|----------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|---------|----------|--------|----------|--------|--------|---------|--------|
|                                                                                                     |   | **Year Ended December                        31,** |    |
|                                                                                                     |   |                                                    |    |
|                                                                                                     |   | **2007**                                           |    | **2006** |   | **2005** |   |
|                                                                                                     |   |                                                    |    |          |   |          |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| **Operating                        Activities:**                                                         |   |                                               |    |     |   |     |   |   |    |   |
| Net income                                                                                               |   | $                                                  | 1,154   |     | $      | 208      |   | $      | 5,597   |   |
| **Amounts to reconcile                        net income to net cash provided by operating activities:** |   |                                               |    |     |   |     |   |   |    |   |
| Depreciation and                        amortization                                                     |   |                                               | 313     |     |   | 479      |   |   | 728     |   |
| Increase in interest                        receivable from current and former officers                  |   |                                               | — |     |   | —  |   |   | (169    | )      |
| Increase in interest                        receivable on short term investments                         |   |                                               | — |     |   | —  |   |   | (44     | )      |
| Stock-based                        compensation                                                          |   |                                               | 2,463   |     |   | 2,126    |   |   | 205     |   |
| Reduction of deferred                        tax asset valuation allowance                               |   |                                               | (1,191  | )        |   | —  |   |   | — |   |
| Changes in operating                        assets and liabilities:                                      |   |                                               |    |     |   |     |   |   |    |   |
| Accounts                        receivable                                                               |   |                                               | 943     |     |   | (3,579   | )      |   | 2,142   |   |
| Prepaid expenses and                        other current assets                                         |   |                                               | (320    | )        |   | 341      |   |   | (6      | )      |
| Other assets                                                                                             |   |                                               | (17     | )        |   | 33       |   |   | (67     | )      |
| Accounts                        payable                                                                  |   |                                               | 109     |     |   | 393      |   |   | (389    | )      |
| Accrued                        liabilities                                                               |   |                                               | (1,230  | )        |   | 2,123    |   |   | (1,372  | )      |
| Deferred                        revenue                                                                  |   |                                               | 3,796   |     |   | 2,156    |   |   | (8,781  | )      |
| Other                        liabilities                                                                 |   |                                               | 42      |     |   | 25       |   |   | 42      |   |
|                                                                                                     |   |                                                    |         |     |        |          |   |        |         |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| Net cash provided by                        (used in) operating activities                               |   |                                               | 6,062   |     |   | 4,305    |   |   | (2,114  | )      |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| **Investing                        Activities:**                                                         |   |                                               |    |     |   |     |   |   |    |   |
| Purchases of property                        and equipment, net                                          |   |                                               | (1,114  | )        |   | (821     | )      |   | (181    | )      |
| Loan to JTT                        Holdings                                                              |   |                                               | (1,000  | )        |   | —  |   |   | — |   |
| Deferred acquisition                        costs                                                        |   |                                               | (319    | )        |   | —  |   |   | — |   |
| Maturity (purchase) of                        short-term investments                                     |   |                                               | — |     |   | 3,043    |   |   | (2,999  | )      |
| Repayment on officer                        loans and accrued interest                                   |   |                                               | — |     |   | 213      |   |   | 3,561   |   |
|                                                                                                     |   |                                                    |         |     |        |          |   |        |         |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| Net cash provided by                        (used in) investing activities                               |   |                                               | (2,433  | )        |   | 2,435    |   |   | 381     |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| **Financing                        Activities:**                                                         |   |                                               |    |     |   |     |   |   |    |   |
| Proceeds from issuance                        of common stock, net                                       |   |                                               | 1,186   |     |   | 602      |   |   | 474     |   |
|                                                                                                     |   |                                                    |         |     |        |          |   |        |         |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| Net cash provided by                        financing activities                                         |   |                                               | 1,186   |     |   | 602      |   |   | 474     |   |
|                                                                                                     |   |                                                    |         |     |        |          |   |        |         |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| Increase (decrease) in                        cash and cash equivalents                                  |   |                                               | 4,815   |     |   | 7,342    |   |   | (1,259  | )      |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| Cash and cash                        equivalents at beginning of period                                  |   |                                               | 16,364  |     |   | 9,022    |   |   | 10,281  |   |
|                                                                                                     |   |                                                    |         |     |        |          |   |        |         |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| Cash and cash                        equivalents at end of period                                        |   | $                                                  | 21,179  |     | $      | 16,364   |   | $      | 9,022   |   |
|                                                                                                     |   |                                                    |         |     |        |          |   |        |         |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| **Supplemental                        disclosure of cash flow information:**                             |   |                                               |    |     |   |     |   |   |    |   |
| Cash paid during the                        year for income taxes                                        |   | $                                                  | 292     |     | $      | 65       |   | $      | 422     |   |
|                                                                                                     |   |                                               |    |     |   |     |   |   |    |   |
| **Supplemental                        disclosure of noncash financing activities:**                      |   |                                               |    |     |   |     |   |   |    |   |
| Common stock                        surrendered in connection with repayment of officer loans            |   |                                               | — |     | $      | 84       |   |   | — |   |

*See accompanying            notes*

Page            45

----

**Scientific            Learning Corporation            Statements of Stockholders’ Equity (Deficit)**            (In thousands, except share amounts)

|                                                                               |   |                                                                                          |       |                                           |   |                                                                                         |    |   |   |   |   |    |   |   |   |   |    |   |   |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|------------|------------------------------------------------|--------|----------------------------------------------------------------------------------------------|---------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|
|                                                                               |   | **Common Stock and                        Additional Paid-In                        Capital** |       | **Accumulated                        Deficit** |   | **Total                        Stockholders’                        Equity (Deficit)** |    |
|                                                                               |   | **Shares**                                                                                    |       | **Amount**                                     |   |                                                                                         |    |
|                                                                               |   |                                                                                               |       |                                                |   |                                                                                              |    |        |   |
| Balance at December 31,                        2004                                |   |                                                                                          | 16,657,589 |                                           |   |                                                                                         | 75,586  |   |   |   |   | (83,697 | )      |   |   |   | (8,111  | )      |   |
| Issuance of common                        stock under stock option plan            |   |                                                                                          | 71,778     |                                           |   |                                                                                         | 215     |   |   |   |   | — |   |   |   |   | 215     |   |   |
| Issuance of common                        stock under employee stock purchase plan |   |                                                                                          | 58,795     |                                           |   |                                                                                         | 259     |   |   |   |   | — |   |   |   |   | 259     |   |   |
| Stock-based                        compensation                                    |   |                                                                                          | —    |                                           |   |                                                                                         | 137     |   |   |   |   | — |   |   |   |   | 137     |   |   |
| Stock issued in                        exchange for services                       |   |                                                                                          | 10,896     |                                           |   |                                                                                         | 68      |   |   |   |   |    |   |   |   |   | 68      |   |   |
| Net income and                        comprehensive income                         |   |                                                                                          | —    |                                           |   |                                                                                         | — |   |   |   |   | 5,597   |   |   |   |   | 5,597   |   |   |
|                                                                               |   |                                                                                               |            |                                           |   |                                                                                              |         |   |   |   |        |         |   |   |   |        |         |   |   |
| Balance at December 31,                        2005                                |   |                                                                                          | 16,799,058 |                                           |   | $                                                                                            | 76,265  |   |   |   | $      | (78,100 | )      |   |   | $      | (1,835  | )      |   |
| Issuance of common                        stock under stock option plan            |   |                                                                                          | 86,422     |                                           |   |                                                                                         | 254     |   |   |   |   | — |   |   |   |   | 254     |   |   |
| Issuance of common                        stock under employee stock purchase plan |   |                                                                                          | 84,555     |                                           |   |                                                                                         | 348     |   |   |   |   | — |   |   |   |   | 348     |   |   |
| Stock-based                        compensation                                    |   |                                                                                          | —    |                                           |   |                                                                                         | 2,052   |   |   |   |   | — |   |   |   |   | 2,052   |   |   |
| Stock issued in                        exchange for services                       |   |                                                                                          | 17,079     |                                           |   |                                                                                         | 74      |   |   |   |   | — |   |   |   |   | 74      |   |   |
| Stock                        surrendered                                           |   |                                                                                          | (14,781    | )                                              |   |                                                                                         | (84     | )      |   |   |   | — |   |   |   |   | (84     | )      |   |
| Net income and                        comprehensive income                         |   |                                                                                          | —    |                                           |   |                                                                                         | — |   |   |   |   | 208     |   |   |   |   | 208     |   |   |
|                                                                               |   |                                                                                               |            |                                           |   |                                                                                              |         |   |   |   |        |         |   |   |   |        |         |   |   |
| Balance at December 31,                        2006                                |   |                                                                                          | 16,972,333 |                                           |   | $                                                                                            | 78,909  |   |   |   | $      | (77,892 | )      |   |   | $      | 1,017   |   |   |
| Issuance of common                        stock under stock option plan            |   |                                                                                          | 182,375    |                                           |   |                                                                                         | 822     |   |   |   |   |    |   |   |   |   | 822     |   |   |
| Issuance of common                        stock under employee stock purchase plan |   |                                                                                          | 81,791     |                                           |   |                                                                                         | 364     |   |   |   |   |    |   |   |   |   | 364     |   |   |
| Stock-based                        compensation                                    |   |                                                                                          | —    |                                           |   |                                                                                         | 2,463   |   |   |   |   |    |   |   |   |   | 2,463   |   |   |
| Vesting of restricted                        stock units                           |   |                                                                                          | 79,387     |                                           |   |                                                                                         | — |   |   |   |   |    |   |   |   |   | — |   |   |
| Net income and                        comprehensive income                         |   |                                                                                          |       |                                           |   |                                                                                         |    |   |   |   |   | 1,154   |   |   |   |   | 1,154   |   |   |
|                                                                               |   |                                                                                               |            |                                           |   |                                                                                              |         |   |   |   |        |         |   |   |   |        |         |   |   |
| Balance at December 31,                        2007                                |   |                                                                                          | 17,315,886 |                                           |   | $                                                                                            | 82,558  |   |   |   | $      | (76,738 | )      |   |   | $      | 5,820   |   |   |
|                                                                               |   |                                                                                               |            |                                           |   |                                                                                              |         |   |   |   |        |         |   |   |   |        |         |   |   |

*See accompanying            notes*

Page            46

----

**Notes to Financial            Statements**

**1. Summary of Significant            Accounting Policies**

**Description of            Business**

Scientific Learning Corporation            develops and distributes the *Fast ForWord* family of software. Our patented            products build learning capacity by rigorously and systematically applying            neuroscience-based learning principles to improve the fundamental cognitive skills            required to read and learn. To facilitate the use of our products, we offer a variety            of on-site and remote professional and technical services, as well as phone, email and            web-based support. We sell primarily to K-12 schools in the United States through a            direct sales force.

All of our activities are in one            operating segment.

We were incorporated in 1995 in            the State of California and were reincorporated in 1997 in the State of            Delaware.

**Use of            Estimates**

The preparation of financial            statements in conformity with accounting principles generally accepted in the United            States requires management to make certain estimates and assumptions that affect the            reported amounts of assets and liabilities as of the date of the financial statements            as well as the reported amounts of revenues and expenses during the periods presented.            Actual results may differ from those estimated.

**Revenue            Recognition**

We derive revenue from the sale            of licenses to our software and from service and support fees. Software license revenue            is recognized in accordance with AICPA Statement of Position 97-2, “Software            Revenue Recognition,” as amended by Statement of Position 98-9 (SOP 97-2). SOP            97-2 provides specific industry guidance and four basic criteria, which must be met to            recognize revenue. These are: 1) persuasive evidence of an arrangement exists; 2)            delivery of the product has occurred; 3) a fixed or determinable fee; and 4) the            probability that the fee will be collected. The application of SOP 97-2 requires us to            exercise significant judgment related to our specific transactions and transaction            types.

Booked sales to our school            customers typically include multiple elements (e.g., Fast ForWord software licenses,            Progress Tracker, our Internet-based participant tracking service, support, training,            implementation management, and other services). We recognize revenue using the residual            method, whereby the difference between the total arrangement fee and the total            “vendor specific objective evidence” (“VSOE”) of fair value of            the undelivered elements is recognized as revenue relating to the delivered elements.            VSOE of fair value for each element of an arrangement is based upon the normal pricing            and discounting practices for those products and services when sold separately and, for            support services, is also measured by the renewal price. We are required to exercise            judgment in determining whether VSOE of fair value exists for each undelivered element            based on whether our pricing for these elements is sufficiently consistent.

The value of software licenses,            services and support invoiced during a particular period is recorded as deferred            revenue until recognized. All revenue from transactions that include new products that            have not yet been delivered is deferred until the delivery of all products. Deferred            revenue is recognized as revenue as discussed below. Direct costs related to deferred            software license revenue are deferred until the related license revenue is            recognized.

Multiple contracts with the same            customer are generally accounted for as separate arrangements, except in cases where            contracts are so closely related that they are effectively part of a single            arrangement.

*Product            revenue*

Product revenue is primarily            derived from the licensing of software and is recognized as follows:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • | Perpetual licenses                        – software licensed on a perpetual basis. Revenue is recognized at                        the later of product delivery date or contract start date using the                        residual method. If VSOE of fair value does not exist for all the                        undelivered elements, all revenue is deferred and recognized ratably over                        the service period if the undelivered element is services or when all                        elements have been delivered. |

Page            47

----

**Notes to Financial            Statements**

|       |                                                                                                                                                                                                                                |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **1.**     | **Summary of                        Significant Accounting Policies (continued)**                                                                                                                                                   |
|       |                                                                                                                                                                                                                                |
| **•** | Term licenses                        – software licensed for a specific time period, generally three to                        twelve months. Revenue is recognized ratably over the license                        term.     |
|       |                                                                                                                                                                                                                                |
| **•** | Individual                        participant licenses – software licensed for a single participant.                        Revenue is recognized over the average period of use, typically six                        weeks. |

*Service and support            revenue*

Service and support revenue is            derived from a combination of training, implementation, technical and professional            services, online services and customer support. Training, technical and other            professional services are typically sold on a per day basis. If VSOE of fair value            exists for all elements of an arrangement or all elements except software licenses,            services revenue is recognized as performed. If VSOE of fair value does not exist for            all the elements in an arrangement except software licenses, service revenue is            recognized over the longest contractual period in an arrangement. Revenue from services            sold alone or with support is recognized as performed.

**Cash and Cash            Equivalents**

We consider all highly liquid            investments purchased with an original maturity of three months or less to be cash            equivalents. Cash and cash equivalents, which primarily consist of cash on deposit with            banks, money market funds, and US Government debt with a maturity of three months or            less, are stated at cost, which approximates fair value. Our cash and cash equivalents            consisted of the following (in thousands):

|                                      |   |                                    |    |     |   |   |   |
|-------------------------------------------|--------|-----------------------------------------|---------|----------|--------|--------|--------|
|                                      |   | **December                        31,** |    |
|                                      |   |                                         |    |
|                                      |   | **2007**                                |    | **2006** |   |
|                                      |   |                                         |    |          |   |
| Cash on                        deposit    |   | $                                       | 336     |     | $      | 1,281  |   |
| Money market                        funds |   |                                    | 20,843  |     |   | 10,833 |   |
| US Government                        debt |   |                                    | — |     |   | 4,250  |   |
|                                      |   |                                         |         |     |        |        |   |
|                                      |   | $                                       | 21,179  |     | $      | 16,364 |   |
|                                      |   |                                         |         |     |        |        |   |

**Short-Term            Investments**

We determine the appropriate            classification of investments at the time of purchase in accordance with Statement of            Financial Accounting Standards No. 115, *“Accounting for Certain Investments in            Debt and Equity Securities,”* and reevaluate such determination at each            balance sheet date.

**Accounts            Receivable**

We conduct business primarily            with public school districts and speech and language professionals in the United            States. We maintain an allowance for doubtful accounts for estimated losses due to the            inability of customers to make payments. We adjust this allowance periodically based on            our historical experience of bad debt write offs.

**Inventories**

Product inventories, which are            primarily finished goods, are stated at the lower of cost or market and are included in            “Prepaid expenses and other current assets”. Cost is determined using a            weighted average approach, which approximates the first-in first-out method. If            inventory costs exceed expected market value due to obsolescence or lack of demand            adjustments are recorded for the difference between the cost and the market            value.

**Fair Value of Financial            Instruments**

The carrying amounts of our cash            and cash equivalents, short-term investments, accounts receivable, notes receivable            from current and former officers, and accounts payable approximate fair            value.

Page            48

----

**Notes to Financial            Statements**

**1. Summary of Significant            Accounting Policies (continued)**

**Concentration of            Risk**

Financial instruments that            potentially subject us to concentrations of credit risk consist principally of cash,            cash equivalents, short-term investments and accounts receivable.

Cash and cash equivalents are            invested in major financial institutions in the United States. Such deposits may be in            excess of insured limits and are not insured in other jurisdictions. Management            believes that the financial institutions that hold the Company’s investments are            financially sound and, accordingly, minimal credit risk exists with respect to these            investments.

Our accounts receivable are            derived from booked sales to customers located primarily in the United States. We            perform ongoing credit evaluations of our customers. We do not require            collateral.

An allowance for doubtful            accounts is determined with respect to those accounts that we have determined to be            doubtful of collection. At December 31, 2007 one customer accounted for more than 10%            of our accounts receivable. At December 31, 2006, no customer accounted for more than            10% of our accounts receivable. One customer accounted for more than 10% of our revenue            in fiscal 2007. No customers accounted for more than 10% of our revenue in fiscal 2006            or 2005.

We have no off-balance sheet            concentration of credit risk, such as foreign exchange contracts, option contracts or            other hedging arrangements.

Our concentration of royalty            arrangements potentially exposes us to risk. The patents and applications that we            license are owned by the Regents of the University of California, and Rutgers, the            State University of New Jersey, and relate to the basic speech and sound modification            and adaptive technology developed at those institutions. In 2007, approximately 78% of            our product booked sales was derived from selling products that use the licensed            inventions.

**Property and            Equipment**

Property and equipment are            recorded at cost. Depreciation is computed using the straight-line method over the            estimated useful lives of the assets, which range from three to five years.

**Software Development            Costs**

We account for software            development costs in accordance with Statement of Financial Accounting Standards            (“SFAS”) No. 86, “*Accounting for the Costs of Computer Software to            be Sold, Leased or Otherwise Marketed,”* under which certain software            development costs incurred subsequent to the establishment of technological feasibility            are capitalized and amortized over the estimated lives of the related products.            Technological feasibility is established upon completion of a working model. In 2007,            2006 and 2005 costs incurred subsequent to the establishment of technological            feasibility for new projects were not significant, and were charged to research and            development expense. Software costs are amortized to cost of product revenues over the            estimated useful life of the software, which is three years. Amortization was zero,            $130,000, and $261,000 for the years ended December 31, 2007, 2006 and 2005,            respectively. All capitalized software development costs were fully amortized by June            30, 2006.

Costs related to internally            developed software and software purchased for internal use are capitalized in            accordance with Statement of Position 98-1, *“Accounting for Costs of Computer            Software Developed or Obtained for Internal Use.”* During the year ended            December 31, 2006, we purchased an enterprise-wide, customer relationship management            system. As of December 31, 2007, a net book value of $1.4 million related to the            purchase and subsequent implementation of this system was included in property and            equipment. These costs are being depreciated over the estimated useful life of five            years.

Page            49

----

**Notes to Financial            Statements**

**1. Summary of Significant            Accounting Policies (continued)**

**Long-Lived            Assets**

We regularly review the carrying            value of long-lived assets. We continually make estimates regarding future cash flows            and other factors to determine the fair value of the respective assets. If these            estimates or their related assumptions change in the future, we may be required to            record impairment charges for these assets.

**Accounting for Stock-Based            Compensation**

Effective January 1, 2006 we            began recording compensation expense associated with stock-based awards and other forms            of equity compensation in accordance with SFAS 123R, *“Share-Based            Payment”* (“SFAS 123R”)*.* We adopted SFAS 123R using the            modified prospective transition method and consequently have not retroactively adjusted            results from prior periods. Under this transition method, compensation cost associated            with stock-based awards recognized for fiscal years 2006 and 2007 includes 1)            amortization related to the remaining unvested portion of stock-based awards granted            prior to January 1, 2006, based on the grant date fair value estimated in accordance            with the original provisions of SFAS 123 *“Accounting for Stock-Based            Compensation”* (“FAS 123”); and 2) amortization related to            stock-based awards granted subsequent to January 1, 2006, based on the grant-date fair            value estimated in accordance with the provisions of SFAS 123R. In addition, we record            expense over the service period in connection with shares issued under our employee            stock purchase plan and stock options and restricted stock awards. The compensation            expense for stock-based awards includes an estimate for forfeitures and is recognized            over the service period of the award on a straight-line basis.

Prior to January 1, 2006, we            accounted for stock-based awards using the intrinsic value method of accounting in            accordance with APB 25, whereby the difference between the exercise price and the fair            market value on the date of grant is recognized as compensation expense. Under the            intrinsic value method of accounting, no compensation expense was recognized in our            Statements of Income when the exercise price of our employee stock option grant equals            the market price of the underlying common stock on the date of grant, and the            measurement date of the option grant is certain. The measurement date is certain when            the date of grant is fixed and determinable.

**Advertising**

Advertising costs are expensed            as incurred. Advertising expense was $2,000, $26,000, and $18,000 for the years ended            December 31, 2007, 2006 and 2005, respectively.

**Income Taxes**

We account for income taxes in            accordance with SFAS No. 109, “*Accounting for Income Taxes*,” which            requires the use of the liability method in accounting for income taxes. Under SFAS No.            109, deferred tax assets and liabilities are measured using enacted tax rates and laws            that are expected to be in effect when the differences are expected to reverse.            Valuation allowances are established when necessary to reduce deferred tax assets to            the net amount expected to be realized.

**Net Income Per            Share**

Basic net income per share is            computed using the weighted-average number of common shares outstanding during the            period. Diluted net income per share reflects the potential dilution of securities by            adding common stock equivalents (computed using the treasury stock method) to the            weighted-average number of common shares outstanding during the period, if            dilutive.

Page            50

----

**Notes to Financial            Statements**

**1. Summary of Significant            Accounting Policies (continued)**

The following table sets forth            the computation of net income per share (in thousands, except per share            data):

|                                                                                                                                             |   |                                               |   |     |   |     |   |   |   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|
|                                                                                                                                             |   | **Year Ended December                        31,** |   |
|                                                                                                                                             |   |                                                    |   |
|                                                                                                                                             |   | **2007**                                           |   | **2006** |   | **2005** |   |
|                                                                                                                                             |   |                                                    |   |          |   |          |   |
| Net                        income                                                                                                                |   | $                                                  | 1,154  |     | $      | 208      |   | $      | 5,597  |   |
|                                                                                                                                             |   |                                                    |        |     |        |          |   |        |        |   |
| Weighted average                        shares used in calculation of basic net income                             per share |   |                                               | 17,161 |     |   | 16,846   |   |   | 16,715 |   |
| Effect of dilutive                        securities:                                                                                            |   |                                               |   |     |   |     |   |   |   |   |
| Employee stock                        options and awards                                                                                         |   |                                               | 1,136  |     |   | 894      |   |   | 1,308  |   |
|                                                                                                                                             |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                                                                                             |   |                                               |   |     |   |     |   |   |   |   |
| Weighted-average                        diluted common shares                                                                                    |   |                                               | 18,297 |     |   | 17,740   |   |   | 18,023 |   |
|                                                                                                                                             |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                                                                                             |   |                                               |   |     |   |     |   |   |   |   |
| Basic net income per                        share                                                                                                |   | $                                                  | 0.07   |     | $      | 0.01     |   | $      | 0.33   |   |
|                                                                                                                                             |   |                                                    |        |     |        |          |   |        |        |   |
|                                                                                                                                             |   |                                               |   |     |   |     |   |   |   |   |
| Diluted net income                        per share                                                                                              |   | $                                                  | 0.06   |     | $      | 0.01     |   | $      | 0.31   |   |
|                                                                                                                                             |   |                                                    |        |     |        |          |   |        |        |   |

For the years ended December 31,            2007, 2006 and 2005, respectively, 923,621, 1,393,649 and 1,058,652 options with            exercise prices greater than the average market price for our common stock were            excluded from the calculation of diluted net income per share because their effect is            anti-dilutive.

**Recent Accounting            Pronouncements**

In September 2006, the FASB            issued Statement of Financial Accounting Standards No. 157, *“Fair Value            Measurements”* (“SFAS 157”). SFAS 157 defines fair value,            establishes a framework for measuring fair value in accordance with generally accepted            accounting principles and expands disclosures about fair value measurements. SFAS 157            is effective for fiscal years beginning after November 15, 2007. We do not believe that            the adoption of SFAS 157 will have a material impact on our financial condition and            results of operations.

In February 2007, the FASB            issued Statement of Financial Accounting Standards No. 159, *“The Fair Value            Option for Financial Assets and Financial Liabilities”* (“SFAS            159”), including an amendment of FASB Statement No. 115, which allows an entity            the irrevocable option to elect fair value for the initial and subsequent measurement            for certain financial assets and liabilities on an instrument-by-instrument basis.            Subsequent measurements for the financial assets and liabilities an entity elects to            record at fair value will be recognized in earnings. Statement 159 also establishes            additional disclosure requirements. SFAS 159 is effective for fiscal years beginning            after November 15, 2007. We have not elected to adopt SFAS 159.

In December 2007, the FASB            issued Statement of Financial Accounting Standards No. 141 (revised 2007) (“SFAS            141R”), *“Business Combinations”* and Statement of Financial            Accounting Standards No. 160 (“SFAS 160”), *“Noncontrolling            Interests in Consolidated Financial Statements, an amendment of Accounting Research            Bulletin No. 51”*. SFAS 141R will change how business acquisitions are            accounted for and will impact financial statements both on the acquisition date and in            subsequent periods. SFAS 160 will change the accounting and reporting for minority            interests, which will be recharacterized as noncontrolling interests and classified as            a component of equity. SFAS 141R and SFAS 160 are effective for us beginning in the            first quarter of fiscal 2010. Early adoption is not permitted. We are currently            evaluating the impact that SFAS 141R and SFAS 160 will have on our financial            statements.

Page            51

----

**Notes to Financial            Statements**

**2. Stock-Based            Compensation**

*Stock-Based Compensation            Plans*

On December 31, 2007, we had            four active share-based compensation plans, which are described below.

In May 1999, our stockholders            approved our 1999 Equity Incentive Plan. The total number of shares authorized for            issuance under the plan is 6,492,666. Restricted stock units awarded under this plan            generally vest over four years of continuous service in annual or semi-annual            installments. Option awards have generally been granted with an exercise price equal to            the market price of our common stock at the date of grant, and generally vest based on            four years of continuous service with a ten-year contractual term.

In May 1999, our stockholders            approved the 1999 Non-Employee Directors’ Stock Option Plan. The total number of            shares authorized for issuance under this plan is 250,000.

In May 2002, the Board of            Directors approved the 2002 CEO Stock Option Plan, which was subsequently approved by            the shareholders in May 2003. The total number of shares authorized for issuance under            this plan is 470,588.

In May 1999 the stockholders            approved the 1999 Employee Stock Purchase Plan (ESPP), which became effective upon the            completion of the initial public offering of our common stock. The total number of            shares originally authorized for issuance under the plan was 700,000. In June 2007 an            additional 500,000 shares were authorized.

Eligible employees may purchase            common stock at 85% of the lesser of the fair market value of our common stock on the            first day of the applicable one-year offering period or the last day of the applicable            six-month purchase period. At December 31, 2007, 500,533 shares were available for            issuance under this plan.

*Adoption of SFAS No.            123R*

Prior to January 1, 2006, we            accounted for our stock plans under the provisions of Accounting Principles Board            Opinion No. 25, *“Accounting for Stock Issued to Employees”* (APB No.            25). Effective January 1, 2006 we began recording compensation expense associated with            stock-based awards and other forms of equity compensation in accordance with SFAS 123R,            *“Share-Based Payment”.* We adopted the modified prospective            transition method provided for under SFAS 123R, and consequently have not retroactively            adjusted results from prior periods.

SFAS No. 123R requires us to            estimate forfeitures at the time of grant and revise those estimates in subsequent            periods if actual forfeitures differ from those estimates. We use historical data to            estimate pre-vesting option forfeitures and record share-based compensation expense            only for those awards that are expected to vest. For purposes of calculating pro forma            information under SFAS 123 for periods prior to January 1, 2006, we accounted for            forfeitures as they occurred. In the fourth quarter of 2007 we changed our estimate of            the forfeiture rate from 11% to 3.5%, based on our experience of actual forfeiture            rates. This resulted in incremental stock compensation expense of approximately            $316,000 in the fourth quarter of fiscal 2007.

In anticipation of the adoption            of SFAS No. 123R, we did not modify the terms of any previously granted options. We            made minor changes to our equity compensation program by reducing the overall number of            shares covered by equity compensation grants and granting restricted stock units            beginning in the first quarter of 2006.

The following table presents the            pro forma effect on net income and net income per share if we had applied the fair            value recognition provisions of SFAS No. 123 to options granted under our share-based            compensation arrangements during the year ended December 31, 2005 (in thousands, except            per share data):

Page            52

----

**Notes to Financial            Statements**

**2. Stock-Based Compensation            (continued)**

|                                                                                                                                                                                      |   |   |   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Net income, as                        reported                                                                                                                                            |   | $      | 5,597  |   |
| Add: Stock-based                        compensation costs included in the determination of net income, net of                        related tax effects                                 |   |   | 205    |   |
|                                                                                                                                                                                      |   |   |   |   |
| Deduct: Total                        stock-based employee compensation expense determined under fair value based                        method for all awards, net of related tax effects |   |   | (1,998 | )      |
|                                                                                                                                                                                      |   |        |        |   |
| Pro forma net                        income                                                                                                                                               |   | $      | 3,804  |   |
|                                                                                                                                                                                      |   |        |        |   |
|                                                                                                                                                                                      |   |   |   |   |
| Basic net income per                        share, as reported                                                                                                                            |   | $      | 0.33   |   |
|                                                                                                                                                                                      |   |        |        |   |
| Basic net income per                        share, pro forma                                                                                                                              |   | $      | 0.23   |   |
|                                                                                                                                                                                      |   |        |        |   |
| Diluted net income per                        share, as reported                                                                                                                          |   | $      | 0.31   |   |
|                                                                                                                                                                                      |   |        |        |   |
| Diluted net income per                        share, pro forma                                                                                                                            |   | $      | 0.21   |   |
|                                                                                                                                                                                      |   |        |        |   |

*Compensation            Cost*

The following table summarizes            the impact of share-based compensation resulting from the application of SFAS 123R in            the years ended December 31, 2007 and 2006 (in thousands, except per share            amounts):

|                                                          |   |                                               |   |     |   |   |   |   |   |   |   |
|---------------------------------------------------------------|--------|----------------------------------------------------|--------|----------|--------|--------|--------|--------|--------|--------|--------|
|                                                          |   | **Year Ended December                        31,** |   |
|                                                          |   |                                                    |   |
|                                                          |   | **2007**                                           |   | **2006** |   |
|                                                          |   |                                                    |   |          |   |
| Cost of service and                        support revenues   |   |                                               | $      | 216      |   |   |   | $      | 193    |   |   |
| Sales and                        marketing                    |   |                                               |   | 892      |   |   |   |   | 738    |   |   |
| Research and                        development               |   |                                               |   | 390      |   |   |   |   | 314    |   |   |
| General and                        administrative             |   |                                               |   | 965      |   |   |   |   | 881    |   |   |
|                                                          |   |                                               |        |          |   |   |   |        |        |   |   |
| Total stock-based                        compensation expense |   |                                               | $      | 2,463    |   |   |   | $      | 2,126  |   |   |
|                                                          |   |                                               |        |          |   |   |   |        |        |   |   |

*Valuation of Stock Option            Awards*

The fair value of each option            award is estimated on the date of grant using the Black-Scholes option valuation model.            This model requires the input of subjective assumptions, including expected stock price            volatility, the estimated life of each award and estimated pre-vesting forfeitures. The            fair value of these stock options was estimated assuming no expected dividends and            estimates of expected life, volatility and risk-free interest rate at the time of            grant. Estimated volatility is based on the historical prices of our common stock over            the expected life of each option. Expected life of the options is based on our history            of option exercise and cancellation activity. The risk free interest rates used are            based on the U.S. Treasury yield curve in effect at the time of grants for periods            corresponding with the expected life of the options. We use historical data to estimate            pre-vesting option forfeitures. We recognize compensation expense for the fair values            of these awards, which typically have graded vesting, on a straight-line basis over the            requisite service period of each of these awards.

The fair value of stock options            granted was estimated using the following weighted-average assumptions:

|                                            |   |     |   |     |   |     |   |   |   |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|--------|--------|--------|
|                                            |   | **2007** |   | **2006** |   | **2005** |   |
|                                            |   |          |   |          |   |          |   |
|                                            |
| Expected life (in                        years) |   |     | 4      |     |   | 4        |   |   | 4      |   |
| Risk-free interest                        rate  |   |     | 4.9    | %        |   | 5.1      | %      |   | 3.7    | %      |
| Dividend                        yield           |   |     | 0.0    | %        |   | 0.0      | %      |   | 0.0    | %      |
| Expected                        volatility      |   |     | 49     | %        |   | 80       | %      |   | 106    | %      |

Page            53

----

**Notes to Financial            Statements**

**2. Stock-Based Compensation            (continued)**

*Summary of Stock            Options*

The following table summarizes            all stock option activity under our share-based compensation plans for the year ended            December 31, 2007:

|                                                                    |   |                                           |      |                                                                                                                                       |   |                                                                                                                                                 |   |                                                                        |   |   |   |   |      |   |
|-------------------------------------------------------------------------|--------|------------------------------------------------|-----------|--------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|--------|--------|--------|-----------|--------|
|                                                                    |   | **Outstanding                        Options** |      |
|                                                                    |   |                                                |      |
|                                                                    |   | **Number of                        Shares**    |      | **Weighted-                        Average                        Exercise                        Price Per                        Share** |   | **Weighted-                        Average                        Remaining                        Contractual                        Term (Years)** |   | **Aggregate                        Intrinsic                        Value** |   |
|                                                                    |   |                                                |           |                                                                                                                                            |        |                                                                                                                                                      |        |                                                                             |   |
| Outstanding at                        December 31, 2006                 |   |                                           | 3,299,644 |                                                                                                                                       |   | $                                                                                                                                                    | 4.23   |                                                                        |   |   |   |   |      |   |
| Granted                                                                 |   |                                           | 230,000   |                                                                                                                                       |   | $                                                                                                                                                    | 7.16   |                                                                        |   |   |   |   |      |   |
| Exercised                                                               |   |                                           | (182,375  | )                                                                                                                                          |   | $                                                                                                                                                    | 4.51   |                                                                        |   |   |   |   |      |   |
| Forfeited                                                               |   |                                           | (63,738   | )                                                                                                                                          |   | $                                                                                                                                                    | 9.24   |                                                                        |   |   |   |   |      |   |
|                                                                    |   |                                                |           |                                                                                                                                       |   |                                                                                                                                                 |   |                                                                        |   |   |   |   |      |   |
| Outstanding at                        December 31, 2007                 |   |                                           | 3,283,531 |                                                                                                                                       |   | $                                                                                                                                                    | 4.33   |                                                                        |   | 4.72   |   | $      | 6,277,925 |   |
|                                                                    |   |                                                |           |                                                                                                                                       |   |                                                                                                                                                      |        |                                                                        |   |        |   |        |           |   |
|                                                                    |   |                                           |      |                                                                                                                                       |   |                                                                                                                                                 |   |                                                                        |   |   |   |   |      |   |
| Vested and expected                        to vest at December 31, 2007 |   |                                           | 3,106,914 |                                                                                                                                       |   | $                                                                                                                                                    | 4.44   |                                                                        |   | 4.72   |   | $      | 5,704,548 |   |
|                                                                    |   |                                           |      |                                                                                                                                       |   |                                                                                                                                                 |   |                                                                        |   |   |   |   |      |   |
| Exercisable at                        December 31, 2007                 |   |                                           | 2,202,374 |                                                                                                                                       |   | $                                                                                                                                                    | 4.98   |                                                                        |   | 4.66   |   | $      | 3,298,478 |   |
|                                                                    |   |                                                |           |                                                                                                                                       |   |                                                                                                                                                      |        |                                                                        |   |        |   |        |           |   |

The aggregate intrinsic value of            options outstanding at December 31, 2007 is calculated as the difference between the            exercise price of the underlying options and the market price of our common stock for            the 1,940,964 shares that had exercise prices that were lower than the $5.36 market            price of our common stock at December 31, 2007 (“in the money options”).            The total intrinsic value of options exercised during the years ended December 31,            2007, 2006 and 2005 was $416,000, $151,000, and $192,000, respectively. The fair value            of options vested during the years ended December 31, 2007, 2006 and 2005 was $1.5            million, $1.7 million, and $1.7 million, respectively. The weighted average grant date            fair value of options granted during the years ended December 31, 2007, 2006 and 2005            was $2.96, $2.67, and $4.31, respectively.

The following table summarizes            information concerning outstanding and exercisable stock options at December 31,            2007:

|                                   |   |                                        |      |                                                                                                                                       |   |                                                                                                                                                 |   |                                        |   |                                                                                        |   |   |      |   |   |   |   |   |   |
|----------------------------------------|--------|---------------------------------------------|-----------|--------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|---------------------------------------------------------------------------------------------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|
|                                   |   | **Outstanding**                             |      | **Exercisable**                                                                                                                            |   |
|                                   |   |                                             |      |                                                                                                                                            |   |
| **Price                        Range** |   | **Number of                        Shares** |      | **Weighted-                        Average                        Exercise                        Price Per                        Share** |   | **Weighted-                        Average                        Remaining                        Contractual                        Life (Years)** |   | **Number of                        Shares** |   | **Weighted Average                        Exercise Price Per                        Share** |   |
|                                        |        |                                             |           |                                                                                                                                            |        |                                                                                                                                                      |        |                                             |        |                                                                                             |        |
|                                   |
| $0.75 -                        $1.39   |   |                                        | 1,097,364 |                                                                                                                                       |   | $                                                                                                                                                    | 1.38   |                                        |   | 4.4                                                                                         |   |   | 347,364   |   |   | $      | 1.35   |   |   |
| $1.40 -                        $1.90   |   |                                        | 376,600   |                                                                                                                                       |   | $                                                                                                                                                    | 1.71   |                                        |   | 4.7                                                                                         |   |   | 376,600   |   |   | $      | 1.71   |   |   |
| $1.98 -                        $5.36   |   |                                        | 467,000   |                                                                                                                                       |   | $                                                                                                                                                    | 4.22   |                                        |   | 4.1                                                                                         |   |   | 457,375   |   |   | $      | 4.20   |   |   |
| $5.39 -                        $5.95   |   |                                        | 662,170   |                                                                                                                                       |   | $                                                                                                                                                    | 5.83   |                                        |   | 6.8                                                                                         |   |   | 526,815   |   |   | $      | 5.81   |   |   |
| $5.96 -                        $30.50  |   |                                        | 680,397   |                                                                                                                                       |   | $                                                                                                                                                    | 9.14   |                                        |   | 3.6                                                                                         |   |   | 494,220   |   |   | $      | 9.88   |   |   |
|                                   |   |                                             |           |                                                                                                                                       |   |                                                                                                                                                 |   |                                        |   |                                                                                        |   |        |           |   |   |   |   |   |   |
|                                   |   |                                        | 3,283,531 |                                                                                                                                       |   | $                                                                                                                                                    | 4.33   |                                        |   | 4.7                                                                                         |   |   | 2,202,374 |   |   | $      | 4.98   |   |   |
|                                   |   |                                             |           |                                                                                                                                       |   |                                                                                                                                                 |   |                                        |   |                                                                                        |   |        |           |   |   |   |   |   |   |

As of December 31, 2007, total            unrecognized compensation cost related to stock options granted under our various plans            was $1.1 million. We expect that cost to be recognized over a weighted-average period            of 0.9 years.

Page            54

----

**Notes to Financial            Statements**

**2. Stock-Based Compensation            (continued)**

*Summary of Restricted Stock            Units and Restricted Stock Awards*

The following table summarizes            all restricted stock unit activity under our share-based compensation plans for the            years ending December 31, 2007 and 2006:

|                                                                                           |   |                                                          |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
|------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|--------|--------|--------|-----------------|--------|--------|
|                                                                                           |   | **Outstanding                        Restricted Stock Units** |   |
|                                                                                           |   |                                                               |   |
|                                                                                           |   | **Number of                        Shares**                   |   | **Weighted-                        Average                        Remaining                        Contractual                        Term (Years)** |   | **Aggregate                        Intrinsic Value** |   |
|                                                                                           |   |                                                               |        |                                                                                                                                                      |        |                                                      |   |
| Outstanding at                        December 31, 2006                                        |   | 229,000                                                       |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
| Awarded                                                                                        |   | 351,500                                                       |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
| Vested                                                                                         |   | (90,499                                                       | )      |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
| Forfeited or                        expired                                                    |   | (14,500                                                       | )      |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
|                                                                                           |   |                                                               |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
| Outstanding at                        December 31, 2007                                        |   | 475,501                                                       |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
|                                                                                           |   |                                                               |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
|                                                                                           |   |                                                          |   |                                                                                                                                                 |   |                                                 |   |   |   |            |   |   |
| Vested and expected                        to vest at                        December 31, 2007 |   | 434,629                                                       |   |                                                                                                                                                 |   | 1.53                                                 |   |   | $      |  2,329,611 |   |   |
|                                                                                           |   |                                                               |   |                                                                                                                                                 |   |                                                      |   |   |        |                 |   |   |

Restricted stock units were            granted for the first time in 2006 under our 1999 Equity Incentive Plan. The fair value            of these grants was calculated based upon the fair market value of our stock at the            date of grant, less an estimate of pre-vesting forfeitures. The weighted-average            grant-date fair value of restricted stock units awarded during fiscal years 2007 and            2006 was $6.83 and $4.88, respectively, and the fair value of stock units that vested            during fiscal years 2007 and 2006 was $771,000 and $289,000, respectively. As of            December 31, 2007, total unrecognized compensation cost related to restricted stock            units was $2.3 million. We expect that cost to be recognized over a weighted-average            period of 3.0 years.

*Employee Stock Purchase Plan            (“ESPP”)*

ESPP awards for offering periods            prior to and after the adoption of SFAS No. 123R were valued using the Black-Scholes            model using the following assumptions:

|                                            |   |     |                             |     |   |                             |   |   |                             |   |
|-------------------------------------------------|--------|----------|----------------------------------|----------|--------|----------------------------------|--------|--------|----------------------------------|--------|
|                                            |   | **2007** |                             | **2006** |   | **2005**                         |   |
|                                            |   |          |                             |          |   |                                  |   |
|                                            |
| Expected life (in                        years) |   |     | 0.5 -                        1.0 |     |   | 0.5 -                        1.0 |   |   | 0.5 -                        1.0 |   |
| Risk-free interest                        rate  |   |     | 5.0%                             |     |   | 4.2%                             |   |   | 2.6%                             |   |
| Dividend                        yield           |   |     | 0.0%                             |     |   | 0.0%                             |   |   | 0.0%                             |   |
| Expected                        volatility      |   |     | 44%                              |     |   | 40%                              |   |   | 45%                              |   |

*Disclosures Pertaining to All            Share-Based Compensation Plans*

Cash received under all            share-based payment arrangements for the years ended December 31, 2007, 2006 and 2005            was $1.2 million, $602,000, and $474,000, respectively, related to the exercise of            stock options and the purchase of ESPP shares. The weighted-average grant-date fair            value of options, restricted stock units and restricted stock awards granted in the            years ended December 31, 2007, 2006 and 2005 was $5.32, $4.21, and $4.36 per share,            respectively.

Page            55

----

**Notes to Financial            Statements**

**3. Prepaid Expenses and Other            Current Assets**

Prepaid expenses and other            current assets consist of the following (in thousands):

|                                     |   |                                    |   |     |   |   |   |
|------------------------------------------|--------|-----------------------------------------|--------|----------|--------|--------|--------|
|                                     |   | **December                        31,** |   |
|                                     |   |                                         |   |
|                                     |   | **2007**                                |   | **2006** |   |
|                                     |   |                                         |   |          |   |
| Prepaid                        expenses  |   | $                                       | 1,037  |     | $      | 815    |   |
| Product                        inventory |   |                                    | 111    |     |   | 130    |   |
| Other                        receivables |   |                                    | 143    |     |   | 26     |   |
|                                     |   |                                         |        |     |        |        |   |
|                                     |   | $                                       | 1,291  |     | $      | 971    |   |
|                                     |   |                                         |        |     |        |        |   |

**4. Property and            Equipment**

Property and equipment consists            of the following (in thousands):

|                                                   |   |                                    |   |     |   |   |   |
|--------------------------------------------------------|--------|-----------------------------------------|--------|----------|--------|--------|--------|
|                                                   |   | **December                        31,** |   |
|                                                   |   |                                         |   |
|                                                   |   | **2007**                                |   | **2006** |   |
|                                                   |   |                                         |   |          |   |
|                                                   |   |                                    |   |     |   |   |   |
| Computer equipment                        and software |   |                                    | 6,376  |     | $      | 5,284  |   |
| Office furniture and                        equipment  |   |                                    | 1,518  |     |   | 1,518  |   |
| Leasehold                        improvements          |   |                                    | 489    |     |   | 489    |   |
|                                                   |   |                                         |        |     |        |        |   |
|                                                   |   |                                    | 8,383  |     |   | 7,291  |   |
| Less accumulated                        depreciation   |   |                                    | (6,641 | )        |   | (6,350 | )      |
|                                                   |   |                                         |        |     |        |        |   |
|                                                   |   | $                                       | 1,742  |     | $      | 941    |   |
|                                                   |   |                                         |        |     |        |        |   |

Depreciation expense for the            years ended December 31, 2007, 2006, and 2005 was $313,000, $350,000, and $467,000,            respectively.

**5. Deferred Acquisition            Costs**

Deferred acquisition costs            consist principally of legal and accounting fees directly associated with the            negotiation and execution of the Purchase Agreement for the acquisition of the            Soliloquy Learning business (see Note 17). These costs will be included in the purchase            price upon the closing of the transaction.

**6. Other            Assets**

Other assets consist of the            following (in thousands):

|                                            |   |                                    |   |     |   |   |   |
|-------------------------------------------------|--------|-----------------------------------------|--------|----------|--------|--------|--------|
|                                            |   | **December                        31,** |   |
|                                            |   |                                         |   |
|                                            |   | **2007**                                |   | **2006** |   |
|                                            |   |                                         |   |          |   |
| Long-term lease                        deposits |   | $                                       | 855    |     | $      | 855    |   |
| Other non current                        assets |   |                                    | 71     |     |   | 54     |   |
|                                            |   |                                         |        |     |        |        |   |
|                                            |   | $                                       | 926    |     | $      | 909    |   |
|                                            |   |                                         |        |     |        |        |   |

Page            56

----

**Notes to Financial            Statements**

**7. Accrued            Liabilities**

Accrued liabilities consist of            the following (in thousands):

|                                                 |   |                                    |    |     |   |   |   |
|------------------------------------------------------|--------|-----------------------------------------|---------|----------|--------|--------|--------|
|                                                 |   | **December                        31,** |    |
|                                                 |   |                                         |    |
|                                                 |   | **2007**                                |    | **2006** |   |
|                                                 |   |                                         |    |          |   |
| Accrued                        vacation              |   | $                                       | 903     |     | $      | 1,036  |   |
| Accrued commissions                        and bonus |   |                                    | 1,267   |     |   | 2,710  |   |
| Accounts payable                        accruals     |   |                                    | 663     |     |   | 503    |   |
| Other accrued                        liabilities     |   |                                    | 1,026   |     |   | 768    |   |
| Accrued income tax                        payable    |   |                                    | — |     |   | 72     |   |
|                                                 |   |                                         |         |     |        |        |   |
|                                                 |   | $                                       | 3,859   |     | $      | 5,089  |   |
|                                                 |   |                                         |         |     |        |        |   |

**8. Deferred            Revenue**

Deferred revenue consists of the            following (in thousands):

|                                       |   |                                    |   |     |   |   |   |
|--------------------------------------------|--------|-----------------------------------------|--------|----------|--------|--------|--------|
|                                       |   | **December                        31,** |   |
|                                       |   |                                         |   |
|                                       |   | **2007**                                |   | **2006** |   |
|                                       |   |                                         |   |          |   |
| Current:                                   |   |                                    |   |     |   |   |   |
| Products                                   |   | $                                       | 4,586  |     | $      | 5,484  |   |
| Service and                        support |   |                                    | 12,793 |     |   | 9,302  |   |
|                                       |   |                                         |        |     |        |        |   |
|                                       |   | $                                       | 17,379 |     | $      | 14,786 |   |
|                                       |   |                                         |        |     |        |        |   |
| Long                        term:          |   |                                    |   |     |   |   |   |
| Products                                   |   | $                                       | 505    |     | $      | 1,519  |   |
| Service and                        support |   |                                    | 5,071  |     |   | 2,854  |   |
|                                       |   |                                         |        |     |        |        |   |
|                                       |   | $                                       | 5,576  |     | $      | 4,373  |   |
|                                       |   |                                         |        |     |        |        |   |

**9. Bank Line of            Credit**

On June 5, 2007 we amended our            existing revolving line of credit agreement with Comerica Bank. The maximum that can be            borrowed under the agreement is $5.0 million. The line expires on December 2, 2008.            Borrowing under the line of credit bears interest at a floating prime rate, or a fixed            rate of LIBOR plus 2.5%. To secure the line we granted Comerica a security interest in            all of our assets other than our intellectual property. We also agreed with Comerica            that we will not grant a security interest in our intellectual property to any third            party. Borrowings under the line are subject to various covenants. The agreement            includes a letter of credit sublimit not to exceed $1.0 million. At December 31, 2007,            we have an outstanding letter of credit for $206,000. There were no borrowings            outstanding on the line of credit at December 31, 2007 and we were in compliance with            all our covenants.

Page            57

----

**Notes to Financial            Statements**

**10. Income            Taxes**

All income before income taxes            is derived from the United States.

The components of the provision            (benefit) for income taxes are as follows (in thousands):

|                                                              |   |                                           |   |   |   |    |   |   |    |   |
|-------------------------------------------------------------------|--------|------------------------------------------------|--------|--------|--------|---------|--------|--------|---------|--------|
|                                                              |   | Year                        ended December 31, |   |
|                                                              |   |                                                |   |
|                                                              |   | 2007                                           |   | 2006   |   | 2005    |   |
|                                                              |   |                                                |   |        |   |         |   |
| Current:                                                          |   |                                           |   |   |   |    |   |   |    |   |
| Federal                                                           |   | $                                              | 28     |   | $      | 97      |   | $      | 159     |   |
| State                                                             |   |                                           | 81     |   |   | 106     |   |   | 23      |   |
|                                                              |   |                                                |        |   |        |         |   |        |         |   |
| Total                        current                              |   |                                           | 109    |   |   | 203     |   |   | 182     |   |
|                                                              |   |                                           |   |   |   |    |   |   |    |   |
| Deferred:                                                         |   |                                           |   |   |   |    |   |   |    |   |
| Federal                                                           |   |                                           | (1,055 | )      |   | — |   |   | — |   |
| State                                                             |   |                                           | (136   | )      |   | — |   |   | — |   |
|                                                              |   |                                                |        |   |        |         |   |        |         |   |
| Total                        deferred                             |   |                                           | (1,191 | )      |   | — |   |   | — |   |
|                                                              |   |                                           |   |   |   |    |   |   |    |   |
| Total provision                        (benefit) for income taxes |   | $                                              | (1,082 | )      | $      | 203     |   | $      | 182     |   |
|                                                              |   |                                                |        |   |        |         |   |        |         |   |

Differences between income taxes            calculated using the federal statutory income tax rate and the provision (benefit) for            income taxes were as follows (in thousands):

|                                                              |   |                                           |   |   |   |   |   |   |    |   |
|-------------------------------------------------------------------|--------|------------------------------------------------|--------|--------|--------|--------|--------|--------|---------|--------|
|                                                              |   | Year                        ended December 31, |   |
|                                                              |   |                                                |   |
|                                                              |   | 2007                                           |   | 2006   |   | 2005   |   |
|                                                              |   |                                                |   |        |   |        |   |
|                                                              |   |                                           |   |   |   |   |   |   |    |   |
| Computed tax at                        statutory rate of 34%      |   | $                                              | 24     |   | $      | 140    |   | $      | 1,965   |   |
| State taxes, net of                        federal benefit        |   |                                           | 80     |   |   | 73     |   |   | 23      |   |
| Federal Alternative                        Minimum Tax            |   |                                           | 41     |   |   | 97     |   |   | 159     |   |
| Losses                        benefited                           |   |                                           | (783   | )      |   | (631   | )      |   | (2,015  | )      |
| Non deductible                        stock-based compensation    |   |                                           | 435    |   |   | 407    |   |   | — |   |
| Other non deductible                        expenses              |   |                                           | 312    |   |   | 117    |   |   | 50      |   |
| Change in valuation                        allowance              |   |                                           | (1,191 | )      |   |   |   |   |    |   |
|                                                              |   |                                                |        |   |        |        |   |        |         |   |
| Total provision                        (benefit) for income taxes |   | $                                              | (1,082 | )      | $      | 203    |   | $      | 182     |   |
|                                                              |   |                                                |        |   |        |        |   |        |         |   |

Deferred income taxes reflect            the net tax effects of temporary differences between carrying amounts of assets and            liabilities for financial reporting purposes and the amounts used for income tax            purposes. Significant components of our deferred tax assets are as follows, (in            thousands):

|                                                              |   |         |    |   |   |    |   |
|-------------------------------------------------------------------|--------|--------------|---------|--------|--------|---------|--------|
|                                                              |   | December 31, |    |
|                                                              |   | 2007         |    | 2006   |   |
|                                                              |   |              |    |        |   |
|                                                              |   |         |    |   |   |    |   |
| Net operating                        losses                       |   | $            | 22,507  |   | $      | 23,353  |   |
| Capitalized software                        and development costs |   |         | 76      |   |   | 202     |   |
| Deferred                        revenue                           |   |         | 2,177   |   |   | 2,250   |   |
| Research credits carry                        forwards            |   |         | 1,918   |   |   | 1,723   |   |
| Other                                                             |   |         | 1,780   |   |   | 509     |   |
|                                                              |   |              |         |   |        |         |   |
| Total gross deferred                        tax assets            |   |         | 28,458  |   |   | 28,037  |   |
| Valuation                        Allowance                        |   |         | (27,267 | )      |   | (28,037 | )      |
|                                                              |   |              |         |   |        |         |   |
| Total net deferred tax                        assets              |   | $            | 1,191   |   | $      | — |   |
|                                                              |   |              |         |   |        |         |   |

Page            58

----

**Notes to Financial            Statements**

**10. Income Taxes            (continued)**

During the fourth quarter of            2007, we recorded an income tax benefit of $1.1 million. This benefit included a $1.2            million reduction in the valuation allowance related to a portion of our deferred tax            assets that will more likely than not be realized. This determination was primarily            based on projected taxable income. In evaluating our ability to realize our deferred            tax assets we consider all available positive and negative evidence including our past            operating results and our forecast of future taxable income. In determining future            taxable income, we make assumptions to forecast federal and state operating income, the            reversal of temporary differences, and the implementation of any feasible and prudent            tax planning strategies. These assumptions require significant judgment regarding the            forecasts of future taxable income, and are consistent with the forecasts used to            manage our business. We intend to maintain the remaining valuation allowance until            sufficient further positive evidence exists to support further reversals of the            valuation allowance. Our income tax expense recorded in the future will be reduced to            the extent of offsetting decreases in our valuation allowance.

As of December 31, 2007, we have            U.S. federal and state net operating loss carryforwards of approximately $61.2 million            and $46.5 million, respectively. The U.S. federal net operating loss carryforwards will            expire at various dates beginning in 2018 through 2027 if not utilized. State net            operating loss carryforwards will expire at various dates beginning in 2012 through            2017.

As of December 31, 2007, we have            U.S. federal and state tax credit carryforwards of approximately $1.2 million and $0.9            million, respectively. The federal credit will expire at various dates beginning in            2011 through 2027, if not utilized. California state research and development credits            can be carried forward indefinitely.

In connection with the            Company’s adoption of SFAS 123R, the Company uses the            “with-and-without” approach described in EITF Topic No. D-32,            “Intraperiod Tax Allocation of the Tax Effect of Pretax Income from Continuing            Operations” to determine the recognition and measurement of excess tax benefits.            In addition, the Company has elected to account for indirect effects of stock option            based awards on other tax attributes, such as research and alternative minimum tax            credits, through the income statement. Accordingly, the Company has elected to            recognize excess tax benefits from stock option exercises in additional paid in capital            only if an incremental income tax benefit would be realized after considering all other            tax attributes presently available to the Company.

Therefore, included in the net            operating loss carryforwards are losses created by the exercise of stock options.            Although these net operating loss carryforwards are reflected in total U.S. net            operating tax loss carryforwards, pursuant to SFAS 123(R), deferred tax assets            associated with these deductions are only recognized to the extent that they reduce            taxes payable. Further, these recognized deductions are treated as direct increases to            stockholders’ equity and as a result do not impact the Statement of Operations.            To the extent stock-option related deductions are not recognized pursuant to            SFAS123(R), the unrecognized benefit is not reflected on the Consolidated Balance            Sheet. Accordingly, the Company has reduced deferred tax assets by approximately $1.2            million which represents the unrecognized benefit from stock-option related net            operating loss carryforwards as of December 31, 2007, that is potentially available for            utilization in future years.

Net operating loss carryforwards            and credit carryforwards reflected above are limited due to ownership changes as            provided in the Internal Revenue Code and similar state provisions.

*Accounting for Uncertainty in            Income Taxes*

Effective January 1, 2007, we            adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty            in Income Taxes — an interpretation of SFAS No. 109” (“FIN            48”). FIN 48 prescribes a recognition threshold and a measurement attribute for            the financial statement recognition and measurement of tax positions taken or expected            to be taken in a tax return. For those benefits to be recognized, a tax position must            be more-likely-than-not to be sustained upon examination by taxing authorities. There            was not a material impact on our financial position and results of operations as a            result of the adoption of the provisions of FIN 48. At December 31, 2007, we had a            liability for unrecognized tax benefits of $1,876,000 (of which $25,000, if recognized,            would favorably affect the company’s effective tax rate). We do not believe there            will be any material changes in our unrecognized tax positions over the next twelve            months.

Page            59

----

**Notes to Financial            Statements**

**10. Income Taxes            (continued)**

Interest and penalty costs            related to unrecognized tax benefits are classified as a component of “Income Tax            Expense” in the accompanying statement of operations and the corresponding            liability in “Income Taxes Payable” or “Prepaid Income Taxes”            in the accompanying balance sheet. We recognized $5,000 of interest expense related to            unrecognized tax benefits for the year ended December 31, 2007.

We file income tax returns in            the U.S. federal jurisdiction and various state jurisdictions. We are subject to U.S.            federal income tax examination for calendar tax years ending 2005 through 2007. We            recently completed an audit from the I.R.S for our 2004 and earlier tax years.            Additionally, we are subject to various state income tax examinations for the 1997            through 2007 calendar tax years.

A reconciliation of the            beginning and ending amount of unrecognized tax benefits is as follows: (in            thousands):

|                                                               |   |   |    |   |
|--------------------------------------------------------------------|--------|--------|---------|--------|
| Balance at January 1,                        2007                  |   | $      | 1,361   |   |
| Additions for tax                        positions of prior years  |   |   | 503     |   |
| Additions for tax                        positions related to 2007 |   |   | 12      |   |
| Reductions for tax                        positions of prior years |   |   | — |   |
| Settlements                                                        |   |   | — |   |
| Balance at December 31,                        2007                |   | $      | 1,876   |   |
|                                                               |   |        |         |   |

The Company accounts for any            applicable interest and penalties on uncertain tax positions as a component of income            tax expense. The liability for uncertain income taxes as of the date of adoption            (January 1, 2007) and December 31, 2007 includes interest and penalties of zero and $            25,000, respectively.

**11. Stockholders’            Equity (Deficit)**

**Common Stock**

At December 31, 2007, we had            reserved shares of common stock for future issuance as follows:

|                                                             |   |   |      |   |
|------------------------------------------------------------------|--------|--------|-----------|--------|
| Stock options                        outstanding                 |   |   | 3,283,531 |   |
| Stock awards                        outstanding                  |   |   | 475,501   |   |
| Stock options available                        for future grants |   |   | 971,167   |   |
| Employee stock purchase                        plan              |   |   | 500,533   |   |
| Common stock                        warrants                     |   |   | 1,375,000 |   |
|                                                             |   |        |           |   |
|                                                             |   |   | 6,605,732 |   |
|                                                             |   |        |           |   |

**Common Stock            Warrants**

In 2001, we issued a fully            vested non-forfeitable warrant to purchase 1,375,000 shares of our common stock at an            exercise price of $8.00 per share. The warrant was issued to WPV, Inc., an affiliate of            a significant former stockholder of ours, in connection with the guarantee of a line of            credit to us. The warrant is outstanding and will expire if unexercised by March 9,            2008.

Page            60

----

**12. Commitments and            Contingencies**

**Leases**

We lease our Oakland, California            corporate office facility and our Tucson, Arizona office under non-cancelable operating            leases with terms expiring in 2013 and 2009, respectively. In early 2008, we entered            into a new lease for our Reading Assistant operations in Waltham, Massachusetts for            approximately 6,000 square feet that expires in September 2011. This lease, as well as            the existing Waltham lease that expires on March 31,2008, is included in the            table.

Future minimum payments under these            leases as of December 31, 2007 are as follows (in thousands):

|                                       |   |   |   |   |
|--------------------------------------------|--------|--------|--------|--------|
| 2008                                       |   | $      | 1,143  |   |
| 2009                                       |   |   | 1,142  |   |
| 2010                                       |   |   | 1,171  |   |
| 2011                                       |   |   | 1,183  |   |
| 2012 and                        thereafter |   |   | 2,312  |   |
|                                       |   |        |        |   |
|                                       |   | $      | 6,951  |   |
|                                       |   |        |        |   |

Rent expense under all operating            leases was $1.0 million for each of the years ended December 31, 2007, 2006 and            2005.

**License            Agreement**

In September 1996, we entered            into a license agreement with a university for the use of the intellectual property            underlying its most significant current products. In exchange for the license, which            expires in 2014, we issued stock and paid a license-issue fee. The agreement also            provided for milestone payments, all of which have been made, and for royalties based            on booked sales of products using the licensed technology. Royalty expenses were            $1,028,000, $868,000, and $1,048,000 for the years ended December 31, 2007, 2006 and            2005, respectively, and are included in cost of product revenues. Annual minimum            guaranteed royalty payments are $150,000.

If we lose or are unable to            maintain the license agreement during the term of the underlying patents, it would            adversely affect our business. The university may terminate the license agreement if we            fail to perform or violate its terms without curing the violation within 60 days of            receiving written notice of the violation.

**Litigation**

Litigation with Former Sales            Representative

On January 23, 2008, Robert G.            (Jerry) Smith, a former account manager in Florida, filed a complaint against us in US            District Court for the Middle District of Florida. The lawsuit claims breach of            contract for unpaid wages of approximately $423,000. Smith alleges that he is owed            additional commission relating to large sale transaction in the second quarter of 2007.            We are in the early stages of this proceeding, discovery has not yet            started.

Litigation with School            District Customer

On October 22, 2007, we were            sued by the Christina School District (the “District”) in the US District            Court for the District of Delaware. The District had previously been sued by investors            who are the assignees of the lessor under a Master Lease Purchase Agreement (the            “Lease Agreement”) entered into by the District in 2003. The District            ceased making payments under the Lease Agreement and the investors have claimed that            the District breached the Lease Agreement. The District filed a third party complaint            against us, claiming that we must refund amounts paid to us by the District for            training and consulting under our contracts with the District. Because the District            decided not to use our products, it did not therefore use all of the services specified            in the contract. The third party complaint alleges unjust enrichment against us. The            District states that the amount it is seeking is approximately $220,000. We have filed            a motion to dismiss the complaint, which has not yet been decided.

Page            61

----

**Notes to Financial            Statements**

**12. Commitments and            Contingencies (continued)**

We believe that these claims are            not meritorious and that we do not have any significant liability to these claimants.            We therefore do not believe that the resolution of these matters will have a material            adverse effect on our financial position or results of operations.

**13. Warranties;            Indemnification**

We generally provide a warranty            that our software products substantially operate as described in the manuals and guides            that accompany the software for a period of 90 days. The warranty does not apply in the            event of misuse, accident, and certain other circumstances. To date, we have not            incurred any material costs associated with these warranties and have no accrual for            such items at December 31, 2007.

From time to time, we enter into            contracts that require us, upon the occurrence of certain contingencies, to indemnify            parties against third party claims. These contingent obligations primarily relate to            (i) claims against our customers for violation of third party intellectual property            rights caused by our products; (ii) claims resulting from personal injury or property            damage resulting from our activities or products; (iii) claims by our office lessors            arising out of our use of the premises; and (iv) agreements with our officers and            directors under which we may be required to indemnify such persons for liabilities            arising out of their activities on our behalf. Because the obligated amounts for these            types of agreements usually are not explicitly stated, the overall maximum amount of            these obligations cannot be reasonably estimated. No liabilities have been recorded for            these obligations on our balance sheet as of December 31, 2007 or 2006.

**14. Employee Retirement and            Benefit Plan**

We have a defined contribution            retirement plan under Section 401(k) of the Internal Revenue Code, which covers            substantially all employees. Eligible employees may contribute amounts to the plan, via            payroll withholding, subject to certain limitations. In 2007 we started to match            contributions by plan participants at a rate of 3% of salary, with an annual maximum of            $2,000 per participant. For the year ended December 31, 2007 our matching contributions            were $280,000.

**15. Related Party            Transactions**

On September 30, 2003, we            entered into an agreement with Posit Science Corporation (“Posit Science”),            formerly Neuroscience Solutions Corporation, to provide Posit Science with exclusive            rights in the healthcare field to certain intellectual property, patents and software            we own or license, along with transfer of certain healthcare research projects. A            co-founder, substantial shareholder, and member of our Board of Directors is a            co-founder, officer, director and substantial shareholder of Posit Science.

The rights were acquired by            Posit Science for a combination of cash, stock and future royalties. Posit Science paid            $500,000 cash, of which $448,000 was recognized as other income during the year ended            December 31, 2003. The balance was recognized over the next nine months as services            were provided to Posit Science. Amounts received to date and any future receipts are            being reported as other income as we do not consider the sale of these rights to be            part of our recurring operations. Under the agreement, we will receive net royalties            between 2% to 4% on products sold by Posit Science that use our patents or            software.

We have a 3.5% equity interest            in Posit Science. We recorded royalty income from Posit Science of $246,000, $150,000,            and $50,000 in fiscal years 2007, 2006 and 2005, respectively. There is an amount of            $158,000 due from Posit Science at December 31, 2007.

In July 2007 Michael A. Moses            joined our Board of Directors as Vice Chair and also entered into a consulting            agreement with us. The consulting agreement provides for a consulting fee of $40,000            per year and two stock options, both with a five year term and at a per share exercise            price of $7.15, the closing price of the Company’s Common Stock on July 25, 2007.            The first option grant for 80,000 shares vests over four years, with a one year cliff            with ratable monthly vesting thereafter. The second option for 100,000 shares vests            only in the event the per share price of the Company’s common stock reaches and            maintains for 20 consecutive business days a specified target closing price as follows:            25,000 shares vesting at each target stock price of $15, $20, $25, and $30.

Page            62

----

**Notes to Financial            Statements**

**15. Related Party            Transactions (continued)**

We also have in place consulting            agreements with two of our founders, who are also members of our Board of Directors.            Dr. Tallal provides ongoing consulting in the areas of customer relationships and            research planning and in 2007, received a retainer of approximately $83,000 for those            services. Dr. Merzenich provides consulting services including public speaking,            meetings with third parties and other projects as agreed from time to time. Dr.            Merzenich is paid a consulting fee of $2,000 per day.

**16. Interim Financial            Information (unaudited)**

Quarterly financial data (in            thousands, except per share amounts):

|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
|-----------------------------------------------------|--------|------------------------------------------|--------|------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|-----------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                                |   | **2007**                                 |   |
|                                                |   |                                          |   |
|                                                |   | **Quarter                        Ended** |   |
|                                                |   | **March                        31**      |   | **June                        30** |   | **September                        30** |   | **December                        31** |   | **Total** |   |
|                                                |   |                                          |        |                                    |        |                                         |        |                                        |        |           |   |
| Total                        revenues               |   |                                     | $      | 8,812                              |   |                                    | $      | 14,577                                 |   |      | $      | 11,350 |   |   |   | $      | 11,314 |   |   | $      | 46,053 |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                        profit                 |   |                                     |   | 6,253                              |   |                                    |   | 11,996                                 |   |      |   | 9,019  |   |   |   |   | 8,566  |   |   |   | 35,834 |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                        (loss)            |   |                                     |   | (2,628                             | )      |                                    |   | 2,659                                  |   |      |   | 246    |   |   |   |   | 877    |   |   |   | 1,154  |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                        per share: |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                               |   |                                     | $      | (0.15                              | )      |                                    | $      | 0.16                                   |   |      | $      | 0.01   |   |   |   | $      | 0.05   |   |   | $      | 0.07   |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted                                             |   |                                     | $      | (0.15                              | )      |                                    | $      | 0.15                                   |   |      | $      | 0.01   |   |   |   | $      | 0.05   |   |   | $      | 0.06   |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                |   | **2006**                                 |   |
|                                                |   |                                          |   |
|                                                |   | **Quarter                        Ended** |   |
|                                                |   | **March                        31**      |   | **June                        30** |   | **September                        30** |   | **December                        31** |   | **Total** |   |
|                                                |   |                                          |   |
| Total                        revenues               |   |                                     | $      | 7,831                              |   |                                    | $      | 12,953                                 |   |      | $      | 9,925  |   |   |   | $      | 10,289 |   |   | $      | 40,998 |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                        profit                 |   |                                     |   | 5,662                              |   |                                    |   | 10,446                                 |   |      |   | 7,403  |   |   |   |   | 7,952  |   |   | $      | 31,463 |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                        (loss)            |   |                                     |   | (2,174                             | )      |                                    |   | 2,388                                  |   |      |   | (332   | )      |   |   |   | 326    |   |   | $      | 208    |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                        per share: |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                               |   |                                     | $      | (0.13                              | )      |                                    | $      | 0.14                                   |   |      | $      | (0.02  | )      |   |   | $      | 0.02   |   |   | $      | 0.01   |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted                                             |   |                                     | $      | (0.13                              | )      |                                    | $      | 0.13                                   |   |      | $      | (0.02  | )      |   |   | $      | 0.02   |   |   | $      | 0.01   |   |
|                                                |   |                                     |   |                               |   |                                    |   |                                   |   |      |   |   |   |   |   |   |   |   |   |   |   |   |

Page            63

----

**Notes to Financial            Statements**

**17. Subsequent Event:            Acquisition**

On January 7, 2008 we entered            into an Asset Purchase Agreement (the “Purchase Agreement”) with JTT            Holdings Inc. dba Soliloquy Learning, (“JTT”), pursuant to which we agreed            to acquire from JTT the Soliloquy Reading AssistantTM product line and            substantially all of the other assets of the Soliloquy Learning business, based in            Waltham, Massachusetts, for cash consideration.

Under the terms of the Purchase            Agreement, we paid at closing $9.7 million and retained $1.0 million in satisfaction of            outstanding indebtedness owed to us by JTT. Of the aggregate cash amount, $1,070,000            was withheld at the closing and placed into a third party escrow to secure JTT’s            indemnification obligations to us under the Purchase Agreement. We assumed certain            specified liabilities associated with the Soliloquy business pursuant to the Purchase            Agreement.

At December 3, 2007, we had            incurred $319,000 in costs related to this acquisition. These costs are classified as            deferred acquisition costs on our balance sheet, and will be included as part of the            purchase price allocation.

|                                                                                                                                                                                                     |                                               |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------|
| **ITEM                        9.      CHANGES IN AND                        DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL                        DISCLOSURE** |
|                                                                                                                                                                                                     |                                               |
| None.                                                                                                                                                                                                    |                                               |
|                                                                                                                                                                                                     |                                               |
| **ITEM                        9A(T).**                                                                                                                                                                   | **CONTROLS AND                        PROCEDURES** |

*Evaluation of Disclosure            Controls and Procedures*

Disclosure controls and            procedures are designed to ensure that information required to be disclosed in our            reports filed under the Exchange Act, such as this Annual Report on Form 10-K, is            recorded, processed, summarized and reported within the required time periods. These            procedures are also designed to ensure that such information is accumulated and            communicated to our management, including our Chief Executive Officer and Chief            Financial Officer, as appropriate to allow timely decisions regarding required            disclosure.

As required under Rule 13a-15(b)            of the Exchange Act, our management, including the Chief Executive Officer and Chief            Financial Officer, conducted an evaluation of the effectiveness of the Company’s            disclosure controls and procedures as of the end of the period covered by this Annual            Report on Form 10-K, and concluded that our disclosure controls and procedures were            effective as of December 31, 2007.

It should be noted that a            control system, no matter how well designed and operated, can provide only reasonable,            not absolute, assurance that the objectives of the control system are met. As a result,            there can be no assurance that a control system will succeed in preventing all possible            instances of error and fraud. Our disclosure controls and procedures are designed to            provide reasonable assurance of achieving their objectives, and the conclusions of our            Chief Executive Officer and the Chief Financial Officer are made at the            “reasonable assurance” level.

*Changes in Internal Controls            over Financial Reporting*

There were no changes in our            internal control over financial reporting that occurred during the year ended December            31, 2007 that have materially affected, or are reasonably likely to materially affect,            our internal control over financial reporting.

*Management’s Report on            Internal Control over Financial Reporting*

Our management is responsible            for establishing and maintaining adequate internal control over financial reporting, as            such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Our internal            control system was designed to provide reasonable assurance regarding the reliability            of financial reporting and the preparation of financial statements for external            purposes, in accordance with generally accepted accounting principles. Because of            inherent limitations, a system of internal control over financial reporting may not            prevent or detect misstatements. Also, projections of any evaluation of effectiveness            to future periods are subject to the risk that controls may become inadequate due to            change in conditions, or that the degree of compliance with the policies or procedures            may deteriorate.

Page            64

----

Our management, including our            Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the            effectiveness of our internal control over financial reporting using the criteria set            forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in            Internal Control—Integrated Framework. Based on its evaluation, our management            concluded that our internal control over financial reporting was effective as of the            end of the period covered by this report.

This annual report does not include an audit report of the            Company’s registered public accounting firm regarding internal control over            financial reporting. Management’s report was not subject to audit by the            Company’s registered public accounting firm pursuant to temporary rules of the            Securities and Exchange Commission that permit the Company to provide only            management’s report in this annual report.

|                                |                                         |
|-------------------------------------|----------------------------------------------|
| **ITEM                        9B.** | **OTHER                        INFORMATION** |

None.

Page            65

----

**PART            III**

|                                |                                                                          |
|-------------------------------------|-------------------------------------------------------------------------------|
| **ITEM                        10.** | **DIRECTORS AND                        EXECUTIVE OFFICERS OF THE REGISTRANT** |

The information required by this            item with respect to our executive officers is contained in Part I “Executive            Officers” and such information is also incorporated by reference in this            section.

Information required by this            item respecting our directors, audit committee and code of ethics is set forth under            the caption “Proposal 1: Election of Directors” in our Proxy Statement            relating to our 2008 Annual Meeting of Stockholders (the “Proxy Statement”)            and is incorporated by reference into this Form 10-K Report. The Proxy Statement will            be filed with the Securities and Exchange Commission in accordance with Rule 14a-6(c)            promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange            Act”). With the exception of the foregoing information and other information            specifically incorporated by reference into this Form 10-K Report, the Proxy Statement            is not being filed as a part hereof.

Information with respect to            compliance with Section 16(a) of the Exchange Act is set forth under the caption            “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy            Statement and is incorporated by reference into this Form 10-K Report.

|                                |                                              |
|-------------------------------------|---------------------------------------------------|
| **ITEM                        11.** | **EXECUTIVE                        COMPENSATION** |

Information required by this            item concerning compensation of executive officers and directors is set forth under the            caption “Executive Compensation” in the Proxy Statement and is incorporated            by reference into this Form 10-K Report.

|                                                                                                                                                                                                          |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **ITEM                        12.     SECURITY OWNERSHIP OF                        CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER                        MATTERS** |

Information required by this            item concerning security ownership of certain beneficial owners and management is set            forth under the caption “Security Ownership of Certain Beneficial Owners and            Management” in the Proxy Statement and is incorporated by reference into this            Form 10-K Report.

Information required by this            item concerning shares authorized for issuance under equity compensation plans approved            by stockholders and not approved by stockholders is set forth under the caption            “Equity Compensation Plan Information” in the Proxy Statement and is            incorporated by reference into this Form 10-K Report.

|                                |                                                                      |
|-------------------------------------|---------------------------------------------------------------------------|
| **ITEM                        13.** | **CERTAIN                        RELATIONSHIPS AND RELATED TRANSACTIONS** |

Information required by this            item concerning certain relationships and related transactions is set forth under the            captions “Employment Agreement” and “Certain Transactions” in            the Proxy Statement and is incorporated by reference into this Form 10-K            Report.

|                                |                                                              |
|-------------------------------------|-------------------------------------------------------------------|
| **ITEM                        14.** | **PRINCIPAL                        ACCOUNTANT FEES AND SERVICES** |

Information required by this            item concerning the independent auditor’s fees and services is set forth under            the caption “Ratification of Selection of Independent Registered Public            Accounting Firm” in the Proxy Statement and is incorporated by reference into            this Form 10-K Report.

Page            66

----

**PART            IV**

|                                |                                                               |
|-------------------------------------|--------------------------------------------------------------------|
| **ITEM                        15.** | **EXHIBITS,                        FINANCIAL STATEMENT SCHEDULES** |

          (a)            Documents filed as part of this report:

|   |                                                                                                                                                                                                                                                                                                                              |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | (1) Financial                        Statements                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                              |
|   | Report of Ernst                        & Young LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                                                             |
|   | Balance Sheet                        – December 31, 2007 and 2006                                                                                                                                                                                                                                                           |
|   | Statements of Income                        – Years Ended December 31, 2007, 2006 and 2005                                                                                                                                                                                                                                  |
|   | Statements of                        Stockholders’ Equity (Deficit) – Years Ended December 31, 2007,                        2006 and 2005                                                                                                                                                                             |
|   | Statements of Cash                        Flows – Years Ended December 31, 2007, 2006 and 2005                                                                                                                                                                                                                              |
|   | Notes to Financial                        Statements                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                              |
|   | (2) Financial                        Statement Schedules                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                              |
|   | As required under                        Item 8, Financial Statements and Supplementary Data, the financial                        statement schedule of the Company is provided in this separate section. The                        financial statement schedule included in this section is as                        follows: |
|   |                                                                                                                                                                                                                                                                                                                              |
|   | Schedule II –                        Valuation and Qualifying Accounts (in thousands*)*:                                                                                                                                                                                                                                    |

|                                                                                |   |                                   |   |                                                                                                         |   |                                                                              |   |                                   |   |   |   |   |   |    |   |   |   |   |   |   |
|-------------------------------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|----------------------------------------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|
| **Allowance for                        Doubtful Accounts Years Ended December 31,** |   |
|                                                                                     |        |                                        |   |
|                                                                                |   | Opening                        Balance |   | Charges                        (credits) to                        Operating                        Expenses |   | Additions                        (deductions)                        to Allowance |   | Closing                        Balance |   |
| 2007                                                                                |   |                                   | $      | 99                                                                                                           |   |                                                                              |   | $                                      | (3     | )      |   |   |   |    |   |   | $      | 96     |   |   |
| 2006                                                                                |   |                                   | $      | 81                                                                                                           |   |                                                                              |   | $                                      | 18     |   |   |   |   |    |   |   | $      | 99     |   |   |
| 2005                                                                                |   |                                   | $      | 121                                                                                                          |   |                                                                              |   | $                                      | (40    | )      |   |   | $      | — |   |   | $      | 81     |   |   |

          (b)            Exhibits

A list of exhibits filed            herewith is contained in the exhibit index that immediately precedes such exhibits and            is incorporated herein by reference.

Page            67

----

**EXHIBITS**

|                                      |                               |            |                                                                                                                                                                                                                                                                |
|-------------------------------------------|------------------------------------|-----------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit                        Number** |                               | **Description** |
|                                           |                               |                 |
|                                      | 3.1(14)                            |            | Amended and Restated                        Certificate of Incorporation                                                                                                                                                                                            |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 3.2(15)                            |            | Amended and Restated                        Bylaws                                                                                                                                                                                                                  |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 3.3(15)                            |            | Certificate of                        Amendment to the Amended and Restated Certificate of                        Incorporation                                                                                                                                     |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 4.1                                |            | Reference is made to                        Exhibits 3.1 and 3.2                                                                                                                                                                                                    |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 4.2(1)                             |            | Specimen Stock                        Certificate                                                                                                                                                                                                                   |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.1(1)*                           |            | Form of Indemnity                        Agreement with each of our directors and executive officers                                                                                                                                                                |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.2(10)*                          |            | 1999 Equity                        Incentive Plan, as amended                                                                                                                                                                                                       |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.3(10)*                          |            | Forms of Restricted                        Stock Unit Grant Notice and Restricted Stock Unit Agreement under the                        Incentive Plan                                                                                                              |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.4(3)*                           |            | Forms of Stock                        Option Grant Notice, Stock Option Agreement and Stock Award Agreement under                        the Incentive Plan                                                                                                         |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.5(9)*                           |            | 1999 Non-Employee                        Directors’ Stock Option Plan, as amended                                                                                                                                                                             |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.6(3)*                           |            | Forms of                        Nonstatutory Stock Option Agreements under the Non-Employee                        Directors’ Stock Option Plan                                                                                                               |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.7(3)*                           |            | 1999 Employee Stock                        Purchase Plan, as amended                                                                                                                                                                                                |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.8(10)*                          |            | Form of 1999                        Employee Stock Purchase Plan Offering under the Employee Stock Purchase                        Plan                                                                                                                             |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.9(7)*                           |            | Milestone Equity                        Incentive Plan                                                                                                                                                                                                              |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.10(2)*                          |            | 2002 CEO Option                        Plan                                                                                                                                                                                                                         |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.11(2)*                          |            | Employment Agreement                        dated as of May 31, 2002 by and between Scientific Learning Corporation and                        Robert C. Bowen                                                                                                      |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.12(7)*                          |            | Letter Agreement                        dated January 2004 by and between the Registrant and Robert C. Bowen                        amending the Employment Agreement                                                                                               |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.13                        (22)  |            | Amendment to                        Employment Agreement with Robert C. Bowen                                                                                                                                                                                       |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.14                        (22)  |            | Offer of Employment                        Letter Agreement with D. Andrew Myers                                                                                                                                                                                    |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.15(8)*                          |            | Independent                        Contractor Agreement dated April l7, 2003 between the Registrant and Paula                        A. Tallal and Project Assignment thereunder dated December 17,                        2004                                     |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.16                        (23)* |            | Independent                        Contractor Agreement dated July 25, 2007 between the Registrant and Michael                        Merzenich                                                                                                                     |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.17                        (23)* |            | Independent                        Contractor Agreement dated July 25, 2007 between the Registrant and Michael                        A. Moses                                                                                                                      |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.18(11)*                         |            | 2006 Management                        Incentive Plan                                                                                                                                                                                                               |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.19                        (13)* |            | 2007 Management                        Incentive Plan                                                                                                                                                                                                               |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.20(6)                           |            | Loan and Security                        Agreement dated as of January 15, 2004 by and between the Registrant and                        Comerica Bank                                                                                                              |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.21(9)                           |            | First Amendment to                        Loan and Security Agreement, dated as of September 29, 2004, by and between                        Comerica Bank and the Registrant, amending the Loan and Security                        Agreement                      |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.22(10)                          |            | Second Amendment to                        Loan and Security Agreement, dated as of December 2, 2005, by and between                        Comerica Bank and the Registrant, amending the Loan and Security                        Agreement                       |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.23(12)                          |            | Third Amendment to                        Loan and Security Agreement, dated as of September 5, 2006, by and between                        Comerica Bank and the Registrant, amending the Loan and Security                        Agreement                       |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.24(15)                          |            | Fourth Amendment to                        Loan and Security Agreement, dated as of June 5, 2007, by and between                        Comerica Bank and the Registrant, amending the Loan and Security                        Agreement                           |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.25(1)†                   |            | Exclusive License                        Agreement, dated September 27, 1996, with the Regents of the University of                        California                                                                                                               |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.26(5)                           |            | Amendment No. 3 to                        Exclusive License Agreement, dated September 27, 1996, with the Regents of                        the University of California, amending the agreement                                                                    |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.27(12)                          |            | Amendment No. 4 to                        Exclusive License Agreement, dated September 27, 1996, with the Regents of                        the University of California, amending the agreement                                                                    |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.28(5)                           |            | Lease, dated as of                        October 1, 2003, with Rotunda Partners II                                                                                                                                                                                 |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.29(4)                           |            | Technology Transfer                        Agreement dated as of September 30, 2003 by and between the Registrant and                        Neuroscience Solutions Corporation (now renamed Posit Science Corporation)                        or “NSC” |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.30(4)                           |            | SLC License                        Agreement dated as of September 30, 2003 by and between the Registrant and                        NSC                                                                                                                            |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.31(4)                           |            | NSC License                        Agreement dated as of September 30, 2003 by and between NSC and the                        Registrant                                                                                                                            |
|                                      |                               |            |                                                                                                                                                                                                                                                                |
|                                      | 10.32                              |            | Major Reseller Agreement dated as of October 15, 2007, between Posit                        Science Corporation and Registrant                                                                                                                                      |

Page            68

----

|                                      |                              |            |                                                                                                                                                                |
|-------------------------------------------|-----------------------------------|-----------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit                        Number** |                              | **Description** |
|                                           |                              |                 |
|                                      | 10.33                        (24) |            | Asset Purchase                        Agreement between Registrant and JTT Holdings, Inc., d/b/a/ Soliloquy                        Learning dated December 18, 2007 |
|                                      | 23.1                              |            | Consent of Independent Registered Public Accounting Firm                                                                                                            |
|                                      | 31.1                              |            | Certification of Chief Executive Officer (Section 302).                                                                                                             |
|                                      | 31.2                              |            | Certification of Chief Financial Officer (Section 302).                                                                                                             |
|                                      | 32.1                              |            | Certification of Chief Executive Officer (Section 906).                                                                                                             |
|                                      | 32.2                              |            | Certification of Chief Financial Officer (Section 906).                                                                                                             |

|   |   |                                                                                                                                                                                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |
|   | 1)     | Incorporated by                        reference to the exhibits previously filed with the Registrant’s                        Registration Statement on Form S-1 (File No. 333-56545).                                            |
|   |   |                                                                                                                                                                                                                                     |
|   | 2)     | Incorporated by                        reference to the exhibits previously filed with the Registrant’s Form                        8-K on June 7, 2002 (File No. 000-24547).                                                      |
|   |   |                                                                                                                                                                                                                                     |
|   | 3)     | Incorporated by                        reference to the exhibits previously filed with the Registrant’s Form                        10-Q for the quarter ended June 30, 2003 (File No. 000-24547).                                 |
|   |   |                                                                                                                                                                                                                                     |
|   | 4)     | Incorporated by                        reference to the exhibits previously filed with the Registrant’s Form                        8-K on October 1, 2003 (File No. 000-24547).                                                   |
|   |   |                                                                                                                                                                                                                                     |
|   | 5)     | Incorporated by                        reference to the exhibits filed with the Registrant’s Form 10-Q for                        the quarter ended September 30, 2003 (File No. 000-24547).                                       |
|   |   |                                                                                                                                                                                                                                     |
|   | 6)     | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form 8-K                        on February 5, 2004 (File No. 000-24547).                                                      |
|   |   |                                                                                                                                                                                                                                     |
|   | 7)     | Incorporated by                        reference to the exhibits previously filed with the Registrant’s Form                        10-Q for the quarter ended March 31, 2004 (File No. 000-24547).                                |
|   |   |                                                                                                                                                                                                                                     |
|   | 8)     | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form 8-K                        filed on December 20, 2004 (File No. 000-24547).                                               |
|   |   |                                                                                                                                                                                                                                     |
|   | 9)     | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form                        10-K for the year ended December 31, 2004 (File No. 000-24547).                                    |
|   |   |                                                                                                                                                                                                                                     |
|   | 10)    | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form                        10-K for the year ended December 31, 2005 (File No. 000-24547).                                    |
|   |   |                                                                                                                                                                                                                                     |
|   | 11)    | Incorporated by                        reference to the exhibits previously filed with the Registrant’s Form                        10-Q for the quarter ended March 31, 2005 (File No. 000-24547).                                |
|   |   |                                                                                                                                                                                                                                     |
|   | 12)    | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form                        10-K for the year ended December 31, 2006 (File No. 000-24547).                                    |
|   |   |                                                                                                                                                                                                                                     |
|   | 13)    | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form 8-K                        filed on March 13, 2007 (File No. 000-24547).                                                  |
|   |   |                                                                                                                                                                                                                                     |
|   | 14)    | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form                        10-Q for the quarter ended March 31, 2007 (File No. 000-24547).                                    |
|   |   |                                                                                                                                                                                                                                     |
|   | 21)    | Incorporated by                        reference to the exhibits previously filed with Amendment No. 1 to the                        Registrant’s Registration Statement on Form S-1 (File No.                        333-143093). |
|   |   |                                                                                                                                                                                                                                     |
|   | 22)    | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form 8-K                        filed on December 7, 2007 (File No. 000-24547).                                                |

Page            69

----

|   |           |                                                                                                                                                                                                                                                |
|--------|----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 23)            | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form 8-K                        filed on July 26, 2007 (File No. 000-24547).                                                              |
|   |           |                                                                                                                                                                                                                                                |
|   | 24)            | Incorporated by                        reference to exhibits previously filed with the Registrant’s Form 8-K                        filed on December 21, 2007 (File No. 000-24547).                                                          |
|   |           |                                                                                                                                                                                                                                                |
|   |  † | Certain portions of                        this exhibit have been omitted based upon confidential treatment granted by                        the Securities and Exchange Commission for portions of the referenced                        exhibit. |
|   |           |                                                                                                                                                                                                                                                |
|   |  *        | Management contract                        or compensatory plan or arrangement.                                                                                                                                                                     |

Page            70

----

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.

SCIENTIFIC LEARNING            CORPORATION

|                                           |   |                                 |
|------------------------------------------------|--------|--------------------------------------|
| By /s/ Robert C.                        Bowen  |   | March                        7, 2008 |
|                                                |   |                                 |
| Robert C.                        Bowen         |   |                                 |
| Chief Executive                        Officer |   |                                 |

Pursuant to the requirements of            the Securities Exchange Act of 1934, this report has been signed below by the following            persons on behalf of the registrant and in the capacities and on the dates            indicated.

|                                                     |   |                                                                                                                                                        |   |                                 |
|----------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|
| **SIGNATURES**                                           |   | **TITLE**                                                                                                                                                   |   | **DATE**                             |
|                                                          |        |                                                                                                                                                             |        |                                      |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Robert C.                        Bowen               |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Robert C.                        Bowen                   |   | Chairman, Chief                        Executive Officer and Director (Principal Executive Officer)                                                         |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Jane A.                        Freeman               |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Jane A.                        Freeman                   |   | Executive Vice                        President, Chief Financial Officer, and Treasurer (Principal Financial and                        Accounting Officer) |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Dr. Michael M.                        Merzenich      |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Dr. Michael M.                        Merzenich          |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Dr. Paula A.                        Tallal           |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Dr. Paula A.                        Tallal               |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Carleton A.                        Holstrom          |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Carleton A.                        Holstrom              |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Rodman W.                        Moorhead, III       |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Rodman W. Moorhead,                        III           |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Ajit M.                        Dalvi                 |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Ajit                        Dalvi                        |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Dr. Joseph B.                        Martin          |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Dr. Joseph                        Martin                 |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Edward Vermont                        Blanchard, Jr. |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Edward Vermont                        Blanchard, Jr.     |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ David W.                        Smith                |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| David W.                        Smith                    |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Michael A.                        Moses              |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Michael                        Moses                     |   | Director                                                                                                                                                    |   | March                        7, 2008 |
|                                                     |   |                                                                                                                                                        |   |                                 |
| /s/ Lance R.                        Odden                |   |                                                                                                                                                        |   |                                 |
|                                                          |   |                                                                                                                                                        |   |                                 |
| Lance                        Odden                       |   | Director                                                                                                                                                    |   | March                        7, 2008 |

----