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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K/A þ Annual Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 For the fiscal year ended December 31, 2003 or o Transition 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  DELAWARE
    
    94-3234458(State or other jurisdiction of
    
    (IRS Employer Identification Number)incorporation or organization)
 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: NONE Securities registered pursuant to Section 12 (g) of the Act:
COMMON STOCK,
PAR VALUE
$0.001 PER SHARE
(Title of Class) 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: þ 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 an accelerated filer (as defined in Exchange Act
Rule 12b-2). Yes: o No: þ 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, 2003 as reported on
the OTC Bulletin Board was approximately $25,362,500. Shares of Common Stock held by each
executive officer and director and by certain 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.




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As of March 15, 2004 the Registrant had outstanding 16,157,716 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrants 2004 Annual Meeting of Stockholders to be held
on June 7, 2004, are incorporated by reference in Part III. EXPLANATORY NOTE This Amendment No. 1 on Form 10-K/A amends our Annual Report on Form 10-K, filed on March 30, 2004
(the Original Form 10-K) to reflect the restatement of our balance sheets as of December 31, 2003
and 2002, our statements of operations, stockholders (deficit) equity and cash flows for the years
ended December 31, 2003, 2002 and 2001, and selected financial data for the year ended December 31,
2000. This restatement principally relates to a correction in our method of revenue recognition
for most of our K-12 school contracts. This correction has resulted in changes to our previously
reported revenues and deferred revenues in all periods included in this Report from 2000 through
2003. This correction is described in Item 8, Financial Statements and Supplementary Data, in
particular in Note 2 to the Financial Statements. We have amended and restated in its entirety each item of the Original Form 10-K that has been
changed to reflect the restatement. These include Part I, Item 1  Business, Part II, Item 6 
Selected Financial Data, Item 7  Managements Discussion and Analysis, Item 8  Financial
Statements and Supplementary Data, and Item 9A  Controls and Procedures. We have included in this Report the full text of all other Items as filed in the Original Form
10-K, without changes. In order to preserve the nature and character of the disclosure set forth
in those other items as originally filed, we have not modified or updated the disclosures in this
Report except as stated in the paragraph above. Except as stated above, this Report speaks only as of the date of the Original Form 10-K. Except
as specified above, this filing does not reflect any events occurring after March 30, 2004. Page 2




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TABLE OF CONTENTS PAGE NO.PART IItem 1.
    
    Business
    
    
    4Item 2.
    
    Properties
    
    
    15Item 3.
    
    Legal Proceedings
    
    
    15Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    15PART IIItem 5.
    
    Market for Registrants Common Equity and Related Stockholder Matters
    
    
    18Item 6.
    
    Selected Financial Data
    
    
    19Item 7.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    21Item 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    30Item 8.
    
    Financial Statements and Supplementary Data
    
    
    31Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
    
    
    56Item 9A.
    
    Controls and Procedures
    
    
    56PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    57Item 11.
    
    Executive Compensation
    
    
    57Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    57Item 13.
    
    Certain Relationships and Related Transactions
    
    
    57Item 14
    
    Principal Accounting Fees and Services
    
    
    57PART IVItem 15.
    
    Exhibits, Financial Statement Schedules, and Reports on Form 8-K
    
    
    58SIGNATURES
    
    
    
    
    62Exhibit 23.1Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Page 3




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ITEM 1. BUSINESS We develop and distribute the Fast ForWord® family of reading intervention software.
Our innovative products apply advances in neuroscience and cognitive research to build the
fundamental cognitive skills required to read and learn. Reading is essential for success in school and in life, yet according to the National Assessment of
Educational Progress conducted by the U.S. Department of Education, 69% of fourth graders in the
U.S. are unable to read proficiently at grade level. Learning to read proficiently is a complex
task involving multiple cognitive processes that have become much better understood in recent
years. Our products incorporate learning from more than 30 years of research on the brain,
language, and reading. Extensive outcomes research by independent researchers, our founding scientists, and our company
demonstrates that the Fast ForWord products help students attain rapid, lasting gains in the skills
critical for reading. Our major products include an optional easy-to-use web-based tool that
provides reports on detailed learning results for individuals and groups of students. To encourage best practices in the use of our products, we provide on-site and remote services,
including product training and professional development, implementation management, consulting and
technical installation. We also provide technical, professional and customer support and a wide
variety of web-based resources. At the end of 2003, approximately 2,200 schools had purchased at least $10,000 of our Fast ForWord
product licenses and services, and over 325,000 individuals had enrolled in one of our products. MARKETS Our primary market is K-12 schools in the United States. In 2003, the K-12 sector represented more
than 90% of our business. Since we began building our school sales force in late 1998, our
business in K-12 schools has grown each year, both in absolute dollars and as a percentage of our
business. The K-12 market is large and is projected to grow. According to the National Center for Education
Statistics, part of the U.S. Department of Education, and Market Data Retrieval, a supplier of
market information to the education industry, U.S. K-12 schools now enroll more than 54 million
students, and enrollment is projected to continue growing through 2013. There are approximately
14,200 public school districts in the U.S., and approximately 114,000 public and private school
buildings, or sites. Eduventures, a strategic consulting firm in the education industry, has estimated that in 2001,
K-12 schools spent $3.2 billion (46% of the total amount schools spent on all instructional
products) on supplementary materials of all types. Simba Information, Inc., a marketing information
company, estimates the K-12 market for instructional software at $1.63 billion in 2003. The general availability of funding for public schools fluctuates from time to time, and state and
local funding is presently negatively affected by reduced levels of tax revenues due to the
economic slowdown. During 2002 and 2003, the education technology industry generally experienced
soft sales, typically attributed to tight funding. State and local education funding is expected
to continue to be tight during 2004. If the economy continues to grow stronger, more funding may
be available in 2005. Nevertheless, substantial federal funding resources remain, and many of
those resources are focused on reading improvement. The federal No Child Left Behind (NCLB) Act of 2001 established as important national priorities
reading achievement and grade level proficiency accomplished through proven practices and products
grounded in scientifically based research. Our products, which build language and reading skills
and are based on more than 30 years of neuroscience and cognitive research, align well with these
objectives. For fiscal year 2005, President Bushs education funding requests include $13.3 billion for Title
1, Part A, grants to local education agencies; $1.125 billion for Reading First; $132 million for
Early Reading First; $12.2 billion for special education grants to states; $692 million for
educational technology; $1 billion for 21st Century Community Learning Centers; and $682
million for English Language Acquisition programs. All of these sources of federal funding have
been used by our customers to purchase Fast ForWord licenses. Page 4




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We believe that the funding for a substantial portion of our K-12 sales comes from federal funding,
so continuing to qualify for major sources of federal funding is critical to our sales success.
The current federal budget deficit may impact the availability of federal education funding. For
example, for 2005 the administration has requested no money for Comprehensive School Reform, Even
Start and Dropout Prevention, and the funding for several other categories has stayed the same as
2004. Nevertheless, the total amount of federal funding for education has increased each year
since 1996. In addition to selling to K-12 schools, we also sell through private practice professionals, and to
learning centers, hospitals, clinics and psychologists. These speech and language or other
professionals recommend the use of our products to appropriate clients and then supervise the use
of those products, often in connection with their other services. Since 1999, our business in this
sector has decreased each year, both in absolute dollars and as a percentage of our business. We
expect that this sector will continue to decline as a percentage of our business. However, these professionals remain significant to us. Private practice professionals were our
first market, and they have extensive knowledge about our products and their use that can be
valuable for us and for all of our customers. These professionals sometimes provide contract
services to schools, and from time to time recommend Fast ForWord products for students in those
schools. PRODUCTS Our Fast ForWord software products develop cognitive skills required to read and learn
effectively. Based on more than 30 years of research in neuroscience, reading and
language, our products use established neuroscience principles to help students learn.
Extensive efficacy research (see Outcomes and Scientific Basisbelow) has demonstrated the
results that can be achieved through use of our products. COGNITIVE SKILLS DEVELOPMENT Reading and learning require a variety of foundational cognitive skills, all functioning
together. The Fast ForWord products develop prerequisite skills that enable students to
take greater advantage of their reading instruction and improve their reading proficiency.
Fast ForWord products do this by developing Learning MAPsÔ skills: Memory. The ability to hold information short- and long-term, essential for comprehension
of complex sentences and for remembering instructions. Attention. The ability to focus on tasks and ignore distractions. Processing. The ability to address information such as images and sounds quickly enough,
and in the correct sequence, to discriminate their differences, a prerequisite for phonemic
awareness (the ability to distinguish among and manipulate the smallest sounds in language
that can change meaning) and reading. Sequencing. The ability to quickly and accurately determine which of two events or stimuli comes
first, which is supported by memory, attention, and processing. Sequencing is essential for
developing phonemic awareness, word fluency, and oral and reading comprehension. FAST POWER LEARNINGÔ FORMULA Neuroscience research has demonstrated the importance of frequency, intensity, adaptivity,
simultaneous development, and timely motivation for learning new tasks. The Fast ForWord products
use these principles to help students learn more rapidly. Frequency and intensity: Brain plasticity research demonstrates that completing a set of
learning tasks in a frequent, intense timeframe is needed to make the changes in brain functioning
that enhance learning. To maximize the efficacy of our products, we recommend protocols for our
major products that require between 48 and 100 minutes of product use a day, 5 days per week. Page 5




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During 2003, a significant portion of our research resources were devoted to developing alternate
protocols to offer educators greater flexibility in fitting Fast ForWord products into school
schedules, while maintaining the products effectiveness. Our original protocols required product
use for 90 to 100 minutes per day, 5 days a week, for a period of 4 to 8 weeks. We have now
introduced protocols for each of our major products that require only 48 to 50 minutes of use, 5
days a week, over a longer period of 6 to 10 weeks. Our research shows that students working under
the new protocols achieve substantially the same results as those using the original protocols.
The shortened daily time protocols make fitting our products into the school day much easier,
although the required time commitment still can present challenges to selling and implementation. Adaptivity: The interactive exercises in the Fast ForWord products adapt to each students
skill level and progress, automatically adjusting 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 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: The Fast ForWord products simultaneously develop both major and
supporting cognitive skills for enduring learning improvements. While each exercise focuses on a
specific set of reading or language tasks, it is also designed to develop underlying cognitive
skills such as memory, attention, processing and sequencing. Timely Motivation: For the brain to learn, the student must be attentive and engaged, so
motivation is critical to maintaining learning improvements. In the Fast ForWord products,
learners are rewarded for a correct answer on their first attempt only, a scientifically validated
motivational technique. Other motivational techniques include a bonus point system and the
delivery of mastery animations that signify milestones as students progress. PRODUCTS IN THE FAST FORWORD FAMILY During 2003, our Fast ForWord family of products accounted for 82% of revenue. These 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 and homes. In 2003 we introduced the Fast ForWord Gateway Editionof our major products. The Gateway Edition
was designed to:  
    Make our products easier to implement and use through alternative
protocol options, simplified administrative procedures, and a
unified interface;
    Improve student results by adding easier introductory levels for
some exercises and providing individualized intervention
recommendations based on a students actual performance;
    Better connect Fast ForWord use to classroom activities through a
teacher interface that aligns the Fast ForWord products to state
learning standards and selected core reading programs; and
    Provide additional progress tracking capabilities, including
reports that enable sub-group tracking, to help educators respond
to increased accountability demands. Customers who purchased earlier editions and wish to move to the Fast ForWord Gateway Edition may
do so for an additional charge. Fast ForWord Languagesoftware includes seven exercises focused on developing oral language
comprehension and listening skills 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,
along with building the requisite underlying MAPs skills. Fast ForWord Middle and High Schoolsoftware is designed for adolescents and teenagers who lack
reading proficiency. The exercises are similar to those in Fast ForWord Language but deliver
content in an age-appropriate sports-themed user interface. Fast ForWord Language to Readingsoftware includes five exercises that help students make the link
between spoken language and written language focusing on word analysis, listening comprehension,
working memory, grammar, syntax, and vocabulary, while continuing to further develop the underlying
MAPs skills. Page 6




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Fast ForWord to Readingis a series of products that build essential reading skills such as
phonemic awareness, vocabulary, fluency, and comprehension while simultaneously developing the
underlying MAPs skills. At more advanced levels, students use these products to build spelling
skills and familiarity with writing conventions, extend word level knowledge of semantic,
phonological, morphological and syntactic structures, and advance their sentence and passage
comprehension skills. (Morphology relates to the use of words, letters, and letter combinations
that change the meaning of a word. Syntax relates to how grammatical markers and words are
combined to make meaningful sentences.) Each Fast ForWord to Reading product is correlated
directly to generally-accepted grade-level reading standards. In 2003, we introduced the Fast
ForWord to Reading 4product, which is correlated to end of fourth grade standards and joined our
earlier Fast ForWord to Reading 3 product. In 2004, we plan to introduce Fast ForWord to Reading 1
and Fast ForWord to Reading 2. Our major products, Fast ForWord Language, Language to Reading, Middle & High School and Fast
ForWord to Reading, include an optional remote progress tracking system, Fast ForWord Progress
Tracker. This easy-to-use web-based tool provides reports on detailed learning results for
individuals or groups of students for all exercises in each of these products. These reports,
generated from learner data securely transmitted by customers to Scientific Learnings database,
permit educators to see exactly how each student is progressing on specific skills. Overview
reports provide summary-level data for a class or other group and provide a quick update on the
groups progress and participation levels. Customers can configure the system to send automatic
emails to parents, administrators or others to provide easy periodic updates. Progress Tracker
data can be reported by subgroup, providing a tool for educators to analyze their progress towards
their Annual Yearly Progress requirements, which are mandated by NCLB. We also sell Fast ForWord Basics,software that prepares pre-readers aged 4 to 7 for learning and
reading; Reading Edge, a reading assessment instrument for students from kindergarten to 2nd grade;
and Fast ForWord Bookshelf, an early reading kit that includes five colorful storybooks and a
multimedia CD-ROM. 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 for a perpetual term or
on a subscription or limited term basis. The license package typically contains at least two of
our major products and varying quantities of our other products. An annual support fee is included
in the package license price. Most customers also purchase implementation services, which aid in
the successful use of the products. Our license list prices range from $10,000 to $65,000 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 major products list for $850 per product per student. The
private practice professional charges separately for his or his 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 TO LEARNING SERVICES AND SUPPORT One of our key strategic goals is to reach beyond early adopters and sell to a broader group of
mainstream reading intervention customers. We believe that selling more services is critical to
achieving that goal, because mainstream customers tend to require more implementation support than
do early adopters. In 2003 and 2002, services and support accounted for 18% of revenue. At the
end of 2003, our service and support organization included 23 employees, supplemented by 37
contractors who provide on-site customer training and technical services. SERVICES School districts have limited resources to support technology at dispersed sites, so they seek
products that are easy to implement and maintain. To facilitate effective implementation, we offer
product training, technical installation, implementation management, consulting, and professional
development services. These services are generally provided on-site by independent contractors who
have been trained and certified on our products. Some of these services are also offered remotely,
including Fast ForWord Getting Started, a self-paced web-based course that provides training on the
science behind and the use of our products. Page 7




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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,
effective implementation strategies, and an introduction to the science behind our products. In
addition, customers can look to Scientific Learning for implementation management services 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 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 Fast ForWord products impact student achievement. These
sessions provide Fast ForWord users with opportunities to network and develop informal support
relationships, and in some cases, are offered with continuing education credits. SUPPORT We provide extensive remote support to Fast ForWord customers, who can access our technical,
professional, and customer support via telephone, email, and web-based chat, in whatever
combination works best for them. Level 1 support services are provided by a third party that
specializes in providing telephone support. More difficult questions are escalated to internal
support staff. In our customer surveys, customers using Fast ForWord products generally give
excellent ratings to the support they receive and the professionalism of our support team. OUTCOMES and SCIENTIFIC BASIS From the founding of our company, we have devoted significant resources to demonstrating that our
products improve learning, and today we continue to accumulate outcomes data from students in
classrooms across the country. Research by our users, independent academics and our own scientists
has demonstrated that Fast ForWord products improve language and reading skills across a broad
spectrum of demographic groups. USER OUTCOMES To date, more than 325,000 individuals have enrolled in Fast ForWord products, and we have
accumulated research outcomes on more than 25,000 individuals, including approximately 17,000
controls. Gains have been confirmed among a variety of groups, including African-American
students, Hispanic students, students with limited English proficiency, students struggling with
reading, and students of low socio-economic status. Gains on specific reading skills have been
confirmed using several standardized, nationally normed reading tests. In addition, schools that
have used Fast ForWord products have provided us with state achievement test scores from students
before and after they have used Fast ForWord products. Analyses of these data have demonstrated
that following Fast ForWord participation, students, on average, achieve significant improvements
on a wide variety of high-stakes tests. BRAIN IMAGING AND READING IMPROVEMENTS A Stanford University study of students aged 8 to 12 who were identified as dyslexic, published in
2003 in the Proceedings of the National Academy of Sciences,confirmed that after using Fast
ForWord, students on average showed significant improvements in reading performance, coupled with
changes in brain activation patterns. Before beginning the study, the students underwent
assessments for reading, reading skills, and language, as well as functional magnetic resonance
imaging (fMRI) of their brains during a series of reading-related tasks. The students then used
the Fast ForWord Language product for five days a week, 100 minutes per day, for an average of 28
days. The fMRIs and assessment tests were then repeated. After Fast ForWord use, the brain
activation patterns of the students showed increased neurological activity in regions of the brain
involved in skills critical to reading. These later images more closely resemble the patterns
exhibited by students reading on or above grade level. A control group showed no similar changes
in fMRI results. The students who used the Fast ForWord product also showed statistically
significant improvements in a variety of reading skills, including word decoding, single word
reading, naming fluency, and reading comprehension. RESEARCH BASIS and FIELD TRIALS The technology that forms the basis of most of our major products grew out of a scientific
collaboration between neuroscientists working at Rutgers, the State University of New Jersey
(Rutgers) and the University of California at San Francisco (UCSF) combining insights about
language development and learning to read with research on brain plasticity. Page 8




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One of a childs early tasks is to learn to extract meaning from speech by identifying its basic
auditory building blocks, or phonemes. Children must be able to recognize and process these
phonemes before they can become skilled in language or reading. The Rutgers group noted that
children who have difficulty distinguishing between closely related phonemes frequently have
problems in other language and cognitive skill areas as well, such as morphology, syntax,
semantics, grammar, short-term memory, attention, and event sequencing. The UCSF group had long
investigated how the human brain changes in response to stimuli, a phenomenon known as brain
plasticity. Their work demonstrated that specific techniques drive the brain to change over time,
adjusting how it processes information. Bringing together their work at Rutgers and UCSF, our
founders developed computerized exercises that use thousands of repetitions, adapted according to
complex and sophisticated formulas and presented with timely motivational sequences, to allow
children to quickly master the language and cognitive skills that are critical to reading. Results from the original research studies combining the work of our scientific founders were
published in the journal Sciencein early 1996. These results were revalidated by a national field
trial of Fast ForWord Language later in 1996, which demonstrated gains of one to two years on
standardized tests of skills critical to reading, after just four to eight weeks of training. A
second national field trial in 1997, among students in 19 public schools in nine districts across
five states, demonstrated significant gains in language and reading skills as measured on
standardized tests, yielding average improvement of more than 1 1/2 years in four to eight weeks 
gains that were significantly greater than those made by students in the control group. SALES AND MARKETING We sell to our principal market, K-12 school districts throughout the United States, primarily
using a direct sales force. As of December 31, 2003, we employed 30 quota-bearing sales
representatives, led by four regional sales directors. These sales personnel typically are
experienced professionals with backgrounds in selling technology-based curriculum products to the
K-12 segment. Most bring strong relationships with educators built over many years. We support
our sales representatives with a strong field sales management team with over 100 years of
collective 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 participate in industry conferences and trade shows and conduct our own Executive Forums for
educational decision makers. Our sales force typically targets sales at the school district level,
although early seeding sales are also made at the individual school level. We sell to clinical professionals, learning centers, hospitals and clinics principally through
direct marketing (mail, web and telesales) and conferences (both industry conferences and forums we
conduct ourselves). We have also recently begun to sell our products outside North America through resellers in a
limited number of countries. To date, the level of these sales has been minimal. COMPETITION The educational market in which we operate is very competitive. We believe that the principal
competitive factors in the industry are ability to deliver measurable improvements in student
achievement, cost, existing relationships with customers, ability to provide effective and
efficient product implementation, and ability to complement and supplement the school curriculum.
We believe that we compete favorably on the basis of these factors. Our products are highly differentiated by their neuroscience basis and their focus on the
development of cognitive skills through scientifically based methods. However, we 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 Scientific Learning, 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 Page 9




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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. DEVELOPMENT AND RESEARCH 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 $3.5 million, $3.0 million, and $3.4
million for the years ended December 31, 2003, 2002 and 2001, respectively. At December 31, 2003,
18 of our employees were engaged in research and development activities, which include both product
development and outcomes research. DEVELOPMENT Our development efforts focus on making our products more effective and easier to use, and
broadening our product line. All of our current development efforts are focused on products
related to reading and language, principally for use in a school environment. Our new 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. We analyze the data that is
uploaded through our Progress Tracker tool to identify trends in product use and efficacy and help
us develop improvements to our products. In 2003, we launched Fast ForWord Gateway Edition, a new edition of our major products. Our
customers received the added features and benefits of the Gateway Edition enthusiastically.
However, we encountered technical issues with the new release that required significant time from
our sales and service teams. This led to additional service and support costs and slowed the
purchasing decisions for a number of transactions, resulting in lower than expected fourth quarter
sales. In 2003 we also launched the second product in our Fast ForWord to Reading series, Fast ForWord to
Reading 4. During 2004, we expect to launch two additional products in the Fast ForWord to Reading
series, Fast ForWord to Reading 1 and 2, which are currently in development. We cannot guarantee
that we will meet the projected introduction schedule for future products, or that future products
will be free of technical issues or be well received in the market. RESEARCH We believe that the emphasis in the No Child Left Behind Act on scientifically based instructional
approaches validates our long-standing support of research on the efficacy of our products, which
has included projects at some of the countrys top research universities. We continue to support
research to demonstrate the outcomes of our products, as well as to identify and support new
product and product improvement opportunities. Support of Outcomes Research School districts throughout the country are studying the impact of Fast ForWord products on their
students reading achievement. Many of these studies focus on outcomes related to state standards
and accompanying state assessment programs. We encourage these studies, assist with data analysis
when appropriate and, whenever practical, make the results available on our Scientific Learning web
site. Researchers at Stanford University are planning a randomized controlled study on the additive
effects of using multiple Fast ForWord products. The study plans to include a wide variety of
students in a broad spectrum of educational settings. An advisory board of reading research
experts is planned to monitor the research design, methods and data analyses procedures. We are
providing a donation to the Haan Foundation to fund a portion of the study. Page 10




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Product Enhancements and New Products The data that is uploaded to our database from participants who use our products is a valuable
resource for improving our products. Analyzing the patterns among groups of participants allows
us to understand, in detail, how students generally progress, where students have difficulty and
where intervention might be appropriate. In 2003, we released alternate protocols for each of our
major products after demonstrating that the alternate protocols resulted in substantially similar
student progress as the original protocols, using analyses of students Progress Tracker data as
well as pre and post test results. We also released Progress Tracker flags providing
individualized intervention recommendations based on the students actual performance and new,
easier introductory levels for exercises where students may tend to experience difficulty when
starting the products. We continue to explore potential product enhancements and alternative usage
protocols that will make our products more useful to educators and more effective for students. INTELLECTUAL PROPERTY We have a broad intellectual property strategy addressing both product technology and product
concepts. Our policy is to aggressively 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, 2003, we held 50 issued U.S. patents and 5 pending U.S. applications. We also held
4 issued patents from other countries and had 13 applications pending abroad. We were the
exclusive licensee under 11 issued U.S. patents, 3 issued foreign patents, and 2 pending foreign
patent applications. The U.S. patents expire between 2014 and 2019. We also have 17 US trademark registrations, including registrations for marks including Fast
ForWord, our most important trademark. During 2002, we were involved in litigation regarding
another partys use of a mark that was similar to our Fast ForWord mark which was resolved
amicably. The licensed patents and applications 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 2003, approximately 74% of our product
booked sales were derived from selling products that use the licensed inventions. 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 sales of our products, subject to certain minimum
royalty amounts. In 2002 and each year thereafter, the minimum royalty payment is $150,000. In
2003, 2002 and 2001, we had approximately $898,000, $723,000 and $635,000, respectively in royalty
and milestone expense under the license. The final milestone payment under the license was paid in
2001. In September 2003, we transferred certain of our technology to Neuroscience Solutions Corporation
(NSC) for use in the healthcare field. The transaction includes a license of the patents we own,
a sublicense of the patents we license from UCSF and Rutgers, the license of certain software we
developed, and the sale of some research-related assets. All of the rights licensed to NSC are
limited to the healthcare field and most of the licenses are exclusive in that field. We will
continue to use the licensed patents and technology in the fields of education and speech and
language therapy, and retain all rights to our technology outside of the health field. The rights were acquired by Neuroscience Solutions for a combination of cash, stock, and future
royalties. The two companies also have agreed to share certain additional technology as it is
developed. NSC is a San Francisco-based company that plans to develop and sell a series of
software-based products for healthcare markets based on research in neuroplasticity. NSCs first
products are expected to focus on issues of aging. Dr. Michael M. Merzenich, who is a founder,
director, significant stockholder and former officer of the Company, is also a founder, director,
significant shareholder and officer of NSC. ADDITIONAL INFORMATION As of December 31, 2003, we had 130 full-time and three part-time employees. We believe our
relations with employees are good. None of our employees is represented by a union or subject to
collective bargaining agreements. We maintain two websites, scientificlearning.com and brainconnection.com, which provide information
and support. Scientificlearning.com provides information about our company and our products and
services, as well as extensive Page 11




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technical and customer support resources. Brainconnection.com provides practical, easily
understandable information about how the brain works and how students learn, web-based professional
development courses on the brain, language, and reading, and links to information about Fast
ForWord products that relate to the topics discussed on the site. We are a Delaware corporation. We incorporated in 1995 in California under the name Scientific
Learning Principles Corporation and reincorporated in 1997 in Delaware under our present name,
Scientific Learning Corporation. FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS OR STOCK PRICE 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
occur, our business, financial condition or results of operations could be materially and adversely
affected and the trading price of our common stock could decline. The success of our business depends on increasing acceptance of our products in the K-12 sector,
particularly among mainstream purchasers, who may be resistant to our non-traditional products. To continue to grow, we need to increase the acceptance of our products among mainstream
educational purchasers. At the end of 2003, approximately 2,200 schools had purchased at least
$10,000 of our Fast ForWord product licenses and services and over 325,000 individuals had enrolled
in one of our products. We believe that to date most educators who have used Fast ForWord products
are early adopters. We believe that our success in moving our products beyond early adopters to
the mainstream market will depend largely on the following critical factors:  
    Our ability to convince key education decision-makers to use Fast
ForWord products even though our methods differ from the way
schools have traditionally addressed reading problems. K-12
educational practices are slow to change, and it can be difficult
to convince educators of the value of a substantially different
approach.
    Our ability to convince schools and teachers to incorporate our
products into their curriculum. Our new protocols have
significantly reduced the daily time required to use our program,
significantly decreasing one of the most critical challenges in
broadly using our products. However, using the products still
requires a substantial time commitment from students and
educators, which can be difficult for schools.
    Our ability to effectively implement our products in schools and
better connect to classroom teachers in a scaleable and efficient
model.
    Our ability to continue to demonstrate that our products achieve
significant gains in student achievement. Unless our products are
implemented well and using in accordance with one of our
protocols, they may not achieve the desired student achievement
results.
    The availability of government funding for public school reading
intervention purchases and for our products in particular. The
general availability of funding for public schools fluctuates from
time to time, and state and local funding is presently negatively
affected by reduced levels of tax revenues due to the economic
slowdown. During 2002 and 2003, the education technology industry
generally experienced soft sales, typically attributed to tight
funding. State and local education funding is expected to
continue to be tight during 2004. However, if the economy
continues to grow stronger, more funding may be available in 2005.
    The extent to which our products qualify for federal education
funding. Future federal education funding could be adversely
affected by the federal budget deficit. Our business experiences seasonal fluctuations and a long sales cycle, which may make it difficult
to predict our results accurately. Since our formation, our quarterly operating results have fluctuated significantly, and we expect
these fluctuations to continue. Like other companies in the instructional market, our sales to
K-12 schools are typically particularly slow in the first quarter. Demand for our products through
private clinicians tends to be lower during the school year than in the summer, because our
products intensive nature can be more conducive to use during school vacation. In addition, the cost of some of our K-12 license packages requires multiples 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
these 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, Page 12




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obtain grants or wait until subsequent budget cycles. As a result, our sales cycle generally takes
several months, and in some cases, can take a year or longer. The timing of revenue recognized from our sales can also be unpredictable. Our various license and
service packages have substantially differing revenue recognition periods, and it may be difficult
to predict which license package a customer will purchase, even when the amount and timing of a
sale can be projected. See Managements Discussion and Analysis Application of 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 sales and
revenue in a given quarter. Our expense levels are based on our expectations of future revenues 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. We may experience difficulties in launching new products efficiently, without significant technical
issues, and on schedule. We are developing additional products in our Fast ForWord to Reading series as part of our strategy
to reach mainstream reading intervention customers. Unexpected challenges could make these
development projects longer or more expensive. In addition, we cannot be certain of market
acceptance of our new products. New technology products usually contain bugs that were 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. During the second quarter of 2003, we launched the
new Gateway Edition of our major products. Although our customers received the added features and
benefits of the Gateway Edition enthusiastically, we encountered technical issues with the new
release that required significant time from our sales and service teams. This led to additional
service and support costs, and slowed the purchasing decisions for a number of transactions,
resulting in lower than expected fourth quarter sales. The restatement of our financial statements has had a material adverse impact on us, including
increased costs, the increased possibility of legal or administrative proceedings, the commencement
of delisting proceedings and a default under our credit agreement. In December 2004, as a result of a reconsideration of our revenue recognition practices, management
of the Company and our Audit Committee concluded that we should correct our revenue recognition
practices for most of the Companys K-12 school contracts. As a result, we have restated our
financial statements for the period from 2000 through June 30, 2004, as described in more detail in
Note 2 to the Condensed Financial Statements. As a result of these events, we have become subject to the following risks:  
    We have incurred substantial unanticipated costs for accounting and legal fees.
    It is not uncommon for lawsuits claiming to be class actions to be brought against
companies that restate their historical financial statements and their directors and
officers. If such actions were to be brought, it is likely that we would incur substantial
defense costs regardless of their outcome. Likewise, such actions might cause a diversion
of our managements time and attention. Likewise, if such actions were brought and we did
not prevail, we could be required to pay substantial damages or settlement costs.
    It is also not uncommon for the Securities and Exchange Commission to investigate
companies that restate their historical financial statements. If any such investigation
were commenced, it would likely divert more of our managements time and attention and
cause us to incur substantial costs. Such investigations could also lead to fines or
injunctions or orders with respect to future activities.
    The need to reconsider our accounting treatment and the restatement of our financial
statements caused us to be late in filing our required report on Form 10-Q for the quarter
ended September 30, 2004. In November 2004, we received notice from Nasdaq that we are
subject to delisting because this delay in our filing has caused us to be out of compliance
with the continued listing requirements of the Nasdaq National Market. In January 2005, we
received the determination of Nasdaq Hearing Panel in this matter, which permits the
Companys securities to remain listed on the Nasdaq National Market so long as the Company
has filed its Form 10-Q for the quarter ended September 30, 2004, as well as any amendments
required by Page 13




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the restatement, no later than February 15, 2005. The determination also requires that the
Company remain in compliance with all requirements for continued listing and give Nasdaq
prompt notice of any significant events during this time, and provides that the Hearing
Panel reserves the right to reconsider the terms of the exception granted to the Company and
to review any compliance document filed by the Company. In addition, under Nasdaq rules, it
is still possible that upon reconsideration the Company could be delisted as a result of the
delay in our filings.
    The need to restate our historical financial statements constitutes an event of default
under our credit agreement, which permits our lender to decline to advance additional funds
under the credit facility. There is no borrowing currently outstanding under the line, and
we do not foresee that we will need to draw down under the line during its term. However,
if we did wish to borrow under the line, it might be unavailable to us. We may not be able to compete effectively in the education market. The market in which we operate is very competitive. Our products are highly differentiated by
their neuroscience basis and their focus on the development of cognitive skills through
scientifically based methods. However, we 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 Scientific Learning, 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. Encouraged by the No Child
Left Behind Act, 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 our approach, the traditional methods are
more widely known and accepted and, therefore, represent significant competition for available
funds. Our intellectual property rights may be challenged. 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.
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. 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. Our most important products are based on licensed inventions owned by two universities. If we were
to lose our rights under this license, it would materially harm our business. The licensor may
terminate the license if we fail to perform our obligations and do not timely cure the violation.
We believe that we are currently in compliance with the license in all material respects. We have only recently become profitable. We started operations in February 1996 and until this year incurred significant operating losses.
In the second quarter of 2003, we recorded our first operating and net profits. 2003 was our first
profitable year. At December 31, 2003, we had an accumulated deficit of approximately $83 million
from inception. We first generated positive cash flow from operating activities in 2002 and our
cash flow from operations was again positive in 2003. During 2004, our objectives include
increasing our profit margin and generating positive cash flow from operations. However,
accomplishing these objectives will require achieving higher sales goals in a soft K-12 market,
which depends on many factors, some of which are outside of our control. To meet our sales
targets, we will need to make substantial expenditures. We cannot assure you that we will meet our
targets with respect to sales, revenues or operating results. Our directors and executive officers and their affiliates effectively control the voting power of
our company. At March 1, 2004, Warburg, Pincus Ventures, our largest shareholder, owned approximately 47% of the
Companys outstanding stock and, in the aggregate, our directors and executive officers and their
affiliates beneficially owned more Page 14




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than 64% 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. Our common stock is thinly traded and its price is volatile. Our common stock presently trades on the Nasdaq Small Cap Market, and our trading volume is low.
For example, during the fourth quarter of 2003, our average daily trading volume was approximately
8,400 shares. The market price of our common stock has been highly volatile since our July 1999
initial public offering and could continue to be subject to wide fluctuations. After our initial public offering, our common stock was traded on the Nasdaq National Market. On
July 22, 2002, we were delisted from the Nasdaq National Market for failure to meet the market
capitalization or tangible net assets alternative tests. Our common stock then traded on OTC
Bulletin Board until December 30, 2003, when we became listed on the Nasdaq Small Cap Market. Our charter provisions could have the effect of delaying or preventing corporate takeovers. Our certificate of incorporation authorizes our board of directors to issue up to 1,000,000 shares
of preferred stock and to determine the price, rights, preferences and privileges, including voting
rights, of those shares without any further vote or action by the stockholders. The rights of the
holders of common stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The authority to issue this
preferred stock could enable our board of directors to deter acquisitions of our company.
Additionally, our certificate of incorporation and bylaws also provide for a classified board of
directors, prevent stockholders from acting by written consent, disallow cumulative voting and
require advance notice of director nominations and stockholder proposals, all of which could have
the effect of delaying or preventing corporate takeovers. 
 ITEM 2. PROPERTIES We lease approximately 30,500 square feet of office space in Oakland, California under a lease that
expires in December 2013. The lease includes two five-year options to extend the term of the
lease. We believe our 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 None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. Page 15




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EXECUTIVE OFFICERS The following table sets forth various information concerning our executive officers, as of March
19, 2004: NAME
    
    AGE
    
    POSITIONRobert C. Bowen
    
    
    62
    
    
    Chairman and Chief Executive OfficerJames R. Bray
    
    
    59
    
    
    Vice President, Business Development and Government AffairsLinda L. Carloni
    
    
    50
    
    
    Vice President, General Counsel and SecretaryGlenn G. Chapin
    
    
    48
    
    
    Vice President, SalesJane A. Freeman
    
    
    50
    
    
    Sr. Vice President, Chief Financial Officer, and TreasurerDr. William M. Jenkins
    
    
    53
    
    
    Sr. Vice President, Product DevelopmentDr. Steven L. Miller
    
    
    40
    
    
    Sr. Vice President, Research and OutcomesGillian M. Rutter
    
    
    48
    
    
    Vice President, OperationsSherrelle J. Walker
    
    
    57
    
    
    Chief Education Officer
 Robert C. Bowenjoined 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. James R. Brayjoined us as Vice President, Business Development and Government Affairs in January
2003. Starting in 1990, Mr. Bray held a variety of executive positions at NCS Pearson and its
predecessors in their education, assessment, and testing products businesses. From 1999 through
2002, Mr. Bray was Vice President Business Development of Pearson Education Technologies and its
predecessors. During 2001 and 2002, Mr. Bray also served as chairman of NCS Pearsons corporate
marketing committee. During 1998 and 1999 Mr. Bray was Vice President and General Manager of
Realskills, an NCS company. Prior to joining NCS, Mr. Bray spent more than 20 years at IBM/Science
Research Associates in Chicago. Mr. Bray is a former member of the St. Paul (Minn.) School
District Foundation and received his bachelors degree in marketing from Northwestern University. Linda L. Carlonijoined the Company as General Counsel in October 1999, became our Secretary in
March 2000 and was elected Vice President in June 2000. From April 1996 to September 1999, Ms.
Carloni was a founder and Vice President of Alere Medical Incorporated, a healthcare services
start-up. From May 1994 to April 1996, Ms. Carloni served as a senior licensing officer for the
University of California Office of Technology Transfer. From April 1992 to April 1994, Ms. Carloni
was a partner at the law firm of Cooley Godward LLP. Earlier in her career, Ms. Carloni was the
general counsel of Nellcor Incorporated, a medical device company, and an associate and a partner
at Cooley Godward. 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. Chapinjoined the Company as Vice President, Sales in April 2001. Prior to joining the
Company, Mr. Chapin served as a Regional Vice President at CompassLearning, an educational
technology company starting in 1995. Prior to CompassLearning, Mr. Chapin was a sales executive
for NCS where he held positions of increasing responsibility over a 15-year period from serving as
the Midwest territory sales representative to Southern Region Sales VP. Mr. Chapin is a graduate
of St. John Fischer College in Rochester, NY where he received his Bachelor of Science degree in
Business Administration. Page 16




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Jane A. Freemanis our Senior Vice President, Chief Financial Officer and Treasurer. She joined us
as Vice President, Finance and Treasurer in August 1999 and was named Chief Financial Officer in
January 2000. She was elected Senior Vice President in January 2004. She also served as our Vice
President Business Development from August 1999 until June 2000. From April 1988 through December
1998, she was employed by Rockefeller & Co., a global investment firm where she served on the
Management Committee of the firm. She is a director of three 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. Jenkinswas elected 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 UCSF. 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. Dr. Steven L. Millerwas elected Senior Vice President, Research and Outcomes in November 2000.
Dr. Miller is a founder and served as our Vice President in charge of research or outcomes research
from June 1997 until November 2000. From May 1996 to June 1997, Dr. Miller was our Vice President,
Professional Relations and Outcomes. From September 1991 to May 1996, he held research appointments
at the Center for Molecular and Behavioral Neuroscience at Rutgers. Dr. Miller has extensive
experience in organizing clinical research studies and conducting longitudinal studies of children
and adults who have language and reading problems. Dr. Miller holds a B.A. in Psychology from
Bloomsburg University of Pennsylvania, an M.A. in Neuroscience from the University of Hartford and
a Ph.D. in Psychology from the University of North Carolina at Greensboro. He received additional
training in Clinical Neuropsychology at the Bowman Gray School of Medicine at Wake Forest
University. Gillian M. Rutterjoined us as Vice President, Operations in October 2002. Prior to joining us,
Ms. Rutter 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. Rutter worked in
management and field positions at Jostens Learning, an educational software company. Ms. Rutter
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. Sherrelle J. Walkerjoined us as Chief Education Officer in July 2002. Prior to joining us, Ms.
Walker had served as Vice President Curriculum at NCS Pearson, an educational software company
beginning in 1998. During 1998, Ms. Walker was vice president products at American Cybercasting
Corporation, which provided on-line curriculum products for teachers and students. Ms. Walker also
has more than 25 years experience as an educator and educational administrator, beginning as a
teacher in the Hartford Public Schools, and serving as an Assistant Principal, Principal and
Director of Secondary Education in the Renton, Washington Public Schools and as Assistant
Superintendent of the public schools in Federal Way, Washington. Ms. Walker played a leading role
in the development of the Washington State Essential Academic Learning Requirements and has been an
adjunct professor at the University of Washington. Ms. Walker completed her BS in teaching at
Hampton University in Hampton Virginia, and her MA at the University of Connecticut. Page 17




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PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Market Information. Our common stock currently is traded on the Nasdaq Small Cap
Market under the symbol SCIL. From July 22, 2002 until December 30, 2003, our common stock was
traded on the OTC Bulletin Board. From January 1, 2002 through July 21, 2002, our common stock was
traded on the Nasdaq National 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
National Market, the OTC Bulletin Board or the Nasdaq Small Cap Market, as applicable. High
    
    
    Low2002First quarter
    
    $
    2.900
    
    
    $
    1.110Second quarter
    
    $
    2.001
    
    
    $
    1.200Third quarter
    
    $
    1.650
    
    
    $
    0.700Fourth quarter
    
    $
    2.400
    
    
    $
    1.2102003First Quarter
    
    $
    3.100
    
    
    $
    1.400Second Quarter
    
    $
    4.500
    
    
    $
    2.300Third Quarter
    
    $
    5.150
    
    
    $
    4.100Fourth Quarter
    
    $
    5.000
    
    
    $
    4.150
 Holders. As of March 18, 2004, the approximate number of stockholders of record of our
common stock was 145. 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. (b) Not applicable (c) Not applicable Page 18




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ITEM 6. Selected Financial Data In thousands, except per share amounts Scientific Learning Corporation
Selected Financial Data (3) Year ended December 31,2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    1999Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedStatement of Operations Data:Revenues:Products
    
    $
    24,491
    
    
    $
    17,879
    
    
    $
    11,702
    
    
    $
    10,983
    
    
    $
    7,353Services and support
    
    
    5,425
    
    
    
    3,958
    
    
    
    3,023
    
    
    
    3,079
    
    
    
    2,899Total revenues
    
    
    29,916
    
    
    
    21,837
    
    
    
    14,725
    
    
    
    14,062
    
    
    
    10,252Cost of revenues (2):Products
    
    
    2,127
    
    
    
    2,109
    
    
    
    1,857
    
    
    
    1,800
    
    
    
    629Services and support
    
    
    3,872
    
    
    
    1,502
    
    
    
    2,402
    
    
    
    1,877
    
    
    
    2,059Total cost of revenues
    
    
    5,999
    
    
    
    3,611
    
    
    
    4,259
    
    
    
    3,677
    
    
    
    2,688Gross profit
    
    
    23,917
    
    
    
    18,226
    
    
    
    10,466
    
    
    
    10,385
    
    
    
    7,564Operating expenses:Sale and marketing
    
    
    12,961
    
    
    
    14,554
    
    
    
    19,701
    
    
    
    20,981
    
    
    
    13,568Research and development
    
    
    3,500
    
    
    
    2,985
    
    
    
    3,390
    
    
    
    5,680
    
    
    
    4,505General and administrative
    
    
    4,529
    
    
    
    4,776
    
    
    
    6,348
    
    
    
    5,746
    
    
    
    4,454Restructuring, lease and asset
impairment write downs
    
    
    (7
    )
    
    
    3,365
    
    
    
    2,608
    
    
    
    492
    
    
    
    Total operating expenses
    
    
    20,983
    
    
    
    25,680
    
    
    
    32,047
    
    
    
    32,899
    
    
    
    22,527Operating income (loss)
    
    
    2,934
    
    
    
    (7,454
    )
    
    
    (21,581
    )
    
    
    (22,514
    )
    
    
    (14,963
    )Interest income (expense), net
    
    
    (1,209
    )
    
    
    (1,332
    )
    
    
    (1,053
    )
    
    
    1,077
    
    
    
    892Other income from related party
    
    
    448
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income (expense), net
    
    
    
    
    
    
    91
    
    
    
    21
    
    
    
    2
    
    
    
    (16
    )Net income (loss) before income tax provision
    
    
    2,173
    
    
    
    (8,695
    )
    
    
    (22,613
    )
    
    
    (21,435
    )
    
    
    (14,087
    )Income tax provision
    
    
    43
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    2,130
    
    
    $
    (8,695
    )
    
    $
    (22,613
    )
    
    $
    (21,435
    )
    
    $
    (14,087
    )Basic net income (loss) per share
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )
    
    $
    (1.92
    )
    
    $
    (2.24
    )Shares used in computing basic net income
(loss) per share
    
    
    16,007
    
    
    
    15,641
    
    
    
    11,777
    
    
    
    11,148
    
    
    
    6,279Diluted net income (loss) per share:
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )
    
    $
    (1.92
    )
    
    $
    (2.24
    )Shares used in computing diluted net income
(loss) per share
    
    
    16,908
    
    
    
    15,641
    
    
    
    11,777
    
    
    
    11,148
    
    
    
    6,279Balance Sheet Data:Cash and cash equivalents
    
    $
    3,648
    
    
    $
    4,613
    
    
    $
    4,610
    
    
    $
    818
    
    
    $
    15,662Investments in government securities
    
    
    
    
    
    
    
    
    
    
    1,169
    
    
    
    7,667
    
    
    
    13,903Working
capital (deficiency)
    
    
    (11,331
    )
    
    
    (10,879
    )
    
    
    (1,010
    )
    
    
    6,609
    
    
    
    27,397Total assets
    
    
    15,597
    
    
    
    18,531
    
    
    
    23,228
    
    
    
    18,953
    
    
    
    36,324Long-term debt, including current portion
    
    
    
    
    
    
    5,000
    
    
    
    10,000
    
    
    
    
    
    
    
    Stockholders (deficit) equity (1)
    
    
    (8,544
    )
    
    
    (11,363
    )
    
    
    (3,247
    )
    
    
    10,281
    
    
    
    29,740
   (1)
    
    We have paid no cash dividends since our inception(2)
    
    Revenues and cost of revenues for 2002 and prior years have been reclassified to conform to the presentation adopted in 2003.(3)
    
    For more detailed information about the restatement of this financial information, refer to Note 2 to the Financial
Statements with respect to years 2001 through 2003 and to page 20 following for the year 2000. Page 19




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SCIENTIFIC LEARNING CORPORATION
EFFECT OF RESTATEMENT ON STATEMENT OF OPERATIONS FOR YEAR ENDED DECEMBER 31, 2000
(In thousands, except share and per share amounts)
Unaudited Year
    
    
    
    
    
    
    Yearended
    
    
    
    
    
    
    endedDecember 31, 2000
    
    
    
    
    
    
    December 31, 2000As reported
    
    
    Adjustments
    
    
    RestatedRevenues:Products
    
    $
    11,693
    
    
    $
    (710
    )
    
    $
    10,983Service and support
    
    
    3,568
    
    
    
    (489
    )
    
    
    3,079Total revenues
    
    
    15,261
    
    
    
    
    
    
    
    14,062Cost of revenues:Cost of products
    
    
    1,687
    
    
    
    113
    
    
    
    1,800Cost of service and support
    
    
    1,870
    
    
    
    7
    
    
    
    1,877Total cost of revenues
    
    
    3,557
    
    
    
    
    
    
    
    3,677Gross profit
    
    
    11,704
    
    
    
    
    
    
    
    10,385Operating expenses:Sales and marketing
    
    
    20,981
    
    
    
    
    
    
    
    20,981Research and development
    
    
    5,680
    
    
    
    
    
    
    
    5,680General and administrative
    
    
    5,746
    
    
    
    
    
    
    
    5,746Restructuring
    
    
    492
    
    
    
    
    
    
    
    492Total operating expenses
    
    
    32,899
    
    
    
    
    
    
    
    32,899Operating
loss
    
    
    (21,195
    )
    
    
    
    
    
    
    (22,514
    )Interest income, net
    
    
    1,077
    
    
    
    
    
    
    
    1,077Other income, net
    
    
    2
    
    
    
    
    
    
    
    2Net loss
    
    
    (20,116
    )
    
    
    
    
    
    
    (21,435
    )Basic and diluted net loss per share:
    
    $
    (1.80
    )
    
    
    
    
    
    $
    (1.92
    )Shares used in computing basic and diluted net loss per share
    
    
    11,148
    
    
    
    
    
    
    
    11,148
 Page 20




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##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-looking statements are not historical facts but rather are based on current expectations
about our business and industry, as well as our beliefs and assumptions. Words such as may,
will, should, expects, intends, plans, anticipates, believes, estimates,
predicts, potential, continue and variations and negatives of these words and similar
expressions are used to identify forward-looking statements. All forward-looking statements,
including but not limited to those identified with asterisks (*) in this report are not guarantees
of future performance or events, and are subject to risks, uncertainties and other factors, many of
which are beyond our control and some of which we may not even be presently aware. As a result,
our future results and other future events or trends may differ materially from those anticipated
in our forward-looking statements. Specific factors that might cause such a difference include,
but are not limited to, the risks and uncertainties discussed in this Managements Discussion, in
particular but not limited to those factors discussed under the caption Factors That May Affect
our Results or Stock Price. We also refer you to the risk factors that are or may be discussed
from time to time in our public announcements and filings with the SEC, including our future Forms
8-K, 10-Q and 10-K. Readers are cautioned not to place undue reliance on forward-looking
statements, which reflect our view only as of the date of this report. We undertake no obligation
to update or revise publicly any forward-looking statements, whether as a result of new
information, future events or otherwise after the date of this report. Overview We develop and distribute the Fast ForWord® family of reading intervention software.
Our innovative products apply advances in neuroscience and cognitive research to build the
fundamental cognitive skills required to read and learn. Extensive outcomes research by
independent researchers, our founding scientists, and our company demonstrates that the Fast
ForWord products help students attain rapid, lasting gains in the skills critical for reading. 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. Our primary market is K-12
schools in the United States, to which we sell using a direct sales force. In 2003, K-12 schools
accounted for 91% of our booked sales. By the end of 2003, approximately 2,200 schools had
purchased at least $10,000 of our Fast ForWord product licenses and services, and over 325,000
individuals had enrolled in one of our products. Restatement We have restated our
previously reported balance sheets as of December 31, 2003,
2002, 2001 and 2000, and our
statements of operations, stockholders (deficit) equity and cash flows for the years ended
December 31, 2003, 2002, 2001 and 2000. This restatement reflects a correction in the Companys
accounting for the recognition of revenue from certain customer contracts that included the Companys Internet
reporting tools. The restatement is described in more detail in Note 2 to Financial Statements
below. The correction relates to all periods included in this Report from fiscal 2000 through 2003. The
main impact of the correction of the error in recognizing revenue is to defer to later periods a
portion of the revenue that had been previously recognized. The primary impact on the balance
sheets at December 31, 2003 and 2002 is to increase deferred revenue. In the statement of
operations, the principal impact of the change in the twelve months ending December 31, 2003 was an
increase in revenue and a small decrease in cost of goods as revenue deferred from sales made in
periods before 2003 more than offset revenue deferred from sales in 2003. For the twelve months
ending December 31, 2002, the impact was an increase in both revenue and cost of goods. For the
twelve months ending December 31, 2001, the impact was a decrease in revenue and an increase in
cost of goods. Business Highlights In 2003 our revenue grew 37% over 2002 to reach $29.9 million, due to continued growth in the K-12
school market, partially offset by a continued decline in sales to private practice professionals. Page 21




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Because a significant portion of our licensed software, services and support revenue is recognized
in periods after the invoice date, our 2003 revenue growth rate was due in part to strong 2002
booked sales, which represented a 35% increase over 2001. (For more explanation of booked sales,
see Revenuebelow.) We do not expect 2004 revenue growth to continue at this rate*, because 2003
sales growth was slower. Our 2003 total booked sales increased by 8% over 2002, and K-12 booked sales increased 12%. Our
results, while stronger than industry results in the K-12 market, were below our expectations. We
encountered technical difficulties with the new Gateway Edition of Fast ForWord, which we
introduced in June 2003. This resulted in lower than expected sales in the fourth quarter. We
released a major update of our software in early 2004 and believe that the negative impact of
Gateway technical issues on sales force focus is now behind us.* One of our major goals is to increase the number of large sales, which we believe to be an
important indicator of mainstream education industry acceptance and an important factor in
continuing to increase the productivity of our sales force.* In 2003, we closed 59 transactions in
excess of $100,000 compared to 48 in 2002. Our goal is to continue to increase this number in
2004.* We reported our first net profit in 2003 of $2.1 million, 7% of revenue compared to an $8.7 million
loss in 2002. Achieving a profit was one of our major financial goals for the year. In 2004, our
goals include increasing both our net income and our profit margin.* To achieve these goals, we
must increase our sales, achieve the necessary product mix, and improve sales force productivity. During the year, we paid off our outstanding debt of $5.0 million. Net cash from operating and
investing activities was $3.6 million. This was the second year we generated cash from operations.
Because our generation and use of cash is seasonal, we borrowed money for working capital purposes
in the first quarter of 2004 and may again do so from time to time. Results of Operations Revenue Year ended December 31,(dollars in thousands)
    
    2003
    
    
    Change
    
    
    2002
    
    
    Change
    
    
    2001Restated
    
    
    
    
    
    Restated
    
    
    
    
    
    RestatedProducts
    
    $
    24,491
    
    
    
    37
    %
    
    $
    17,879
    
    
    
    53
    %
    
    $
    11,702Service and support
    
    
    5,425
    
    
    
    37
    %
    
    
    3,958
    
    
    
    31
    %
    
    
    3,023Total revenues
    
    $
    29,916
    
    
    
    37
    %
    
    $
    21,837
    
    
    
    48
    %
    
    $
    14,725
 2003 revenue compared to 2002: The growth in product revenues in 2003 was largely attributable to
an 8% growth in 2003 booked sales and the continued impact of sales made in previous periods. Our
product license sales are initially recorded as deferred revenue and recognized to revenue over the
term of the licenses. Because the license term frequently crosses over two fiscal years, our
strong 2002 license sales positively affected product revenue in both 2003 and 2002. In addition,
sales of our products with no Internet connection feature increased in 2003 compared to 2002, which
had a positive impact on revenue because these sales were recognized into revenue over a shorter
period than are products licensed with an Internet connection feature. Service and support
revenues increased, primarily due to increased sales of on-site services. The sale and delivery of
on-site services to schools was a major focus for us in 2003 to enhance school implementations.
Service and support revenue also increased as a result of the increase in the number of schools on
support contracts. 2002 revenue compared to 2001: The increase in product revenue in 2002 resulted from a 35%
increase in booked sales and strong sales in previous years. Service and support revenue increased
31% in 2002 compared to 2001. In 2002, we changed our service business to offer training and
implementation services at a lower price than in 2001. Revenue grew more rapidly than sales
primarily due to sales growth in previous periods. For 2002 and 2001 support revenues have been
reclassified to be comparable with 2003, when we began including support revenues with service
revenues. Booked sales and selling activity: Because a significant portion of our software, services and
support revenue is recognized in periods after the invoice date, management uses booked sales to
evaluate current selling activity. Page 22




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Booked sales is a non GAAP financial measure that we believe is
useful for investors as well as management as a 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. We record booked sales and deferred revenue when all of the
requirements for revenue recognition have been met, other than the requirement that the revenue for
software licenses and services has been earned. We use booked sales information for resource
allocation, planning, compensation and other management purposes. We believe that revenues is the
GAAP measurement closest to booked sales, however, booked sales should not be considered in
isolation from, and is not intended to represent, a substitute measure of revenues or any other
performance measure calculated under GAAP. The following reconciliation table sets forth our booked sales, revenues and change in deferred
revenue for the years ended December 31, 2003, 2002 and 2001. Year ended December 31,(dollars in thousands)
    
    2003
    
    
    Change
    
    
    2002
    
    
    Change
    
    
    2001Booked sales
    
    $
    30,704
    
    
    
    8
    %
    
    $
    28,353
    
    
    
    35
    %
    
    $
    21,038Less revenue
    
    
    29,916
    
    
    
    37
    %
    
    
    21,837
    
    
    
    48
    %
    
    
    14,725Net increase in deferred revenue
    
    
    788
    
    
    
    
    
    
    
    6,516
    
    
    
    
    
    
    
    6,313Current and long-term deferred
revenue beginning of the period
    
    
    18,712
    
    
    
    
    
    
    
    12,196
    
    
    
    
    
    
    
    5,883Current and long-term deferred
revenue end of the period
    
    $
    19,500
    
    
    
    4
    %
    
    $
    18,712
    
    
    
    53
    %
    
    $
    12,196
 Booked sales in the K-12 sector, which accounted for 91% of sales in 2003, grew 12% to $27.9
million, compared to $24.9 million in 2002. The increases were achieved in a difficult K-12 market
with tight state funding. We sold 862 site license packages over $10,000 compared to 828 in the
same period in 2002. The average sale per school for customers purchasing site license packages
increased slightly due to the introduction of our new Gateway Edition and sales of increased
training and implementation services, partially offset by purchases of more limited use licenses.
In 2003 we began reporting private school booked sales in the K-12 sector rather than in the
private sector where they had been reported in previous years. We have retroactively revised 2002
and 2001 booked sales numbers to be comparable. In 2003 we continued to focus our sales force on multi-site sales. The number of sales over
$100,000 increased to 59 in 2003 from 48 in 2002 and 24 in 2001. In 2003, we had our first $2
million sale, our largest sale to date. Sales in the fourth quarter were negatively impacted by
technical issues in our new Gateway Edition, which diverted the focus of our sales and service
organizations and delayed some customer purchases. We recorded a revenue reserve of $337,000 to
reflect Gateway technical issues. In 2002 K-12 sector booked sales increased by 52% to $24.9 million compared to $16.4 million in
2001. The K-12 sector represented 88% of booked sales in 2002, compared to 78% in 2001. The
average sale per school increased by 61% in 2002 compared to 2001 since we did not repeat a lower
priced sampling package introduced in 2001. In addition, in 2002, perpetual licenses, which have a
higher average price per school, became a more significant portion of our sales mix. Booked sales to the private sector declined by 18% in 2003 to $2.8 million compared to $3.4 million
in 2002 and declined 26% in 2002 from $4.6 million in 2001. We attribute the decline in both 2003
and 2002 to the continued focus on the K-12 market. Although funding uncertainty continues, we
believe that we are positioned to achieve steady growth in the K-12 market during 2004.* We expect
that the sales of services will continue to grow as a percent of total sales. Sales to the private
sector are expected to decline modestly, as we continue to focus on the K-12 market.* Unpredictability:Although federal, state and local budget pressures make for an uncertain funding
environment for our customers, we believe that we are positioned to achieve continued growth in the
K-12 market during the rest of 2004.* However, achieving our sales growth objectives will depend
on increasing mainstream customer acceptance of our products, which requires us to continue to
focus on improving our products ease of use, their fit with school Page 23




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##### Table of Contents



requirements, and our
connection with classroom teachers and administrators.* A key part of our growth strategy is to
increase our sales force productivity.* This may be challenging in a K-12 market that is still
negatively impacted by tight state and local funding. For a discussion of some of the other
important factors that affect our results, see Factors that May Affect Results of Operations or
Stock Price.In addition, the revenue recognized from our 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 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 sales and revenue at any given time. Gross Profit and Cost of Revenues Year ended December 31,(dollars in thousands)
    
    2003
    
    
    2002
    
    
    2001Restated
    
    Restated
    
    RestatedGross profit on products
    
    $
    22,364
    
    
    $
    15,770
    
    
    $
    9,845Gross profit margin on products
    
    
    91
    %
    
    
    88
    %
    
    
    84
    %Gross profit on service and support
    
    
    1,553
    
    
    
    2,456
    
    
    
    621Gross profit margin on services and support
    
    
    29
    %
    
    
    62
    %
    
    
    21
    %Total gross profit
    
    $
    23,917
    
    
    $
    18,226
    
    
    $
    10,466Total gross profit margin
    
    
    80
    %
    
    
    83
    %
    
    
    71
    %
 The overall gross profit margin fell in 2003 compared to 2002, largely due to a decline in our
service and support margins and an increase in the proportion of revenues from service and support.
In the first quarter of 2003, we reorganized our service and support business to increase the
number of people available to provide service and support to our customers. In addition, products
tend to be more challenging to implement when they are first introduced. We also incurred
additional service costs in the second half of 2003 associated with our new Gateway Edition.
Service and support costs consist primarily of the cost of personnel, materials and travel. In 2003, the gross margin on products increased due to slightly lower materials costs and
amortization of capitalized software cost. Product costs consist of manufacturing, packaging and
fulfillment costs, amortization of capitalized software and royalties. In 2002, overall gross margin improved compared to 2001 primarily due to the increased proportion
of high margin product sales in our revenue mix and lower customer service and support costs.
Lower service and support costs resulted from improved product usability and a decline in the cost
to provide services to our customers. In 2002, we primarily used per diem consultants rather than
full time employees to provide training services. In 2004, we expect gross profit margins to improve for service and support and for products.*
Improving our service margins will depend on higher utilization of staff.* We expect that lower
amortization of capitalized software cost, a lower average royalty rate, and a higher proportion of
product sales on which we do not pay royalties will contribute to improved product margins.*
However, overall gross margin is not expected to improve significantly because we expect a higher
proportion of services and support in our revenue mix.* Operating Expenses Year ended December 31,(dollars in thousands)
    
    2003
    
    
    Change
    
    
    2002
    
    
    Change
    
    
    2001Restated
    
    
    
    
    
    Restated
    
    
    
    
    
    RestatedSales and marketing
    
    $
    12,961
    
    
    
    -11
    %
    
    $
    14,554
    
    
    
    -26
    %
    
    $
    19,701Research and development
    
    
    3,500
    
    
    
    17
    %
    
    
    2,985
    
    
    
    -12
    %
    
    
    3,390General and administrative
    
    
    4,529
    
    
    
    -5
    %
    
    
    4,776
    
    
    
    -25
    %
    
    
    6,348Restructuring, lease and
asset impairment
write-down
    
    
    (7
    )
    
    
    n/a
    
    
    
    3,365
    
    
    
    29
    %
    
    
    2,608Total operating expenses
    
    $
    20,983
    
    
    
    -18
    %
    
    $
    25,680
    
    
    
    -20
    %
    
    $
    32,047
 Page 24




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##### Table of Contents



Sales and Marketing Expenses:In 2003, our sales and marketing expenses decreased primarily
because some staff formerly classified in sales and marketing became part of our expanded service
and support team. 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. At December 31, 2003, we had 30
quota-bearing sales personnel selling to public schools. In 2002 sales and marketing
expenses decreased, compared to 2001, primarily due to a decrease in personnel in the marketing
department, as well as lower spending on conferences, trade shows and marketing materials. During 2004, we expect to increase our investment in sales and marketing as we focus on increasing
sales in the K-12 market. Research and Development Expenses:Research and development expenses increased in 2003 compared to
2002, due to increased development activity to complete and release our new Gateway Edition in June
2003. 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. Research and development expenses decreased in 2002 compared to
2001, due to a reduction in research and development staff as we continued to reduce spending on
activities other than improving our core products. In 2003, no software development costs were capitalized. 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 2003, costs incurred subsequent to the establishment of technological
feasibility were not significant, and were charged to research and development expense. In 2002,
$116,000 in software development costs were capitalized compared to $1.2 million in 2001. We expect research and development expenses to increase in 2004 as we continue to invest in
improving our current product suite and introducing new products.* Two new products in our Fast
ForWord to Reading series are scheduled for launch in 2004.* General and Administrative Expenses:General and administrative expenses decreased in 2003
compared to 2002, primarily due to lower personnel and rent expenses, as well as an adjustment to
our allowance for doubtful accounts to reflect an improvement in our bad debt experience. These
were partially offset by an increase in legal expenses and consulting expenses. 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. General and administrative expenses decreased in 2002 compared
to 2001, primarily because of decreases in personnel and legal costs. Restructuring, Lease and Asset Impairment Write Downs:In October 2003 we entered into a lease
termination agreement with our landlord to terminate the lease on our Oakland headquarters and
entered into a new lease agreement for a reduced amount of space in the same building. The
reduction in space is expected to reduce future lease payments by $6.5 million (net of lease
termination fees described below) through 2008.* Under the lease termination agreement we paid an
increased security deposit of $550,000 and lease termination fees totaling $490,000 in 2003. The
balance of the lease termination fees of $1.8 million will be paid over the next 12 months. A net
credit adjustment of $7,000 was charged to restructuring expense. The adjustment represented an
addition to the restructuring reserve of $350,000 for lease and asset impairment charges, offset by
a reduction in deferred rent of $357,000 to account for the reduction in space under the new lease
agreement. In 2001 management restructured and consolidated operations to focus on the K-12 market. We
recorded a restructuring, lease and asset impairment charge of $2.6 million in operating expenses.
This charge included $1.8 million to reflect the value of excess unoccupied office space in our
current and former corporate office facilities. For our current facility, the cost included a
portion of the lease liability and brokerage fees reduced by estimated sublease income over the
remaining lease term. The estimated cost of excess lease facilities and the estimated value of the
sublease were based on market information provided by a commercial real estate brokerage firm. The
restructuring also resulted in a workforce reduction of approximately 50 employees. We also
recorded an asset impairment charge of $361,000 to write down the value of long-lived assets to net
realizable value. The write down Page 25




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##### Table of Contents



included the remaining capitalized development cost for the
ReWord software product, which targeted the aphasic adult market, which is not our focus. As
well, we reduced the value of furniture and leasehold improvements related to excess office space.
At December 31, 2001 accrued liabilities included $1.5 million relating to the excess office space
and termination benefits. During 2002, we recorded restructuring charges totaling $3.4 million, reflecting employee severance
benefits and rent for excess office space. The restructuring resulted in a workforce reduction of
approximately 30 employees and a total charge to operations for severance benefits of $1.1 million.
Most of the employees affected by the workforce reduction were located in our Oakland office in
the marketing and customer service departments. Due to continued weakness in the commercial real
estate market in 2002 we recorded an additional charge for excess office space at our Oakland
headquarters of $2.3 million. This charge reflected adjustments to the assumptions on which the
2001 write down for excess office space had been made, including our assumptions about the time
period that the excess office space would be vacant and potential sublease terms. We calculated the
estimated costs for the additional facilities restructuring charge based on current market
information provided by a commercial real estate broker. The following table sets forth the restructuring activity for the years ended December 31, 2003,
2002 and 2001. Lease
    
    
    Asset
    
    
    Severanceobligation
    
    
    write-downs
    
    
    benefits
    
    
    TotalCharged to restructuring expense in 2001
    
    $
    1,791
    
    
    $
    361
    
    
    $
    456
    
    
    $
    2,608Cash paid in 2001
    
    
    (333
    )
    
    
    
    
    
    
    (374
    )
    
    
    (707
    )Asset write-downs
    
    
    
    
    
    
    (361
    )
    
    
    
    
    
    
    (361
    )Accrued restructuring costs, December 31, 2001
    
    
    1,458
    
    
    
    
    
    
    
    82
    
    
    
    1,540Restructuring Charges in 2002
    
    
    2,306
    
    
    
    
    
    
    
    1,059
    
    
    
    3,365Cash paid in 2002
    
    
    (759
    )
    
    
    
    
    
    
    (632
    )
    
    
    (1,391
    )Accrued restructuring costs, December 31, 2002
    
    
    3,005
    
    
    
    
    
    
    
    509
    
    
    
    3,514Restructuring Charges in 2003
    
    
    154
    
    
    
    196
    
    
    
    
    
    
    
    350Cash paid in 2003
    
    
    (1,386
    )
    
    
    
    
    
    
    (509
    )
    
    
    (1,895
    )Asset write-downs
    
    
    
    
    
    
    (196
    )
    
    
    
    
    
    
    (196
    )Accrued restructuring costs, December 31, 2003
    
    $
    1,773
    
    
    $
    
    
    
    $
    
    
    
    $
    1,773
 Other Income from Related Party During 2003 we recorded $448,000 as other income from a transaction that included the sale and
licensing of certain intellectual property, patents and software to Neuroscience Solutions
Corporation (NSC). One of our co-founders, substantial shareholders, and board members is also a
co-founder, officer, director and substantial shareholder of NSC. See Transaction with
Neuroscience Solutions below. 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 recurring operations.
There was no comparable transaction for the same period of 2002 or 2001. Interest Expense, net December 31,(dollars in thousands)
    
    2003
    
    
    Change
    
    
    2002
    
    
    Change
    
    
    2001Interest expense, net
    
    
    (1,209
    )
    
    
    -9
    %
    
    
    (1,332
    )
    
    
    26
    %
    
    
    (1,053
    )
 Interest expense, net decreased in 2003, compared to 2002, and increased in 2002 compared to 2001.
The decrease in 2003 was attributable to lower borrowing in 2003 compared to 2002, and the increase
in 2002 was due to increased borrowing in 2002 compared to 2001. In 2004 we expect interest
expense, net to be significantly lower because only $232,000 of deferred financing cost remains to
be amortized to interest expense during the year.* Deferred financing cost amortized in 2003 was
$1.2 million. In 2003, interest expense, net included $159,000 in interest income primarily from
loans to current and former officers. Page 26




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Provision for Income Taxes In 2003, we recorded a $43,000 provision for income taxes, our first such provision, as we have
incurred a net loss for tax purposes since inception. At December 31, 2003, we had net operating
loss carryforwards for federal income tax purposes of approximately $72 million. Unutilized net
operating loss carryforwards will expire in years 2011 through 2023. Utilization of the net
operating losses may be subject to a substantial annual limitation due to the ownership change
limitations.* Previous or future equity transactions may result in such an ownership change.* The
annual limitation may result in the expiration of net operating losses before they become available
to reduce future tax liabilities.* At December 31, 2003, we had approximately $30.4 million of
deferred tax assets, comprised primarily of net operating loss carryforwards. Realization of
deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are
uncertain.* Accordingly, the net deferred tax assets have been fully offset by a valuation
allowance. Liquidity and Capital Resources Our cash and cash equivalents were $3.6 million at December 31, 2003, compared to $4.6 million at
December 31, 2002 and 2001. During 2002 and 2003 we generated cash flow from operations, which was
used to pay down bank borrowing from 2001. At December 31, 2001 we had $10 million outstanding on
our bank line of credit; at December 31, 2003 there were no borrowings outstanding under the line.
We expect that our cash flow from operations and our current cash balances will be the primary
source of the funds for our operations and capital expenditures during 2004. During 2004, we plan
to continue to generate positive cash flow from operations and to generate a profit.* However,
accomplishing these objectives will require us to achieve specific sales targets in the K-12
market.* We cannot assure you that we will meet our targets with respect to sales, revenues or
operating results. Net cash provided by operating activities in 2003 was $4.6 million, compared to $3.7 million in
2002. Net cash increased in both 2003 and 2002 primarily because booked sales increased at a
faster rate than spending and our collection experience was good. Accounts receivable at year end
was $5.1 million in 2003 compared to $4.7 million in 2002 and $5.8 million in 2001. The net cash
used in operating activities in 2001 was $12.5 million, primarily from our net loss of $22.6
million, partially offset by an increase in deferred revenue and an increase in the restructuring
reserve. Net cash used in investing activities in 2003 was $959,000, consisting primarily of an increase in
non-current assets for the additional deposit of $550,000 under our new lease. In 2002, net cash
of $849,000 was provided by investing activities, primarily from the sale of the $1.2 million
balance of our portfolio of government securities. In 2001, net cash was provided by the sale of
$6.5 million in government securities, partially offset by loans to officers of $3.1 million and
investments in property and equipment of $1.4 million and capitalized software development of $1.2
million. Our level of capital expenditures was quite low in both 2003 and 2002, approximately
$256,000 and $124,000, respectively. In 2004, we expect that our capital spending will be
modestly higher than in 2003 as we continue to upgrade computer equipment and purchase new software
to improve operations.* Financing activities used $4.6 million in cash in both 2003 and 2002, primarily to pay down $5
million, net, on our line of credit in both years, partially offset by cash raised from the sale of
stock upon option exercises and through our employee stock purchase plan. In 2001 financing
activities provided $15.4 million from net borrowings of $10 million and $5.4 million from the
issuance of common stock. Because our sales tend to be seasonal, we may have negative cash flow in particular quarters,
particularly the first quarter, when sales tend to be substantially lower than in other quarters.
We borrowed money for working capital purposes in the first quarter of 2004 and may borrow again
from to time.* We have a line of credit with Comerica Bank totaling $5.0 million, which expires on July 14, 2005.
The facility initially totaled $7.0 million and was partially secured by a letter of credit
provided by WPV, Inc., an affiliate of Warburg, Pincus Ventures, our largest stockholder. The
letter of credit was for $4.0 million through May 30, 2004 and $3.0 million from May 31, 2004 to
July 30, 2004. The WPV letter of credit expired on July 30, 2004. The line is subject to
limitations based on our accounts receivable balance. Borrowings under the line are subject to
various covenants, which may limit our financial and operating flexibility. The need to restate
our historical financial statements constitutes an event of default under our agreement with
Comerica. This event of default entitles Page 27




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Comerica to decline to advance additional funds under the line. There is no borrowing currently
outstanding under the line, and we do not foresee that we will need to draw down under the line
during its term.* Therefore, we do not believe that this default will have a material impact on
us.* In January 2004 we terminated the $10.0 million revolving loan agreement with Fleet National Bank,
which was also guaranteed by WPV, Inc. The guarantee was due to expire in March 2004. After 2004, 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 sales.
If the Company is unable to achieve sufficient levels of cash flow from operations, the Company
may seek other sources of debt or equity financing, or may be required to reduce expenses.
Reducing the Companys expenses could adversely affect its 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. Contractual Obligations and Commitments We have a non-cancelable lease agreement for our corporate office facilities. In 2003, we
renegotiated the lease, terminating the prior agreement and entering into a new lease agreement for
a reduced amount of space in the same location. The minimum lease payment under the new agreement
on our office facility (excluding lease termination charges) 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 terminates in December 2013. The following table summarizes our outstanding borrowings and contractual obligations at December
31, 2003 and the effects such obligations are expected to have on our liquidity and cash flow in
future periods. (dollars in thousands)
    
    Total
    
    
    Less than 1 year
    
    
    2 - 3 years
    
    
    4 - 5 years
    
    
    Thereafter 1.Lease termination agreement
    
    $
    1,760
    
    
    $
    1,760
    
    
    $
    
    
    
    $
    
    
    
    $
    Non-cancelable operating leases
    
    
    10,107
    
    
    
    940
    
    
    
    1,880
    
    
    
    1,880
    
    
    
    5,407Minimum royalty payments
    
    
    1,650
    
    
    
    150
    
    
    
    300
    
    
    
    300
    
    
    
    900Total
    
    $
    13,517
    
    
    $
    2,850
    
    
    $
    2,180
    
    
    $
    2,180
    
    
    $
    6,307
   1.
    
    Non-cancelable operating leases expires December 31, 2013. Minimum royalty payments expire in 2014. Our purchase order commitments at December 31, 2003 are not material. 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. The total receivable including accrued interest at December 31, 2003 and 2002 was $3.5
million and $3.4 million, respectively. Accrued interest of $419,000 and $265,000 for the years
ended December 31, 2003 and 2002 respectively was included in Other Assets on the Balance Sheet.
In 2002 some of these officers left our Company. The Notes are full recourse loans secured by
shares of our Common Stock owned by the current and former officers. The loans bear interest at
4.94%. Principal and interest are due December 31, 2005. Transaction with Neuroscience Solutions Corporation In September 2003, we signed an agreement with Neuroscience Solutions Corporation (NSC),
transferring technology to NSC for use in the health field. The transaction includes a license of
the patents we own, a sublicense of the patents we license from others, the license of certain
software we developed, and the transfer of assets related to certain research projects. All of the
rights licensed to NSC are limited to the health field and most are exclusive in that field. We
will continue to use the licensed patents and technology in the fields of education and speech and
language therapy, and retain all rights to our technology outside of the health field. We also agreed with NSC that we would license one another certain patents that may be issued in the
future, on which royalties would be paid, and that we would provide NSC certain technology
transfer, hosting and support services. Page 28




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NSC is a start-up company located in San Francisco that plans to develop, market, and sell a series
of software-based products for healthcare markets based on neuroplasticity research. NSCs first
products are expected to focus on addressing issues that commonly arise as a result of aging. Dr.
Michael M. Merzenich, who is a founder, director, significant stockholder and former officer of our
company, is also a founder, director, significant shareholder and officer of NSC. The terms of the transaction were determined through arms length negotiations between NSC and us,
in which Dr. Merzenich did not participate. We received an initial payment of $500,000 and will be
entitled to a 2% to 4% royalty on future products of NSC that use the licensed technology. We were
also issued 1,772,727 shares of Series A Preferred Stock in NSC. Because NSC is a start-up
venture, the shares of which are not actively traded, in our financial statements we have assigned
a value of zero to the NSC shares we received. 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. The estimates, assumptions and judgments pertaining to revenue recognition, allowance for doubtful
accounts, software development costs and long lived assets 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. 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; 2) delivery of the product; 3) a
fixed or determinable fee; and 4) the probability that the fee will be collected.
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). The Company allocates revenue to each element of a
transaction based upon its fair value as determined in reliance on vendor specific objective
evidence (VSOE). 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. The value of software licenses, services and support invoiced during a particular period is
recorded as deferred revenue until recognized. Deferred revenue is recognized as revenue as
discussed below. Revenue from the licensing of software is recognized as follows: 1) for licenses purchased with
Progress Tracker, because the Company has not established VSOE for Progress Tracker, revenue is
recognized ratably over the contractual life of the longest undelivered element, typically support
and the period of Progress Tracker access, 2) for individual participant licenses, revenue is
recognized over the average duration of the products use, typically 6 weeks; 3) for perpetual
licenses that are not purchased with Internet-based services, revenue is recognized at the later
of product shipment or the contract start date, provided that the other criteria stated above are
met, and 4) for term licenses revenue is recognized ratably over the license term. Service and support revenue is derived from a combination of on-site and remote training,
implementation, technical and professional services and customer support. Revenue from services
sold with license arrangements that include Progress Tracker is recognized ratably over the
contractual term of the longest undelivered element purchased, typically support. Revenue from
services sold with license arrangements that do not include Progress Tracker, sold alone, or sold
only with support is recognized as delivered. Revenue from support is recognized over the
contractual support period. Page 29




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Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses due to the inability of
customers to make payments. These estimates are based on historical experience. In 2001 and early
2002 our experience was that bad debt expense was about 2% of revenue. In the later half of 2002
and 2003 our bad debt experience improved significantly to less than 1% of revenue and in the
4th quarter of 2003 we adjusted our bad debt allowance to reflect the improvement in our
experience. To the extent experience requires it, we may in the future again adjust this reserve.
Cancellations and refunds are allowed in limited circumstances, and such amounts have not been
significant. Software Development Costs We capitalize software development cost in accordance with Financial Accounting Standards Board
(FASB) No. 86 Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed, under which software development costs incurred subsequent to the establishment of
technological feasibility are capitalized and amortized over the estimated life of the related
product. Prior to the establishment of technological feasibility we expense all software development cost
associated with a product. Technological feasibility is deemed established upon completion of a
working version. We estimate the useful life of our developed products to be 3 years. On an ongoing basis, we evaluate the net realizable value of the capitalized software development
cost by estimating the future revenue to be generated from the product and compare this estimate to
the unamortized cost of the product. At December 31, 2003 future revenues from sale of products
for which development costs remain on the balance sheet are anticipated to exceed the $743,000 of
unamortized development costs. Impairment of Long-Lived Assets We regularly review the carrying value of loans to current and former officers, capitalized
software development costs and property and equipment. We continually make estimates regarding
the probability of repayment, 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, the
Company may be required to record impairment charges for these assets. See the Notes to our Condensed Financial Statements, which contain additional information regarding
our accounting policies and other disclosures required by GAAP. Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 (EITF
00-21), Revenue Arrangements with Multiple Deliverables.EITF 00-21 provides guidance on how to
account for arrangements that involve the delivery or performance of multiple products, services
and/or rights to use assets. The provisions of EITF 00-21 apply to revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. We believe that our revenue recognition
policies conform to the requirements of EITF 00-21. In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulleting No. 104
Revenue Recognition (SAB 104), which updates and summarizes the Commissions views on the
application of generally accepted accounting principles to revenue recognition in financial
statements. We believe that our revenue recognition policies conform to the requirements of SAB
104. 
 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
we will pay on our new revolving credit facility with Comerica Bank. Interest rates on loans
extended under that facility are at the banks prime rate plus 0.5%. A hypothetical increase or decrease in market interest rates by 10%
from the market interest rates at December 31, 2003 would not have a material affect on our results
of operations. Page 30




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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 (the Company)
as of December 31, 2003 and 2002, and the related statements of operations, stockholders (deficit)
equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audit
also included the financial statement schedule included in Item 15. These financial statements and
financial statement schedule are the responsibility of the Companys management. Our responsibility
is to express an opinion on these financial statements and financial statement schedule based on
our audits. We conducted our audits in accordance with auditing standards generally accepted in the 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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of Scientific Learning Corporation at December 31, 2003 and 2002,
and the results of its operations and its cash flows for each of the three years in the period
ended December 31, 2003, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the selected 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 Note 2 to the
accompanying financial statements, the Company has restated its
financial statements for the three years ended December 31, 2003. /s/ERNST & YOUNG LLP Walnut Creek, California
February 6, 2004 except as to the effects of the restatement
as described in Note 2, as to which the date is
February 11, 2005 Page 31




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Scientific Learning Corporation
Balance Sheets
(In thousands, except share and per share amounts) December 31,2003
    
    
    2002Restated
    
    RestatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    3,648
    
    
    $
    4,613Accounts
receivable, net of allowance for doubtful accounts $139 and $270 at December 31, 2003 and 2002, respectively
    
    
    5,117
    
    
    
    4,867Prepaid expenses and other current assets
    
    
    1,144
    
    
    
    1,340Total current assets
    
    
    9,909
    
    
    
    10,820Property and equipment, net
    
    
    537
    
    
    
    1,198Notes receivable from current and former officers
    
    
    3,114
    
    
    
    3,114Other assets
    
    
    2,037
    
    
    
    3,399Total assets
    
    $
    15,597
    
    
    $
    18,531Liabilities and stockholders deficitCurrent liabilities:Accounts payable
    
    $
    481
    
    
    $
    287Accrued liabilities
    
    
    3,875
    
    
    
    5,411Deferred revenue
    
    
    16,884
    
    
    
    16,001Total current liabilities
    
    
    21,240
    
    
    
    21,699Borrowings under bank line of credit
    
    
    
    
    
    
    5,000Deferred revenue, long-term
    
    
    2,616
    
    
    
    2,711Other liabilities
    
    
    285
    
    
    
    484Total liabilities
    
    
    24,141
    
    
    
    29,894CommitmentsStockholders deficit:Preferred stock, $0.001 par value; 1,000,000 shares authorized,
no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value; 40,000,000 shares authorized,
16,150,551 and 15,879,083 shares issued and outstanding
at December 31, 2003 and 2002, respectively
    
    
    74,460
    
    
    
    73,771Accumulated deficit
    
    
    (83,004
    )
    
    
    (85,134
    )Stockholders deficit:
    
    
    (8,544
    )
    
    
    (11,363
    )Total liabilities and stockholders deficit
    
    $
    15,597
    
    
    $
    18,531See accompanying notes.
 Page 32




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Scientific Learning Corporation
Statement of Operations
(In thousands, except share and per share amounts) Year ended December 31,2003
    
    
    2002
    
    
    2001Restated
    
    
    Restated
    
    
    RestatedRevenues:Products
    
    $
    24,491
    
    
    $
    17,879
    
    
    $
    11,702Service and support
    
    
    5,425
    
    
    
    3,958
    
    
    
    3,023Total revenues
    
    
    29,916
    
    
    
    21,837
    
    
    
    14,725Cost of revenues:Cost of products
    
    
    2,127
    
    
    
    2,109
    
    
    
    1,857Cost of service and support
    
    
    3,872
    
    
    
    1,502
    
    
    
    2,402Total cost of revenues
    
    
    5,999
    
    
    
    3,611
    
    
    
    4,259Gross profit
    
    
    23,917
    
    
    
    18,226
    
    
    
    10,466Operating expenses:Sales and marketing
    
    
    12,961
    
    
    
    14,554
    
    
    
    19,701Research and development
    
    
    3,500
    
    
    
    2,985
    
    
    
    3,390General and administrative
    
    
    4,529
    
    
    
    4,776
    
    
    
    6,348Restructuring charges
    
    
    (7
    )
    
    
    3,365
    
    
    
    2,608Total operating expenses
    
    
    20,983
    
    
    
    25,680
    
    
    
    32,047Operating income (loss)
    
    
    2,934
    
    
    
    (7,454
    )
    
    
    (21,581
    )Other income from related party
    
    
    448
    
    
    
    
    
    
    
    Interest expense, net
    
    
    (1,209
    )
    
    
    (1,332
    )
    
    
    (1,053
    )Other income (expense), net
    
    
    
    
    
    
    91
    
    
    
    21Net income (loss) before income tax provision
    
    
    2,173
    
    
    
    (8,695
    )
    
    
    (22,613
    )Income tax provision
    
    
    43
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    2,130
    
    
    $
    (8,695
    )
    
    $
    (22,613
    )Basic net income (loss) per share:
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )Shares used in computing basic net income (loss)
    
    
    16,006,565
    
    
    
    15,641,849
    
    
    
    11,777,415Diluted net income (loss) per share:
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )Shares used in computing diluted net income (loss)
    
    
    16,908,361
    
    
    
    15,641,849
    
    
    
    11,777,415
 Certain 2001 and 2002 items have been reclassified to conform to the presentation adopted in 2003.
See accompanying notes. Page 33




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Scientific Learning Corporation Statements of Stockholders(Deficit) Equity
(In thousands, except share amounts)
Restated Common Stock
    
    
    Deferred
    
    
    Accumulated
    
    
    TotalStockholdersShares
    
    
    Amount
    
    
    Compensation
    
    
    Deficit
    
    
    (Deficit) EquityBalances at December 31, 2000
    
    
    11,336,380
    
    
    $
    64,179
    
    
    $
    (72
    )
    
    $
    (53,826
    )
    
    $
    10,281Issuance of common stock under stock option plan
    
    
    7,395
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    29Issuance of common stock under employee stock purchase plan
    
    
    131,844
    
    
    
    373
    
    
    
    
    
    
    
    
    
    
    
    373Issuance of common stock in a private placement, net of offering costs
    
    
    4,000,000
    
    
    
    4,964
    
    
    
    
    
    
    
    
    
    
    
    4,964Issuance of common stock warrants in connection with guarantee of
line of credit
    
    
    
    
    
    
    3,647
    
    
    
    
    
    
    
    
    
    
    
    3,647Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    72
    
    
    
    
    
    
    
    72Net loss and comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22,613
    )
    
    
    (22,613
    )Balance December 31, 2001
    
    
    15,475,619
    
    
    
    73,192
    
    
    
    
    
    
    
    (76,439
    )
    
    
    (3,247
    )Issuance of common stock under stock option plan
    
    
    274,471
    
    
    
    318
    
    
    
    
    
    
    
    
    
    
    
    318Issuance of common stock under employee stock purchase plan
    
    
    116,861
    
    
    
    119
    
    
    
    
    
    
    
    
    
    
    
    119Compensation charge relating to granting of common stock options
    
    
    
    
    
    
    122
    
    
    
    
    
    
    
    
    
    
    
    122Stock issue in exchange for services
    
    
    12,132
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    20Net loss and comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,695
    )
    
    
    (8,695
    )Balance December 31, 2002
    
    
    15,879,083
    
    
    
    73,771
    
    
    
    
    
    
    
    (85,134
    )
    
    
    (11,363
    )Issuance of common stock under stock option plan
    
    
    207,438
    
    
    
    264
    
    
    
    
    
    
    
    
    
    
    
    264Issuance of common stock under employee stock purchase plan
    
    
    52,912
    
    
    
    180
    
    
    
    
    
    
    
    
    
    
    
    180Compensation charge relating to granting of common stock options
    
    
    
    
    
    
    198
    
    
    
    
    
    
    
    
    
    
    
    198Stock issue in exchange for services
    
    
    11,118
    
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    47Net income and comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,130
    
    
    
    2,130Balance December 31, 2003
    
    
    16,150,551
    
    
    $
    74,460
    
    
    $
    
    
    
    $
    (83,004
    )
    
    $
    (8,544
    )
 See accompanying notes Page 34




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##### Table of Contents



Scientific Learning Corporation
Statement of Cash Flows
(In thousands) Year ended December 31,2003
    
    
    2002
    
    
    2001Restated
    
    
    Restated
    
    
    RestatedOperating Activities:Net income (loss)
    
    $
    2,130
    
    
    $
    (8,695
    )
    
    $
    (22,613
    )Adjustments to reconcile net income (loss) to cash provided by operating activities:Depreciation
    
    
    721
    
    
    
    1,082
    
    
    
    1,262Amortization of software development costs
    
    
    617
    
    
    
    718
    
    
    
    553Amortization of deferred financing costs
    
    
    1,215
    
    
    
    1,216
    
    
    
    984Stock based compensation
    
    
    245
    
    
    
    142
    
    
    
    72Asset impairment write downs
    
    
    
    
    
    
    50
    
    
    
    360Changes in operating assets and liabilities:Accounts receivable
    
    
    (250
    )
    
    
    887
    
    
    
    (1,029
    )Prepaid expenses and other current assets
    
    
    428
    
    
    
    (52
    )
    
    
    121Accounts payable
    
    
    194
    
    
    
    (157
    )
    
    
    (704
    )Accrued liabilities
    
    
    (1,339
    )
    
    
    1,814
    
    
    
    2,071Deferred revenues
    
    
    788
    
    
    
    6,515
    
    
    
    6,313Other liabilities
    
    
    (199
    )
    
    
    197
    
    
    
    123Net cash provided by (used in) operating activities
    
    
    4,550
    
    
    
    3,717
    
    
    
    (12,487
    )Investing Activities:Sale of government securities
    
    
    
    
    
    
    1,169
    
    
    
    6,498Purchases of property and equipment, net
    
    
    (256
    )
    
    
    (124
    )
    
    
    (1,445
    )Notes receivable from current and former officers
    
    
    
    
    
    
    
    
    
    
    (3,114
    )Increase in capitalized software development costs
    
    
    
    
    
    
    (116
    )
    
    
    (1,153
    )(Increase) decrease in other non-current assets
    
    
    (703
    )
    
    
    (80
    )
    
    
    126Net cash (used in) provided by investing activities
    
    
    (959
    )
    
    
    849
    
    
    
    912Financing Activities:Proceeds from issuance of common stock, net
    
    
    444
    
    
    
    437
    
    
    
    5,367Borrowings under bank line of credit
    
    
    2,000
    
    
    
    4,000
    
    
    
    14,000Repayments of borrowings under bank line of credit
    
    
    (7,000
    )
    
    
    (9,000
    )
    
    
    (4,000
    )Net cash (used in) provided by financing activities
    
    
    (4,556
    )
    
    
    (4,563
    )
    
    
    15,367(Decrease) increase in cash and cash equivalents
    
    
    (965
    )
    
    
    3
    
    
    
    3,792Cash and cash equivalents at beginning of year
    
    
    4,613
    
    
    
    4,610
    
    
    
    818Cash and cash equivalents at end of year
    
    $
    3,648
    
    
    $
    4,613
    
    
    $
    4,610Supplemental disclosureInterest paid
    
    $
    134
    
    
    $
    294
    
    
    $
    432Supplemental disclosure of noncash investing and financing activities:Issuance of common stock warrants in connection with guarantee
of line of credit
    
    $
    
    
    
    $
    
    
    
    $
    3,647
 Page 35




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##### Table of Contents



Notes to Financial Statements 1. Summary of Significant Accounting Policies Description of Business Scientific Learning Corporation (the Company) is the leading provider of neuroscience-based
software products that develop underlying cognitive skills required for reading and learning. The
Companys Fast ForWord® products are a series of reading intervention products for
children, adolescents and adults. We sell primarily to K-12 schools through a direct sales force.
The Company also sells to speech and language professionals. To support our products, we provide
on-site and remote training and implementation services, as well as technical, professional and
customer support and a wide variety of Web-based resources. The Company was incorporated in 1995 in the State of California and was 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; 2) delivery of the product; 3) a
fixed or determinable fee; and 4) the probability that the fee will be collected.
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). The Company allocates revenue to each element of a
transaction based upon its fair value as determined in reliance on vendor specific objective
evidence (VSOE). 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. The value of software licenses, services and support invoiced during a particular period is
recorded as deferred revenue until recognized. Deferred revenue is recognized as revenue as
discussed below. Revenue from the licensing of software is recognized as follows: 1) for licenses purchased with
Progress Tracker, because the Company has not established VSOE for Progress Tracker, revenue is
recognized ratably over the contractual life of the longest undelivered element, typically support
and the period of Progress Tracker access, 2) for individual participant licenses, revenue is
recognized over the average duration of the products use, typically 6 weeks; 3) for perpetual
licenses that are not purchased with Internet-based services, revenue is recognized at the later
of product shipment or the contract start date, provided that the other criteria stated above are
met, and 4) for term licenses revenue is recognized ratably over the license term. Service and support revenue is derived from a combination of on-site and remote training,
implementation, technical and professional services and customer support. Revenue from services
sold with license arrangements that include Progress Tracker is recognized ratably over the term of
the longest undelivered element purchased, typically support. Revenue from services sold with
license arrangements that do not include Progress Tracker, sold alone, or sold only with support is
recognized as delivered. Revenue from support is recognized over the contractual support period. Page 36




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##### Table of Contents



Notes to Financial Statements  (continued) Cash and Cash Equivalents Cash and cash equivalents consist of cash and highly liquid short-term investments with original
maturities of three months or less. Accounts Receivable The Company conducts business primarily with public school districts and speech and language
professionals in the United States. Ongoing credit evaluations are performed on customers and
collateral is generally not required. Allowances for uncollectible accounts are made for
potential credit issues based on past experience and management assessment of current risks. Fair Value of Financial Instruments The carrying amounts of the Companys cash and cash equivalents, accounts receivable, notes
receivable from current and former officers, and accounts payable approximate fair value. 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 The Company accounts for software development costs in accordance with Statement of Financial
Accounting Standards (FAS) 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 2003, costs incurred subsequent to the establishment
of technological feasibility were not significant, and were charged to research and
development expense. The Company capitalized $116,000 of software development costs for the
year ended December 31, 2002. Software costs are amortized to cost of revenues over the
estimated useful life of the software, which is three years: amortization was $617,000,
$718,000 and $553,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Long-Lived Assets The Company regularly reviews the carrying value of long-lived assets. We continually make
estimates regarding the probability of repayment, 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, the Company may be required to record impairment charges for these assets. Accounting for Stock-Based Compensation The Company accounts for stock issued to employees in accordance with Accounting Principles Board
Opinion No. 25 (APB 25), Accounting for Stock Issued to Employeesand complies with the
disclosure provisions of SFAS No. 123 (SFAS 123), Accounting for Stock-Based Compensationand
SFAS No. 148 (SFAS 148), Accounting for Stock-Based Compensation  Transition and Disclosure.
Under APB 25, compensation expense of fixed stock options is based on the difference, if any, on
the date of the grant between the fair value of the Companys stock and the exercise price of the
option. The Company accounts for stock issued to non-employees in accordance with the provisions of
SFAS 123 and EITF No. 96-18, Accounting for Equity Instruments That are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Page 37




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Notes to Financial Statements  (continued) Pro Forma Disclosures of the Effect of Stock-Based Compensation Pro forma information regarding the results of operations and net income (loss) per share is
determined as if the Company had accounted for its employee stock options using the fair value
method. The fair value of each option granted is estimated on the date of grant using the Black
Scholes valuation model with the following assumptions: Year ended December 31,2003
    
    
    2002
    
    
    2001Weighted average expected life of option
    
    5 years
    
    5 years
    
    5 yearsRisk-free interest rate
    
    
    3.0
    %
    
    
    3.0
    %
    
    
    4.5
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Volatility
    
    
    85
    %
    
    
    85
    %
    
    
    85
    %Weighted average fair value
    
    $
    2.05
    
    
    $
    0.90
    
    
    $
    2.51
 The Company has elected to use the intrinsic value method in accounting for its employee stock
options because, as discussed below, the alternative fair value accounting requires the use of
option valuation models that were not developed for use in valuing employee stock options. Under
the intrinsic value method, when the exercise price of the Companys employee stock options equals
the market price of the underlying stock on the date of grant, no compensation expense is
recognized. The option valuation models were developed for use in estimating the fair value of traded options
that have no vesting restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected life of the option. Had compensation cost for the Companys stock-based compensation plans been determined using the
fair value at the grant dates for awards under those plans calculated using the Black Scholes
valuation model, the Companys pro forma net income (loss) and basic and diluted net income (loss)
per share would have been as follows (in thousands, except per share amounts): Year Ended December 31,2003
    
    
    2002
    
    
    2001Restated
    
    
    Restated
    
    
    RestatedNet income (loss), as reported
    
    $
    2,130
    
    
    $
    (8,695
    )
    
    $
    (22,613
    )Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards
    
    
    (1,465
    )
    
    
    (2,472
    )
    
    
    (3,066
    )Net income
(loss) per share
    
    $
    665
    
    
    $
    (11,167
    )
    
    $
    (25,679
    )Basic, as reported
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )Diluted, as reported
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )Basic, pro forma
    
    $
    0.04
    
    
    $
    (0.71
    )
    
    $
    (2.18
    )Diluted, pro forma
    
    $
    0.04
    
    
    $
    (0.71
    )
    
    $
    (2.18
    )
 The pro forma impact of options on the net income (loss) for the years ended December 31, 2003,
2002 and 2001, is not representative of the effects on net income
 (loss) for future years, as
future years will include the effects of additional years of stock option grants. Page 38




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##### Table of Contents



Notes to Financial Statements  (continued) Advertising Advertising costs are expensed as incurred. Advertising expense was $1,000, $4,000 and $61,000 for
the years ended December 31, 2003, 2002 and 2001, respectively. Income Taxes The Company accounts 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 (Loss) per Share Under the provisions of SFAS No. 128, Earnings per Share,basic net income (loss) per share is
computed using the weighted-average number of common shares outstanding during the period. Diluted
net income (loss) per share reflects the potential dilution of securities by adding common stock
equivalents to the weighted-average number of common shares outstanding during the period, if
dilutive. Potentially dilutive securities have been excluded from the computation of diluted net
income (loss) per share if their inclusion is antidilutive. The following table sets forth the computation of net income (loss) per share (in thousands, except
share and per share data): Year Ended December 31,2003
    
    
    2002
    
    
    2001Restated
    
    
    Restated
    
    
    RestatedNet income (loss)
    
    $
    2,130
    
    
    $
    (8,695
    )
    
    $
    (22,613
    )Weighted average shares used in calculation of
basic net income (loss) per share
    
    
    16,006,565
    
    
    
    15,641,849
    
    
    
    11,777,415Effect of dilutive securities:Employee stock options
    
    
    901,796
    
    
    
    
    
    
    
    Weighted-average diluted common share
    
    
    16,908,361
    
    
    
    15,641,849
    
    
    
    11,777,415Net income (loss) per common share- basic :
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )Net income (loss) per common share- diluted:
    
    $
    0.13
    
    
    $
    (0.56
    )
    
    $
    (1.92
    )
 If the Company had reported net income in 2002 and 2001, the calculation of diluted earnings per
share would have included the shares used in the computation of basic net loss per share as well as
an additional 64,000 and 36,000 common equivalent shares (computed using the treasury stock method)
related to outstanding stock options not included in the calculations above for the years ended
December 31, 2002 and 2001, respectively. Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 (EITF
00-21), Revenue Arrangements with Multiple Deliverables.EITF 00-21 provides guidance on how to
account for arrangements that involve the delivery or performance of multiple products, services
and/or rights to use assets. The provisions of EITF 00-21 apply to revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. The Company believes that its revenue
recognition policies conform to the requirements of EITF 00-21. In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104
Revenue Recognition (SAB 104), which updates and summarizes the Commissions views on the
application of generally accepted accounting principles to revenue recognition in financial
statements. The Company believes that its revenue recognition policies conform to the requirements
of SAB 104. Page 39




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##### Table of Contents



Notes to Financial Statements  (continued) Reclassifications Certain revenue and cost of revenue items from prior years have been reclassified to conform to the
current presentation. 2. Restatement The Company has restated its previously reported balance sheets as of December 31, 2003 and 2002
and its statements of operations, stockholders (deficit) equity and cash flows for the years ended
December 31, 2003, 2002 and 2001. This restatement reflects a correction in the Companys method
of accounting for the recognition of revenue from most of its K-12 school contracts. The restatement of revenue resulted from a re-evaluation of our treatment of multiple-element sales
from fiscal 2000 onwards. Perpetual licenses sold requiring Internet access to function: The Company had historically recognized revenues from services and shrink wrapped product as
delivered. Upon review, as the perpetual licenses required Internet access and since VSOE did not
exist for the Internet access service, all of the revenue under these
arrangements should have been
recognized ratably over the longest contractual term stated in the
arrangements, in accordance with
paragraphs 12 and 58(a) of SOP 97-2. Perpetual licenses sold after July 2003 bundled with services and the Companys Internet reporting
application (Progress Tracker): The Company had historically recognized revenue associated with the perpetual software license
ratably over a one year period irrespective of whether or not the Progress Tracker arrangement was
for a one year period or longer. Services and shrink wrapped product revenues were recorded as
delivered. As there was no VSOE for Progress Tracker, all revenue, including services and shrink
wrapped product should have been recognized ratably over the longest contractual period stated in the
arrangement (generally the Progress Tracker period that ranges between 1 and 5 years). Term-based licenses sold with other elements: Term-based licenses and associated maintenance had been appropriately recorded over the contractual
terms. However, the Company had historically recognized the revenue associated with the services
and shrink-wrapped product included in these arrangements as these services and products were
delivered. Since the Company did not have VSOE for the PCS element in these term arrangements (as
it is never sold separately), the revenue for the services and shrink wrapped product should have
also been recognized ratably over the contractual license terms in accordance with paragraph 12 of
SOP 97-2 because VSOE did not exist to allow the allocation of revenue to the various elements
included in the arrangement. As a result of the restatement of the timing of revenue recognition for these matters the Company
has also restated the timing of certain direct costs of products including royalties and the timing
of capitalized software amortization commission expense and income tax provisions. The following tables summarize the changes to the balance sheets at December 31, 2003 and 2002 and
the statements of operations for the years ended December 31, 2003, 2002 and 2001. Page 40




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Scientific Learning Corporation
Balance Sheet
(In thousands, except share and per share amounts) December 31,
    
    
    
    
    
    
    December 31,2003
    
    
    
    
    
    
    2003As reported
    
    
    Adjustments
    
    
    RestatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    3,648
    
    
    
    
    
    
    $
    3,648Accounts
receivable, net of allowance for doubtful accounts of $139 at December 31, 2003
    
    
    5,117
    
    
    
    
    
    
    
    5,117Prepaid expenses and other current assets
    
    
    1,134
    
    
    
    10
    
    
    
    1,144Total current assets
    
    
    9,899
    
    
    
    
    
    
    
    9,909Property and equipment, net
    
    
    537
    
    
    
    
    
    
    
    537Notes receivable from current and former officers
    
    
    3,114
    
    
    
    
    
    
    
    3,114Other assets
    
    
    2,004
    
    
    
    33
    
    
    
    2,037Total assets
    
    $
    15,554
    
    
    
    
    
    
    $
    15,597Liabilities and stockholders deficitCurrent liabilities:Accounts
payable
    
    $
    481
    
    
    
    
    
    
    $
    481Accrued
liabilities
    
    
    3,832
    
    
    
    43
    
    
    
    3,875Deferred revenue
    
    
    16,233
    
    
    
    651
    
    
    
    16,884Total current liabilities
    
    
    20,546
    
    
    
    
    
    
    
    21,240Borrowings under bank line of credit
    
    
    Deferred revenue, long-term
    
    
    1,289
    
    
    
    1,327
    
    
    
    2,616Other liabilities
    
    
    285
    
    
    
    
    
    
    
    285Total liabilities
    
    
    22,120
    
    
    
    
    
    
    
    24,141CommitmentsStockholders deficit:Preferred stock, $0.001 par value; 1,000,000 shares authorized,
no shares issued or outstanding
    
    
    
    
    
    
    
    
    
    
    Common stock, $0.001 par value; 40,000,000 shares authorized,
16,150,551 shares issued and outstanding at December 31, 2003
    
    
    74,460
    
    
    
    
    
    
    
    74,460Accumulated deficit
    
    
    (81,026
    )
    
    
    (1,978
    )
    
    
    (83,004
    )Stockholders deficit:
    
    
    (6,566
    )
    
    
    
    
    
    
    (8,544
    )Total liabilities and stockholders deficit
    
    $
    15,554
    
    
    
    
    
    
    $
    15,597
 Page 41




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Scientific Learning Corporation
Balance Sheet
(In thousands, except share and per share amounts) December 31,
    
    
    
    
    
    
    December 31,2002
    
    
    
    
    
    
    2002As reported
    
    
    Adjustments
    
    
    RestatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    4,613
    
    
    
    
    
    
    $
    4,613Accounts
receivable, net of allowance for doubtful accounts of $270 at December 31, 2002
    
    
    4,867
    
    
    
    
    
    
    
    4,867Prepaid expenses and other current assets
    
    
    1,340
    
    
    
    
    
    
    
    1,340Total current assets
    
    
    10,820
    
    
    
    
    
    
    
    10,820Property and equipment, net
    
    
    1,198
    
    
    
    
    
    
    
    1,198Notes receivable from officers
    
    
    3,114
    
    
    
    
    
    
    
    3,114Other assets
    
    
    3,511
    
    
    
    (112
    )
    
    
    3,399Total assets
    
    $
    18,643
    
    
    
    
    
    
    $
    18,531Liabilities and stockholders deficitCurrent liabilities:Accounts
payable
    
    $
    287
    
    
    
    
    
    
    $
    287Accrued
liabilities
    
    
    5,411
    
    
    
    
    
    
    
    5,411Deferred
revenue
    
    
    13,433
    
    
    
    2,568
    
    
    
    16,001Total current liabilities
    
    
    19,131
    
    
    
    
    
    
    
    21,699Borrowings under line of credit
    
    
    5,000
    
    
    
    
    
    
    
    5,000Deferred revenue, long-term
    
    
    2,151
    
    
    
    560
    
    
    
    2,711Other liabilities
    
    
    484
    
    
    
    
    
    
    
    484Total liabilities
    
    
    26,766
    
    
    
    
    
    
    
    29,894CommitmentsStockholders deficit:Preferred stock, $0.001 par value; 1,000,000 shares authorized,
no shares issued or outstanding
    
    
    
    
    
    
    
    
    
    
    Common stock, $0.001 par value; 40,000,000 shares authorized,
15,879,083 shares issued and outstanding at December 31, 2002
    
    
    73,771
    
    
    
    
    
    
    
    73,771Accumulated deficit
    
    
    (81,894
    )
    
    
    (3,240
    )
    
    
    (85,134
    )Stockholders deficit:
    
    
    (8,123
    )
    
    
    
    
    
    
    (11,363
    )Total liabilities and stockholders deficit
    
    $
    18,643
    
    
    
    
    
    
    $
    18,531
 Page 42




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\

SCIENTIFIC LEARNING CORPORATION
STATEMENT OF OPERATIONS
(In thousands, except share and per share amounts) Year ended
    
    
    
    
    
    
    Year endedDecember 31, 2003
    
    
    
    
    
    

December 31, 2003As reported
    
    
    Adjustments
    
    
    RestatedRevenues:Products
    
    $
    23,225
    
    
    $
    1,266
    
    
    $
    24,491Service and support
    
    
    5,471
    
    
    
    (46
    )
    
    
    5,425Total revenues
    
    
    28,696
    
    
    
    
    
    
    
    29,916Cost of revenues:Cost of products
    
    
    2,217
    
    
    
    (90
    )
    
    
    2,127Cost of service and support
    
    
    3,867
    
    
    
    5
    
    
    
    3,872Total cost of revenues
    
    
    6,084
    
    
    
    
    
    
    
    5,999Gross profit
    
    
    22,612
    
    
    
    
    
    
    
    23,917Operating expenses:Sales and marketing
    
    
    12,961
    
    
    
    
    
    
    
    12,961Research and development
    
    
    3,500
    
    
    
    
    
    
    
    3,500General and administrative
    
    
    4,529
    
    
    
    
    
    
    
    4,529Restructuring
    
    
    (7
    )
    
    
    
    
    
    
    (7
    )Total operating expenses
    
    
    20,983
    
    
    
    
    
    
    
    20,983Operating income
    
    
    1,629
    
    
    
    
    
    
    
    2,934Other income from related party
    
    
    448
    
    
    
    
    
    
    
    448Interest expense, net
    
    
    (1,209
    )
    
    
    
    
    
    
    (1,209
    )Net income before income tax provision
    
    
    868
    
    
    
    
    
    
    
    2,173Income tax provision
    
    
    
    
    
    
    43
    
    
    
    43Net income
    
    $
    868
    
    
    
    
    
    
    $
    2,130Basic net income per share:
    
    $
    0.05
    
    
    
    
    
    
    $
    0.13Shares used in computing basic net income
    
    
    16,006,565
    
    
    
    
    
    
    
    16,006,565Diluted net income per share:
    
    $
    0.05
    
    
    
    
    
    
    $
    0.13Shares used in computing diluted net income
    
    
    16,908,361
    
    
    
    
    
    
    
    16,908,361
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SCIENTIFIC LEARNING CORPORATION
STATEMENT OF OPERATIONS
(In thousands, except share and per share amounts) Year ended
    
    
    
    
    
    
    Year endedDecember 31, 2002
    
    
    
    
    
    

December 31, 2002As reported
    
    
    Adjustments
    
    
    RestatedRevenues:Products
    
    $
    16,917
    
    
    $
    962
    
    
    $
    17,879Service and support
    
    
    3,369
    
    
    
    589
    
    
    
    3,958Total revenues
    
    
    20,286
    
    
    
    
    
    
    
    21,837Cost of revenues:Cost of products
    
    
    1,979
    
    
    
    130
    
    
    
    2,109Cost of service and support
    
    
    1,499
    
    
    
    3
    
    
    
    1,502Total cost of revenues
    
    
    3,478
    
    
    
    
    
    
    
    3,611Gross profit
    
    
    16,808
    
    
    
    
    
    
    
    18,226Operating expenses:Sales and marketing
    
    
    14,554
    
    
    
    
    
    
    
    14,554Research and development
    
    
    2,985
    
    
    
    
    
    
    
    2,985General and administrative
    
    
    4,776
    
    
    
    
    
    
    
    4,776Restructuring
    
    
    3,365
    
    
    
    
    
    
    
    3,365Total operating expenses
    
    
    25,680
    
    
    
    
    
    
    
    25,680Operating loss
    
    
    (8,872
    )
    
    
    
    
    
    
    (7,454
    )Interest expense, net
    
    
    (1,332
    )
    
    
    
    
    
    
    (1,332
    )Other income, net
    
    
    91
    
    
    
    
    
    
    
    91Net loss
    
    $
    (10,113
    )
    
    
    
    
    
    $
    (8,695
    )Basic and diluted net loss per share:
    
    $
    (0.65
    )
    
    
    
    
    
    $
    (0.56
    )Shares used in computing basic and diluted net loss per share
    
    
    15,641,849
    
    
    
    
    
    
    
    15,641,849
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SCIENTIFIC LEARNING CORPORATION
STATEMENT OF OPERATIONS
(In thousands, except share and per share amounts) Year ended
    
    
    
    
    
    
    Year endedDecember 31, 2001
    
    
    
    
    
    
    December 31, 2001As reported
    
    
    Adjustments
    
    
    RestatedRevenues:Products
    
    $
    14,109
    
    
    $
    (2,407
    )
    
    $
    11,702Service and support
    
    
    3,780
    
    
    
    (757
    )
    
    
    3,023Total revenues
    
    
    17,889
    
    
    
    
    
    
    
    14,725Cost of revenues:Cost of products
    
    
    1,690
    
    
    
    167
    
    
    
    1,857Cost of service and support
    
    
    2,395
    
    
    
    7
    
    
    
    2,402Total cost of revenues
    
    
    4,085
    
    
    
    
    
    
    
    4,259Gross profit
    
    
    13,804
    
    
    
    
    
    
    
    10,466Operating expenses:Sales and marketing
    
    
    19,701
    
    
    
    
    
    
    
    19,701Research and development
    
    
    3,390
    
    
    
    
    
    
    
    3,390General and administrative
    
    
    6,348
    
    
    
    
    
    
    
    6,348Restructuring
    
    
    2,608
    
    
    
    
    
    
    
    2,608Total operating expenses
    
    
    32,047
    
    
    
    
    
    
    
    32,047Operating income
    
    
    (18,243
    )
    
    
    
    
    
    
    (21,581
    )Interest expense, net
    
    
    (1,053
    )
    
    
    
    
    
    
    (1,053
    )Other income, net
    
    
    21
    
    
    
    
    
    
    
    21Net loss
    
    $
    (19,275
    )
    
    
    
    
    
    $
    (22,613
    )Basic and diluted net loss per share:
    
    $
    (1.64
    )
    
    
    
    
    
    $
    (1.92
    )Shares used in computing basic and diluted net loss per share
    
    
    11,777,415
    
    
    
    
    
    
    
    11,777,415
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Notes to Financial Statements -  (continued) 3. Restructuring, Lease and Asset Impairment Write Downs In October 2003 the Company entered into a lease termination agreement with its landlord to terminate the lease on its Oakland headquarters and
entered into a new lease agreement for a reduced amount of space in the same building. The reduction in space is expected to reduce future lease
payments by $6.5 million (net of lease termination fees described below) through 2008. Under the lease termination agreement the Company paid an
increased security deposit of $550,000 and lease termination fees totaling $490,000 in 2003. The balance of the lease termination fees of $1.8
million will be paid over the next 12 months. A net credit adjustment of $7,000 was charged to operations. The adjustment represented an addition to
the restructuring reserve of $350,000 for lease and asset impairment charges, offset by a reduction in deferred rent of $357,000 to account for the
reduction in space under the new lease agreement. The following table sets forth the restructuring activity during the year ended December 31, 2003 (dollar in thousands). Accrued restructuring
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accrued restructuringcosts, December 31,
    
    
    Restructuring
    
    
    Asset
    
    
    
    
    
    
    costs, December 31,2002
    
    
    charges
    
    
    write-down
    
    
    Cash paid
    
    
    2003Lease obligation
    
    $
    3,005
    
    
    $
    154
    
    
    $
    
    
    
    $
    (1,386
    )
    
    $
    1,773Asset write-down
    
    
    
    
    
    
    196
    
    
    
    (196
    )
    
    
    
    
    
    
    Severance benefits
    
    
    509
    
    
    
    
    
    
    
    
    
    
    
    (509
    )
    
    
    Total
    
    $
    3,514
    
    
    $
    350
    
    
    $
    (196
    )
    
    $
    (1,895
    )
    
    $
    1,773
 In 2002 the Company recorded restructuring, lease and asset impairment charges of $3.4 million in operating expenses. The restructuring resulted in a
workforce reduction of approximately 30 employees and a total charge to operations for severance benefits of $1.1 million. All affected employees had
been terminated or notified of their severance benefits by December 31, 2002. Most of the employees affected by the workforce reduction were located
in the Companys Oakland office in the marketing and customer service departments. Due to continued weakness in the commercial real estate market in 2002 the Company recorded an additional charge for excess office space at the
Companys Oakland headquarters of $2.3 million. This charge reflected adjustments to the assumptions on which the 2001 write down for excess office
space had been made, including assumptions about the time period that the excess office space would be vacant and potential sublease terms. The
Company calculated the estimated costs for the additional facilities restructuring charge based on current market information provided by a
commercial real estate broker. We estimated the $3.0 million accrued at December 31, 2002 would be paid over the next two years. The following table sets forth the restructuring activity during the year ended December 31, 2002 (in thousands). Accrued restructuring costs,
    
    
    
    
    
    
    
    
    
    
    Accrued restructuring costs,December 31, 2001
    
    
    Restructuring Charges
    
    
    Cash paid
    
    
    December 31, 2002Lease obligation
    
    $
    1,458
    
    
    $
    2,306
    
    
    $
    (759
    )
    
    $
    3,005Severance benefits
    
    
    82
    
    
    
    1,059
    
    
    
    (632
    )
    
    
    509Total
    
    $
    1,540
    
    
    $
    3,365
    
    
    $
    (1,391
    )
    
    $
    3,514
 Page 46




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Notes to Financial Statements   (continued) 4. Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consist of the following (in thousands): December 31,2003
    
    
    2002RestatedPrepaid expenses
    
    $
    791
    
    
    $
    1,070Deferred financing
    
    
    232
    
    
    
    Product inventory
    
    
    109
    
    
    
    223Other receivables
    
    
    12
    
    
    
    47$
    1,144
    
    
    $
    1,340
 5. Property and Equipment Property and equipment consists of the following (in thousands): December 31,2003
    
    
    2002Computer equipment
    
    $
    3,978
    
    
    $
    4,233Office furniture and equipment
    
    
    1,403
    
    
    
    1,439Leasehold improvements
    
    
    432
    
    
    
    5775,813
    
    
    
    6,249Less accumulated depreciation
    
    
    (5,276
    )
    
    
    (5,051
    )$
    537
    
    
    $
    1,198
 6. Notes Receivable from Current and Former Officers Notes receivable from current and former officers was $3.1 million for each of the years ended December 31, 2003 and 2002. The Notes are full
recourse loans secured by shares of the Companys Common Stock owned by the current and former officers and bear interest at 4.94%. Principal and
interest are due December 31, 2005. Accrued interest of $419,000 and $265,000 at December 31, 2003 and 2002 respectively is recorded in Other Assets. Page 47




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##### Table of Contents



Notes to Financial Statements  (continued) 7. Other Assets Other Assets consist of the following (in thousands): December 31,2003
    
    
    2002Restated
    
    
    RestatedSoftware development cost
    
    $
    3,089
    
    
    $
    3,089Less accumulated amortization
    
    
    (2,346
    )
    
    
    (1,728
    )Software development costs, net
    
    
    743
    
    
    
    1,361Deferred financing cost, net
    
    
    
    
    
    
    1,447Other non current assets
    
    
    1,294
    
    
    
    591$
    2,037
    
    
    $
    3,399
 8. Accrued Liabilities Accrued liabilities consist of the following (in thousands): December 31,2003
    
    
    2002RestatedAccrued restructuring costs
    
    $
    1,773
    
    
    $
    3,514Accrued vacation
    
    
    831
    
    
    
    684Accrued commissions and bonus
    
    
    930
    
    
    
    911Other accrued liabilities
    
    
    341
    
    
    
    302$
    3,875
    
    
    $
    5,411
 9. Bank Line of Credit In 2001, the Company entered into a revolving loan agreement with a bank for an unsecured revolving credit facility in the amount of $15 million
expiring June 30, 2004. In October 2003, the credit facility was reduced to $10 million, because the Company did not believe that it needed the full
amount of the facility during its remaining term. Borrowings under the loan agreement bear interest at the election of the Company at the rate of
LIBOR plus one percent or the banks Base Rate. WPV, Inc., an affiliate of Warburg, Pincus Ventures, a significant stockholder of the Company, has
provided an unlimited guarantee for the facility. The guarantee would have expired in March 2004. As of December 31, 2003, no borrowings were
outstanding under the line of credit. In January 2004 the line was terminated and a new bank line of credit was obtained. See Note 15. In consideration of the original guarantee the Company granted a security interest in substantially all of the
Companys assets and issued WPV, Inc. a fully vested and non-forfeitable warrant to purchase 1,375,000 shares of common stock of the Company at an
exercise price of $8.00. The warrant will expire if unexercised by March 9, 2008. The fair value of the warrant at the date of issuance was $3.6
million and this amount is being amortized as deferred financing costs by a charge to interest expense through July 31, 2004. WPV, Inc. will continue
to provide a guarantee on the new line of credit through July 2004. Page 48




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Notes to Financial Statements  (continued) 10. Income Tax The Company recorded a tax provision of $43,000 relating to the U.S. federal alternative minimum tax for
the year ended December 31,2003. The Company has made no
provisions for U.S. federal, U.S. state or foreign income taxes for
the years ended December 31, 2002 and 2001 as the
Company has incurred tax losses in all periods prior to 2003 and for all jurisdictions. 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 the Companys deferred tax assets are as
follows, (in thousands): 2003
    
    
    2002Restated
    
    
    RestatedDeferred tax assets:Net operating loss carryforwards
    
    
    26,272
    
    
    
    26,112Restructuring reserve
    
    
    710
    
    
    
    506Capitalized software and development costs
    
    
    698
    
    
    
    670Deferred revenue
    
    
    1,008
    
    
    
    2,111Research credit carryforwards
    
    
    811
    
    
    
    715Other
    
    
    941
    
    
    
    683Total deferred tax assets
    
    
    30,440
    
    
    
    30,797Valuation allowance
    
    
    (30,440
    )
    
    
    (30,797
    )Net deferred tax assets
    
    $
    
    
    
    $
    
 Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are
uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation
allowance decreased from December 31, 2002 to December 31, 2003 in the amount of $358,000. As of December 31, 2003,
the Company had net operating loss carryforwards for federal income tax purposes of
approximately $72,415,000, which expire in the years 2011 through 2023 and federal research tax credits of
approximately $489,000, which expire in the years 2011 through 2023. The Company also had net operating loss
carryforwards for state income tax purposes of approximately $27,508,000 expiring in the years 2004 through 2013
and state research tax credits of approximately $322,000 which carry forward indefinitely. Utilization of the Companys net operating loss carryforwards may be subject to substantial annual limitation due to
the ownership change limitation provided by the Internal Revenue Code and a similar state provision. Such an
annual limitation could result in the expiration of the net operating loss carryfowards before utilization. 11. Stockholders Deficit Common Stock At December 31, 2003, the Company had reserved shares of common stock for future issuance as follows: Stock Options outstanding
    
    
    3,045,027Stock Options available for future grants
    
    
    652,197Employee stock purchase plan
    
    
    304,143Common stock warrants
    
    
    1,382,2225,383,589
 Page 49




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Notes to Financial Statements  (continued) Stock Options The Companys employee stock option plans provide for the issuance of incentive stock options (ISO)
or nonstatutory stock options (NSO) to eligible participants. The ISOs may be granted at a price
per share not less than the fair market value at the date of grant. The NSOs may be granted at a
price per share not less than 85% of the fair market value at the date of grant. Certain options
previously granted can be exercised prior to vesting, but, if so exercised, these unvested shares
are subject to repurchase by the Company. Options and unvested shares granted generally vest over
a period of four years. Options under the employee plans have a maximum term of 10 years. In the
event option holders cease to be employed by the Company, all unvested options are forfeited and
all vested options may be exercised within a 90-day period after termination. The 90-day exercise
period is sometimes extended by agreement with the optionee, which could result in a modification
charge to operations. In May 1999, the Companys stockholders approved the 1999 Equity Incentive Plan, which amended and
restated the Companys previous stock option plan. 3,292,666 shares of common stock were
authorized for issuance under the plan, including shares originally authorized under predecessor
plans and shares added to the plan in 2001. In May 2002, the Companys Board of Directors approved
and in May 2003, the shareholders subsequently approved, adding 1,350,000 shares to the 1999 Equity
Incentive Plan. The total number of shares authorized for issuance under the plan is now
4,642,666. The Board of Directors also approved the 2002 CEO Stock Option Plan in May 2002, which
was subsequently approved by the shareholders in May 2003. This plan reserved an aggregate of
470,588 shares for grants of stock options under the plan. In May 1999, the Companys stockholders approved the 1999 Non-Employee Directors Stock Option Plan
and reserved an aggregate of 75,000 shares of common stock for grants of stock options under the
plan. In May 2003, the Companys stockholders approved an increase in the number of shares
authorized for issue under the plan from 75,000 shares to a total of 150,000 shares. Page 50




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##### Table of Contents



Notes to Financial Statements  (continued) A summary of the Companys stock option activity under the plans is as follows: Outstanding OptionsWeighted-AverageExerciseNumber of
    
    
    Price PerShares
    
    
    ShareOutstanding at December 31, 2000
    
    
    1,618,274
    
    
    $
    11.34Granted
    
    
    438,826
    
    
    
    3.62Exercised
    
    
    (7,395
    )
    
    
    3.91Canceled
    
    
    (396,539
    )
    
    
    10.73Outstanding at December 31, 2001
    
    
    1,653,166
    
    
    
    9.47Granted
    
    
    2,239,290
    
    
    
    1.36Exercised
    
    
    (274,471
    )
    
    
    1.15Canceled
    

    (628,681
    )
    
    
    9.35Outstanding at December 31, 2002
    
    
    2,989,304
    
    
    
    4.20Granted
    
    
    501,834
    
    
    
    3.08Exercised
    
    
    (207,445
    )
    
    
    1.27Canceled
    
    
    (238,666
    )
    
    
    9.85Outstanding at December 31, 2003
    
    
    3,045,027
    
    
    $
    3.76Vested and exercisable
    
    
    1,417,970
 The following table summarizes information concerning outstanding and exercisable stock options at
December 31, 2003: Vested andOutstanding
    
    
    ExercisableWeighted-
    
    
    Weighted-
    
    
    
    
    
    
    WeightedAverage
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    Remaining
    
    
    
    
    
    
    ExerciseNumber of
    
    
    Price Per
    
    
    Contractual
    
    
    Number of
    
    
    Price PerPrice Range
    
    Shares
    
    
    Share
    
    
    Life (Years)
    
    
    Shares
    
    
    Share$0.2600 - $1.3900
    
    
    1,517,564
    
    
    $
    1.37
    
    
    
    8.36
    
    
    
    424,313
    
    
    $
    1.34$1.4000 - $6.1250
    
    
    1,164,304
    
    
    $
    3.35
    
    
    
    7.89
    
    
    
    640,643
    
    
    $
    3.68$6.2500 - $39.8750
    
    
    363,149
    
    
    $
    15.11
    
    
    
    5.74
    
    
    
    353,014
    
    
    $
    15.233,045,027
    
    
    
    
    
    
    
    
    
    
    
    1,417,970
 Page 51




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##### Table of Contents



Notes to Financial Statements  (continued) Common Stock Warrants In 2001, the Company issued a fully vested non-forfeitable warrant to purchase 1,375,000 shares of
common stock of the Company at an exercise price of $8.00 per share. The warrant was issued to
WPV, Inc., an affiliate of a significant stockholder of the Company, in connection with the
guarantee of a line of credit to the Company. The warrant is outstanding and will expire if
unexercised by March 9, 2008. The fair value of the warrant at the date of issuance was $3.6
million. The value of the warrant was determined using the Black-Scholes model with the following
assumptions: a share price of $3.88, volatility of .85, a risk-free interest rate of 4.94%, no
dividend yield and an expected life of seven years. In 1999, the Company issued a fully vested warrant to purchase 7,222 shares of Series D Preferred
Stock of the Company at an exercise price of $7.50 per share. The warrant was issued to the
placement agent in the Series D Preferred Stock offering and was converted to an equivalent number
of common stock on completion of the initial public offering. The warrant expired unexercised in
January 2004. 1999 Employee Stock Purchase Plan In May 1999 the stockholders approved the 1999 Employee Stock Purchase Plan, which became effective
upon the completion of the initial public offering of the Companys common stock. The Company
initially reserved a total of 350,000 shares of common stock for issuance under the plan. In May
2002 the Companys shareholders approved an additional 350,000 shares for a total of 700,000
shares. Eligible employees may purchase common stock at 85% of the lesser of the fair market value
of the Companys common stock on the first day of the applicable one-year offering period or the
last day of the applicable six-month purchase period. The Company issued 52,912 and 116,861 shares
of common stock under the plan during the years ended December 31, 2003 and 2002, respectively.
At December 31, 2003, 304,143 shares were available for issuance under the Plan. 12. Commitments Leases The Company leases its corporate office facility under a non-cancelable operating lease with a term
expiring in 2013. Future minimum payments under this lease as of December 31, 2003 are as follows
(in thousands): 2004
    
    $
    9402005
    
    
    9402006
    
    
    9402007
    
    
    9402008
    
    
    9402009 and thereafter
    
    
    5,407Total minimum lease payments
    
    $
    10,107
 Rent expense under all operating leases net of sublease income was $1 million, $1.7 million and
$2.0 million for the years ended December 31, 2003, 2002 and 2001, respectively. Page 52




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Notes to Financial Statements  (continued) License Agreement In September 1996, the Company 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, the Company issued 131,192 shares of Series A preferred stock and paid the university a
license-issue fee of $200,000. In March 1997, the number of shares of Series A preferred stock
issued under the agreement was reduced to 114,526. On completion of the initial public offering
these shares were converted to an equivalent number of common shares. The agreement also provides for additional royalties and milestone payments based upon revenues
from products using the licensed technology. Royalty and milestone
expenses were $898,000, $723,000
and $635,000 for the years ended December 31, 2003, 2002 and 2001, respectively, and are included
in cost of revenues. All milestone payments required under the license have now been paid. Annual
minimum guaranteed royalty payments are $150,000. If the Company loses or is unable to maintain the license agreement during the term of the
underlying patents, it would materially harm its business. The university may terminate the license
agreement if the Company fails to perform or violates its terms without curing the violation within
60 days of receiving written notice of the violation. 13. Guarantees The Company generally provides a warranty that its 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, the Company has not incurred any material costs associated with these warranties and has no
accrual for such items at December 31, 2003. 14. Employee Retirement and Benefit Plan The Company has 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. The Company does not presently match
contributions by plan participants. 15. Related Party Transaction On September 30, 2003 the Company entered into an agreement with Neuroscience Solutions Corporation
(NSC) to provide NSC with exclusive rights in the healthcare field to certain intellectual
property, patents and software owned or licensed by the Company, along with transfer of certain
healthcare research projects. A co-founder, substantial shareholder, and member of the Board of
Directors of the Company is a co-founder, officer, director and substantial shareholder of NSC. The rights were acquired by NSC for a combination of cash, stock and future royalties. NSC paid
$500,000 cash, of which $448,000 was recognized at December 31, 2003. The balance will be
recognized over the next nine months as services are provided to NSC. Amounts received to date and
any future receipts are being reported as other income as the Company does not consider the sale of
these rights to be part of its recurring operations. Under the agreement, the Company will receive
net royalties between 2% to 4% on products sold by NSC that use the Companys patents or software.
We did not record a value for the 1.8 million shares of NSC received in the transaction, because
NSC is a private start-up venture, the shares of which have no determinable value. Page 53




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Notes to Financial Statements  (continued) 16. Subsequent Events
On January 30, 2004 the Company entered into a revolving line of credit agreement with Comerica
Bank. The line totals $7.0 million through July 22, 2004; after that date, the maximum that can be
borrowed under the agreement is $5.0 million. The line expires on January 14, 2005. Borrowing
under the line of credit bears interest at prime plus 0.5%, currently 4.5%. The facility is
partially secured by a letter of credit provided by WPV, Inc., an affiliate of Warburg, Pincus
Ventures, a significant stockholder of the Company. The letter of credit is for $4.0 million
through May 30, 2004 and $3.0 million from May 31, 2004 to July 30, 2004. The non-guaranteed
portion of the line is subject to limitations based on the Companys accounts receivable balance.
To further secure the line the Company granted Comerica a security interest in all of our assets
other than our intellectual property, and agreed not to restrict our ability to grant a security
interest in our intellectual property. On January 15, 2004, the Company terminated its $10.0 million revolving loan agreement with Fleet
National Bank. This line of credit was also guaranteed by WPV, Inc. The guarantee was due to expire
in March 2004. 17. Subsequent Event (unaudited) We have a line of credit with Comerica Bank totaling $5.0 million, which expires on July 14, 2005.
The line is subject to limitations based on our accounts receivable balance. Borrowings under the
line are subject to various covenants, which may limit or financial and operating flexibility. The
need to restate our historical financial statements constitutes an event of default under our
agreement with Comerica. This event of default entitles Comerica to decline to advance additional
funds under the line. 18. Interim Financial Information (unaudited) Quarterly financial data (in thousands, except per share amounts) Page 54




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2003Quarter ended
    
    
    Quarter ended
    
    
    Quarter ended
    
    
    Quarter ended
    
    
    TotalMarch 31
    
    
    June 30
    
    
    Sept 30
    
    
    Dec 31
    
    
    2003Previously
    
    
    
    
    
    
    Previously
    
    
    
    
    
    
    Previously
    
    
    
    
    
    
    Previously
    
    
    
    
    
    
    PreviouslyReported
    
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    Reported
    
    
    RestatedTotal revenues
    
    
    6,377
    
    
    
    6,583
    
    
    
    7,357
    
    
    
    8,074
    
    
    
    8,017
    
    
    
    8,293
    
    
    
    6,945
    
    
    
    6,966
    
    
    
    28,696
    
    
    
    29,916Gross profit
    
    
    4,994
    
    
    
    5,158
    
    
    
    5,846
    
    
    
    6,630
    
    
    
    6,372
    
    
    
    6,724
    
    
    
    5,400
    
    
    
    5,405
    
    
    
    22,612
    
    
    
    23,917Net income (loss)
    
    
    (610
    )
    
    
    (454
    )
    
    
    (56
    )
    
    
    745
    
    
    
    1,289
    
    
    
    1,678
    
    
    
    245
    
    
    
    162
    
    
    
    868
    
    
    
    2,130Net income (loss)
per share:Basic
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    0.00
    
    
    
    0.05
    
    
    
    0.08
    
    
    
    0.10
    
    
    
    0.02
    
    
    
    0.01
    
    
    
    0.05
    
    
    
    0.13Diluted
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    0.00
    
    
    
    0.04
    
    
    
    0.08
    
    
    
    0.10
    
    
    
    0.01
    
    
    
    0.01
    
    
    
    0.05
    
    
    
    0.13
 2002Quarter ended
    
    
    Quarter ended
    
    
    Quarter ended
    
    
    Quarter ended
    
    
    TotalMarch 31
    
    
    June 30
    
    
    Sept 30
    
    
    Dec 31
    
    
    2002Previously
    
    
    
    
    
    
    Previously
    
    
    
    
    
    
    Previously
    
    
    
    
    
    
    Previously
    
    
    
    
    
    
    PreviouslyReported
    
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    Reported
    
    
    RestatedTotal revenues
    
    
    3,184
    
    
    
    4,046
    
    
    
    4,449
    
    
    
    4,520
    
    
    
    6,396
    
    
    
    6,755
    
    
    
    6,257
    
    
    
    6,516
    
    
    
    20,286
    
    
    
    21,837Gross profit
    
    
    2,511
    
    
    
    3,235
    
    
    
    3,583
    
    
    
    3,644
    
    
    
    5,374
    
    
    
    5,742
    
    
    
    5,340
    
    
    
    5,605
    
    
    
    16,808
    
    
    
    18,226Net loss
    
    
    (3,862
    )
    
    
    (3,204
    )
    
    
    (2,926
    )
    
    
    (2,917
    )
    
    
    (450
    )
    
    
    (40
    )
    
    
    (2,875
    )
    
    
    (2,534
    )
    
    
    (10,113
    )
    
    
    (8,695
    )Net loss
per share:Basic
    
    
    (0.25
    )
    
    
    (0.21
    )
    
    
    (0.19
    )
    
    
    (0.19
    )
    
    
    (0.03
    )
    
    
    (0.00
    )
    
    
    (0.18
    )
    
    
    (0.16
    )
    
    
    (0.65
    )
    
    
    (0.56
    )Diluted
    
    
    (0.25
    )
    
    
    (0.21
    )
    
    
    (0.19
    )
    
    
    (0.19
    )
    
    
    (0.03
    )
    
    
    (0.00
    )
    
    
    (0.18
    )
    
    
    (0.16
    )
    
    
    (0.65
    )
    
    
    (0.56
    )
 Page 55




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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 
 ITEM 9A. 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/A, 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. In connection with the Original Form 10-K, as required under Rule 13a-15(b) of the Exchange Act,
the Companys management, including the Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the Companys disclosure controls and procedures.
Based on this evaluation, the Companys Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and procedures were effective as of December 31,
2003. In December 2004, the management of the Company and the Audit Committee of the Companys Board of
Directors concluded that the Company should correct its revenue recognition method for most of the
Companys K-12 school contracts. As a result, the Company is restating its historical financial
statements for the period from 2000 through June 30, 2004. This restatement is described in more
detail in Note 2 to the Financial Statements. This correction in the Companys revenue recognition treatment reflects a correction in the
Companys application of AICPA Statement of Position 97-2, Software Revenue Recognition (as
amended by Statement of Position 98-9) to these historical transactions. Controls over the
application of accounting policies are within the scope of internal controls. Therefore,
management has concluded that there was a material weakness in the Companys internal controls, as
defined by the Public Company Accounting Oversight Board. In connection with the filing of this Form 10-K/A Report, the Companys management, including the
Chief Executive Officer and Chief Financial Officer, has re-evaluated the effectiveness of the
Companys disclosure controls and procedures as of December 31, 2003. Solely because of the
revenue recognition issue discussed above, the Companys Chief Executive Officer and Chief
Financial Officer have now concluded that the Companys disclosure controls and procedures were not
effective as of December 31, 2003. The Company has reflected the revised revenue recognition treatment in this Form
10-K/A and Forms 10-Q/A for the first and second quarters of 2004. We are in the process of
evaluating what changes should be made in our internal controls over financial reporting with
respect to revenue recognition. Except for these changes, for the year ended December 31, 2003,
there were no changes in the Companys internal controls over financial reporting that materially
affected, or are reasonably likely to materially affect the Companys internal control over
financial reporting. 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. The Companys 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. Page 56




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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 2004 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 ACCOUNTING FEES AND SERVICES Information required by this item concerning the independent auditors fees and services is set
forth under the caption Independent Registered Public Accounting Firm in the Proxy Statement and
is incorporated by reference into this Form 10-K Report. Page 57




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##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of this report: (1) Financial Statements Independent Registered Public Accounting Firms Report
Restated Balance Sheet  December 31, 2003 and 2002
Restated Statement of Operations  Years Ended December 31, 2003, 2002 and 2001
Restated Statements of Stockholders (Deficit) Equity  Years Ended December 31, 2003,
2002 and 2001
Restated Statement of Cash Flows  Years Ended December 31, 2003, 2002 and 2001
Notes to the 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) Valuation and Qualifying Accounts which are deducted in the Balance Sheet from the
assets to which they apply: Allowance for Doubtful Accounts Years ended December 31 Charges toOpening
    
    
    Operating
    
    
    Charges to
    
    
    
    
    
    
    ClosingBalance
    
    
    Expenses
    
    
    Allowance1
    
    
    Deductions
    
    
    Balance2003:
    
    $
    270
    
    
    $
    0
    
    
    $
    89
    
    
    $
    (220
    )
    
    $
    1392002:
    
    $
    248
    
    
    $
    19
    
    
    $
    309
    
    
    $
    (306
    )
    
    $
    2702001:
    
    $
    241
    
    
    $
    130
    
    
    $
    239
    
    
    $
    (362
    )
    
    $
    248
   1
    
    The Company invoiced certain customers whose
accounts were deemed potentially uncollectible. As such, the accounts
were entirely reserved for and no amounts were recognized as revenue. Page 58




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(3)
    Exhibits Exhibit No.
    
    Description of Document3.3(1)
    
    Restated Certificate of Incorporation.3.4 (20)
    
    Amended and Restated Bylaws.4.1(1)
    
    Reference is made to Exhibits 3.3 and 3.4.4.2(2)
    
    Amended and Restated Registration Rights Agreement, dated as of December 31, 1998.4.3(1)
    
    Specimen Stock Certificate.4.4(3)
    
    Amendment No. 1 by and among Scientific Learning Corporation, Warburg, Pincus Ventures, L.P.
and WPV, Inc., effective as of March 9, 2001 to Amended and Restated Registration Rights
Agreement entered into as of December 30, 19984.5(9)
    
    Amendment No. 2 By and Among Scientific Learning Corporation, Warburg, Pincus Ventures, L.P.
and WPV, Inc., Effective as of November 30, 2001 to Amended and Restated Registration Rights
Agreement Entered Into as of December 30, 199810.1(1)*
    
    Form of Indemnity Agreement with each of our directors and executive officers.10.2(14)*
    
    1999 Equity Incentive Plan, as amended.10.3(14)*
    
    Forms of Stock Option Grant Notice, Stock Option Agreement and Stock Award Agreement under the
Incentive Plan.10.4(14)*
    
    1999 Non-Employee Directors Stock Option Plan, as amended.10.5(14)*
    
    Forms of Nonstatutory Stock Option Agreements under the Non-Employee Directors Stock Option
Plan10.6(14)*
    
    1999 Employee Stock Purchase Plan, as amended.10.8(14)*
    
    Form of 1999 Employee Stock Purchase Plan Offering under the Employee Stock Purchase Plan.10.9 (21)
    
    Loan and Security Agreement dated as of January 15, 2004 by and between Scientific Learning
Corporation and Comerica Bank10.10 (21)
    
    Reimbursement and Security Agreement dated as of January 15, 2004 by and between Scientific
Learning Corporation and WPV, Inc.10.11 (21)
    
    Intercreditor Agreement dated as of January 15, 2004 by and between Comerica Bank and WPV, Inc10.13(1)
    
    Exclusive License Agreement, dated September 27, 1996, with the Regents of the University of
California.10.14 (22)
    
    Amendment No. 3 to Exclusive License Agreement, dated September 27, 1996, with the Regents of
the University of California, amending the agreement filed as Exhibit 10.13.10.15(1)
    
    Securities Purchase Agreement, dated September 24, 1996, with Warburg, Pincus Ventures, L.P.10.16 (23)
    
    Lease, dated as of October 1, 2003, with Rotunda Partners II10.17 (24)
    
    Lease Termination Agreement, dated as of October 1, 2003, with Rotunda Partners II10.18(4)
    
    Revolving Loan Agreement dated as of March 9, 2001 by and between Scientific Learning
Corporation and Fleet National Bank10.19(5)
    
    Agreement to Issue Warrant and Grant of Security Interest dated as of March 9, 2001 by and
between Scientific Learning Corporation and WPV, Inc.10.20(6)
    
    Warrant to Purchase 1,375,000 Shares of Common Stock of Scientific Learning Corporation10.21(7)*
    
    Loan agreements, promissory notes and pledge agreements with each of Sheryle Bolton, Frank
Mattson, Steve Miller, and James Mills10.22(8)
    
    Stock Purchase Agreement dated November 9, 2001 between Scientific Learning Corporation and
Warburg Pincus Ventures, L.P.10.23(10)*
    
    Letter Agreement dated March 12, 2002 between the Company and Sheryle Bolton.10.24(10)
    
    First Amendment Agreement, dated March 26, 2002, between the Company and Fleet National Bank
amending the agreement filed as Exhibit 10.18.10.25(10)*
    
    2002 Management Incentive Plan.10.26(11)*
    
    Employment Agreement dated as of May 31, 2002 by and between Scientific Learning Corporation
and Robert C. Bowen10.27(12)*
    
    2002 CEO Option Plan10.29(13)*
    
    Milestone Equity Incentive Plan10.30(13)*
    
    2003 Management Incentive Plan
 Page 59




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Exhibit No.
    
    Description of Document10.31 (15)
    
    Second Amendment Agreement dated as of September 24, 2003, by and between Scientific Learning
Corporation and Fleet National Bank, amending the agreement filed as Exhibit 10.18, which was
previously amended by the First Amendment Agreement filed as Exhibit 10.24.10.32(16)
    
    Technology Transfer Agreement dated as of September 30, 2003 by and between the Company and
Neuroscience Solutions Corporation (NSC).10.33(17)
    
    SLC License Agreement dated as of September 30, 2003 by and between the Company and NSC.10.34(18)
    
    NSC License Agreement dated as of September 30, 2003 by and between NSC and the Company.10.35(19)
    
    Services Agreement dated as of September 30, 2003 by and between the Company and NSC.23.1
    
    Consent of Ernst & Young, LLP, Independent Registered Public Accounting Firm31.1
    
    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 same numbered exhibit previously filed with the Companys Registration Statement on
Form S-1 (SEC File No. 333-77133).(2)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 10-K for the year
ended December 31, 1999 (SEC File No. 000-24547).(3)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 8-K on March 12, 2001
(SEC File No. 000-24547).(4)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the Companys Form 8-K on March 12, 2001 (SEC File
No. 000-24547).(5)
    
    Incorporated by reference to Exhibit 99.2 previously filed with the Companys Form 8-K on March 12, 2001 (SEC File
No. 000-24547).(6)
    
    Incorporated by reference to Exhibit 99.3 previously filed with the Companys Form 8-K on March 12, 2001 (SEC File
No. 000-24547).(7)
    
    Incorporated by reference to Exhibit 10.20 previously filed with the Companys Form 10-Q for the quarter ended March
31, 2001 (SEC File No. 000-24547).(8)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 10-Q for the quarter
ended September 30, 2001 (SEC File No. 000-24547).(9)
    
    Incorporated by reference to Exhibit 4.4 previously filed with the Companys Form 8-K on December 7, 2001 (SEC File
No. 000-24547).(10)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 10-K for the year
ended December 31, 2001 (SEC File No. 000-24547).(11)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the Companys Form 8-K on June 7, 2002 (SEC File No.
000-24547).(12)
    
    Incorporated by reference to Exhibit 99.2 previously filed with the Companys Form 8-K on June 7, 2002 (SEC File No.
000-24547).(13)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 10-K for the year
ended December 31, 2002 (SEC File No. 000-24547).(14)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 10-Q for the quarter
ended June 30, 2003 (SEC File No. 000-24547).(15)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the Companys Form 8-K on October 3, 2003 (SEC File
No. 000-24547).(16)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the Companys Form 8-K on October 1, 2003 (SEC File
No. 000-24547).(17)
    
    Incorporated by reference to Exhibit 99.2 previously filed with the Companys Form 8-K on October 1, 2003 (SEC File
No. 000-24547).(18)
    
    Incorporated by reference to Exhibit 99.3 previously filed with the Companys Form 8-K on October 1, 2003 (SEC File
No. 000-24547).
 Page 60




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##### Table of Contents



(19)
    
    Incorporated by reference to Exhibit 99.4 previously filed with the Companys Form 8-K on October 1, 2003 (SEC File
No. 000-24547).(20)
    
    Incorporated by reference to the same numbered exhibit previously filed with the Companys Form 10-Q for the quarter
ended September 30, 2003 (SEC File No. 000-24547).(21)
    
    Incorporated by reference to Exhibits previously filed with the Companys Form 8-K on February 5, 2004 (SEC File No.
000-24547).(22)
    
    Incorporated by reference to Exhibit 10.36 previously filed with the Companys Form 10-Q for the quarter ended
September 30, 2003 (SEC File No. 000-24547).(23)
    
    Incorporated by reference to Exhibit 10.37 previously filed with the Companys Form 10-Q for the quarter ended
September 30, 2003 (SEC File No. 000-24547).(24)
    
    Incorporated by reference to Exhibit 10.38 previously filed with the Companys Form 10-Q for the quarter ended
September 30, 2003 (SEC 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. (b) Reports on Form 8-K. On October 1, 2003, the Company filed a Report on Form 8-K disclosing the closing under a
technology transfer agreement with Neuroscience Solutions Corporation. On October 3, 2003, the Company filed a Report on Form 8-K disclosing its agreement to
reduce the amount available for borrowing under its credit line. On October 30, 2003, the Company filed a Report on Form 8-K furnishing its press release
announcing its financial results for the quarter ended September 30, 2003 and the transcript
of its conference call discussing those earnings. Page 61




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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 CORPORATIONBy
    
    /s/ Robert C. Bowen
    
    February 10, 2005Robert C. BowenChief 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)
    
    February 10, 2005/s/ Jane A. Freeman

Jane A. Freeman
    
    Senior Vice President, Chief Financial Officer,
and Treasurer (Principal Financial and
Accounting Officer)
    
    February 10, 2005/s/ Dr. Michael M. Merzenich

Dr. Michael M. Merzenich
    
    Director
    
    February 10, 2005/s/ Dr. Paula A. Tallal

Dr. Paula A. Tallal
    
    Director
    
    February 10, 2005/s/ Carleton A. Holstrom

Carleton A. Holstrom
    
    Director
    
    February 10, 2005/s/ Rodman W. Moorhead, III

Rodman W. Moorhead, III
    
    Director
    
    February 10, 2005/s/ Ajit Dalvi

Ajit Dalvi
    
    Director
    
    February 9, 2005/s/ Dr. Joseph Martin

Dr. Joseph Martin
    
    Director
    
    February 10, 2005/s/ Edward Vermont Blanchard, Jr.

Edward Vermont Blanchard, Jr.
    
    Director
    
    February 7, 2005David W. Smith
    
    Director
 Page 62




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Index to ExhibitsExhibit No.
    
    Description of Document3.3(1)
    
    Restated Certificate of Incorporation.3.4 (20)
    
    Amended and Restated Bylaws.4.1(1)
    
    Reference is made to Exhibits 3.3 and 3.4.4.2(2)
    
    Amended and Restated Registration Rights Agreement, dated as of December 31, 1998.4.3(1)
    
    Specimen Stock Certificate.4.4(3)
    
    Amendment No. 1 by and among Scientific Learning Corporation, Warburg, Pincus
Ventures, L.P. and WPV, Inc., effective as of March 9, 2001 to Amended and Restated
Registration Rights Agreement entered into as of December 30, 19984.5(9)
    
    Amendment No. 2 By and Among Scientific Learning Corporation, Warburg, Pincus
Ventures, L.P. and WPV, Inc., Effective as of November 30, 2001 to Amended and
Restated Registration Rights Agreement Entered Into as of December 30, 199810.1(1)*
    
    Form of Indemnity Agreement with each of our directors and executive officers.10.2(14)*
    
    1999 Equity Incentive Plan, as amended.10.3(14)*
    
    Forms of Stock Option Grant Notice, Stock Option Agreement and Stock Award
Agreement under the Incentive Plan.10.4(14)*
    
    1999 Non-Employee Directors Stock Option Plan, as amended.10.5(14)*
    
    Forms of Nonstatutory Stock Option Agreements under the Non-Employee Directors Stock Option Plan10.6(14)*
    
    1999 Employee Stock Purchase Plan, as amended.10.8(14)*
    
    Form of 1999 Employee Stock Purchase Plan Offering under the Employee Stock Purchase Plan.10.9 (21)
    
    Loan and Security Agreement dated as of January 15, 2004 by and between Scientific Learning Corporation and Comerica Bank10.10 (21)
    
    Reimbursement and Security Agreement dated as of January 15, 2004 by and between Scientific Learning Corporation and WPV, Inc.10.11 (21)
    
    Intercreditor Agreement dated as of January 15, 2004 by and between Comerica Bank and WPV, Inc10.13(1)
    
    Exclusive License Agreement, dated September 27, 1996, with the Regents of the University of California.10.14 (22)
    
    Amendment No. 3 to Exclusive License Agreement, dated September 27,
1996, with the Regents of the University of California, amending the agreement filed
as Exhibit 10.13.10.15(1)
    
    Securities Purchase Agreement, dated September 24, 1996, with Warburg, Pincus Ventures, L.P.10.16 (23)
    
    Lease, dated as of October 1, 2003, with Rotunda Partners II10.17 (24)
    
    Lease Termination Agreement, dated as of October 1, 2003, with Rotunda Partners II10.18(4)
    
    Revolving Loan Agreement dated as of March 9, 2001 by and between Scientific Learning Corporation and Fleet National Bank10.19(5)
    
    Agreement to Issue Warrant and Grant of Security Interest dated as of March 9,
2001 by and between Scientific Learning Corporation and WPV, Inc.10.20(6)
    
    Warrant to Purchase 1,375,000 Shares of Common Stock of Scientific Learning Corporation10.21(7)*
    
    Loan agreements, promissory notes and pledge agreements with each of Sheryle
Bolton, Frank Mattson, Steve Miller, and James Mills10.22(8)
    
    Stock Purchase Agreement dated November 9, 2001 between Scientific Learning
Corporation and Warburg Pincus Ventures, L.P.10.23(10)*
    
    Letter Agreement dated March 12, 2002 between the Company and Sheryle Bolton.10.24(10)
    
    First Amendment Agreement, dated March 26, 2002, between the Company and Fleet
National Bank amending the agreement filed as Exhibit 10.18.10.25(10)*
    
    2002 Management Incentive Plan.10.26(11)*
    
    Employment Agreement dated as of May 31, 2002 by and between Scientific Learning Corporation and Robert C. Bowen
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10.27(12)*
    
    2002 CEO Option Plan10.29(13)*
    
    Milestone Equity Incentive Plan10.30(13)*
    
    2003 Management Incentive Plan10.31 (15)
    
    Second Amendment Agreement dated as of September 24, 2003, by and
between Scientific Learning Corporation and Fleet National Bank, amending the
agreement filed as Exhibit 10.18, which was previously amended by the First Amendment
Agreement filed as Exhibit 10.24.10.32(16)
    
    Technology Transfer Agreement dated as of September 30, 2003 by and between the
Company and Neuroscience Solutions Corporation (NSC).10.33(17)
    
    SLC License Agreement dated as of September 30, 2003 by and between the Company and NSC.10.34(18)
    
    NSC License Agreement dated as of September 30, 2003 by and between NSC and the Company.10.35(19)
    
    Services Agreement dated as of September 30, 2003 by and between the Company and NSC.23.1
    
    Consent of Ernst & Young, LLP, Independent Registered Public Accounting Firm31.1
    
    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 same numbered exhibit previously filed
with the Companys Registration Statement on Form S-1 (SEC File No. 333-77133).(2)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 10-K for the year ended December 31, 1999 (SEC File No. 000-24547).(3)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 8-K on March 12, 2001 (SEC File No. 000-24547).(4)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the Companys Form 8-K on March 12, 2001 (SEC File No. 000-24547).(5)
    
    Incorporated by reference to Exhibit 99.2 previously filed with the Companys Form 8-K on March 12, 2001 (SEC File No. 000-24547).(6)
    
    Incorporated by reference to Exhibit 99.3 previously filed with the
Companys Form 8-K on March 12, 2001 (SEC File No. 000-24547).(7)
    
    Incorporated by reference to Exhibit 10.20 previously filed with the
Companys Form 10-Q for the quarter ended March 31, 2001 (SEC File No. 000-24547).(8)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 10-Q for the quarter ended September 30, 2001 (SEC File No.
000-24547).(9)
    
    Incorporated by reference to Exhibit 4.4 previously filed with the
Companys Form 8-K on December 7, 2001 (SEC File No. 000-24547).(10)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 10-K for the year ended December 31, 2001 (SEC File No. 000-24547).(11)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the
Companys Form 8-K on June 7, 2002 (SEC File No. 000-24547).(12)
    
    Incorporated by reference to Exhibit 99.2 previously filed with the
Companys Form 8-K on June 7, 2002 (SEC File No. 000-24547).(13)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 10-K for the year ended December 31, 2002 (SEC File No.
000-24547).(14)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 10-Q for the quarter ended June 30, 2003 (SEC File No.
000-24547).(15)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the
Companys Form 8-K on October 3, 2003 (SEC File No. 000-24547).
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(16)
    
    Incorporated by reference to Exhibit 99.1 previously filed with the
Companys Form 8-K on October 1, 2003 (SEC File No. 000-24547).(17)
    
    Incorporated by reference to Exhibit 99.2 previously filed with the
Companys Form 8-K on October 1, 2003 (SEC File No. 000-24547).(18)
    
    Incorporated by reference to Exhibit 99.3 previously filed with the
Companys Form 8-K on October 1, 2003 (SEC File No. 000-24547).(19)
    
    Incorporated by reference to Exhibit 99.4 previously filed with the
Companys Form 8-K on October 1, 2003 (SEC File No. 000-24547).(20)
    
    Incorporated by reference to the same numbered exhibit previously filed
with the Companys Form 10-Q for the quarter ended September 30, 2003 (SEC File No.
000-24547).(21)
    
    Incorporated by reference to Exhibits previously filed with the Companys
Form 8-K on February 5, 2004 (SEC File No. 000-24547).(22)
    
    Incorporated by reference to Exhibit 10.36 previously filed with the
Companys Form 10-Q for the quarter ended September 30, 2003 (SEC File No.
000-24547).(23)
    
    Incorporated by reference to Exhibit 10.37 previously filed with the
Companys Form 10-Q for the quarter ended September 30, 2003 (SEC File No.
000-24547).(24)
    
    Incorporated by reference to Exhibit 10.38 previously filed with the
Companys Form 10-Q for the quarter ended September 30, 2003 (SEC 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 65