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

FORM 10-Q

OR

For the transition period from _____ to _____

Commission File number # 000-24547

Scientific Learning Corporation
(Exact name of registrant as specified in its charter)

300 Frank H. Ogawa Plaza, Suite 500
Oakland, California 94612
(510) 444-3500
(Address of Registrants principal executive offices, including zip code, and
telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes |X|   No |_|

        The number of shares of the Registrant’s Common Stock, $.001 par value per share, outstanding at October 31, 2002 was 15,777,068

SCIENTIFIC LEARNING CORPORATION

INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SCIENTIFIC LEARNING CORPORATION
CONDENSED BALANCE SHEETS
(In thousands)

Certain 2001 items have been reclassified to conform to the presentation adopted in 2002.
See accompanying notes to the condensed financial statements.

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SCIENTIFIC LEARNING CORPORATION
CONDENSED STATEMENT OF OPERATIONS
(In thousands, except share and per share amounts)
Unaudited

Certain 2001 items have been reclassified to conform to the presentation adopted in 2002.
See accompanying notes to the condensed financial statements.

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SCIENTIFIC LEARNING CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
Unaudited

Certain 2001 items have been reclassified to conform to the presentation adopted in 2002.
See accompanying notes to the condensed financial statements.

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Notes To Condensed Financial Statements

1. Summary of Significant Accounting Policies

Description of Business

Scientific Learning Corporation (the “Company”) was incorporated on November 30, 1995 in the State of California and was reincorporated on May 2, 1997 in the State of Delaware. The Company commenced operations in February 1996. The Company’s proprietary Fast ForWord® software is designed to improve language and reading skills. The Company develops, markets and sells the Fast ForWord software and other educational products primarily to public and private schools, and through speech and language professionals in private practice. We also offer training, professional development and support services to our customers.

Use of Estimates

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

Interim Financial Information

The interim financial information as of September 30, 2002 and for the three and nine months ended September 30, 2002 and 2001 is unaudited, but includes all normal recurring adjustments, that the Company considers necessary for a fair presentation of its financial position at such date and its results of operations and cash flows for those periods.

These condensed financial statements and notes should be read in conjunction with the Company’s audited financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Securities and Exchange Commission.

Operating results for the three and nine months ended September 30, 2002 are not necessarily indicative of results that may be expected for any future periods.

Revenue Recognition

The Company derives revenue from the sale of licenses to its software and from service fees. Software license revenue is recognized in accordance with AICPA Statement of Position 97-2, “Software Revenue Recognition,” (SOP 97-2) as amended by Statement of Position 98-9. 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. The SOP further stipulates that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on vendor specific objective evidence of the relative fair value of the elements. The Company’s revenue recognition policy is also based on the Securities and Exchange Commission’s Staff Accounting Bulletin 101 (SAB 101) that requires companies who provide an ongoing service to recognize revenue over the term of the services agreement.

The value of software licenses and services invoiced during a particular period is recorded as deferred revenue until recognized. Customers license the right to use Fast ForWord software during the term of the license, but do not acquire unlimited rights to the products.

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Revenues from the licensing of software are recognized as follows: 1) for perpetual licenses that require ongoing internet based participant tracking services revenue is recognized over the period in which the Company provides such services, typically from 1 to 3 years; 2) for limited term site licenses revenue is recognized over the life of the license, typically 3 to 12 months; 3) for individual participant licenses revenue is recognized over the average duration of the product’s use, typically 6 weeks; and 4) for perpetual licenses with no ongoing support requirement revenue is recognized when the product has been shipped, provided that the fees are fixed or determinable and collectible.

Service revenues are derived from the Company’s conferences and training seminars. Revenues from conferences and seminars are recognized when the event is held.

Other Assets

Other assets consist of the following (in thousands):

Restructuring and employee termination charges

Management has approved plans to restructure operations to focus on the public school market. In connection with these plans, the Company reduced its work force and recorded charges from asset impairment and the abandonment of excess office space. Although during the quarter ended September 30, 2002 no additional charges were recorded, termination benefits totaling $170,000 were paid to employees terminated during the second quarter of 2002.

The following table sets forth the restructuring activity during the quarter ended September 30, 2002 (in thousands).

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Net Loss Per Share

Basic and diluted net loss per share information for all periods is presented under the requirements of FAS No. 128, “Earnings per Share”. Basic net loss per share has been computed using the weighted-average number of shares outstanding during the period and excludes any dilutive effects of stock options, warrants, and convertible securities. Potentially dilutive securities have been excluded from the computation of diluted net loss per share, as their inclusion would be antidilutive.

If the Company had reported net income, the calculation of diluted earnings per share would have included approximately an additional 9,000 and 21,000 common equivalent shares (computed using the treasury stock method) related to the outstanding options and warrants for the quarter ended September 30, 2002 and 2001, respectively, and an additional 33,000 and 36,000 common equivalent shares for the nine months ended September 30, 2002 and 2001, respectively.

2. Comprehensive Loss

The Company has no items of other comprehensive income (loss), and accordingly the comprehensive loss is equal to the net loss for all periods reported.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

        This Management’s Discussion and Analysis contains forward-looking statements that are subject to the safe harbor created by Section 27A of the federal securities law. Such statements include, among others, statements relating to trends and projected future levels of revenue, sales, margins and expenses, and the drivers behind those trends; trends in market channels; and projected levels of liquidity and capital resources. Numerous risks and uncertainties could cause actual results to differ materially. These risks and uncertainties include the factors discussed and referred to below under the heading “Factors That May Affect Quarterly Results of Operations.” All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.

        The following should be read in conjunction with the audited financial statements and the notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2001.

Overview

        We develop, market and sell proprietary software and other educational products and services. Our products and services are based on research on how the brain works and learns. We have developed products to help children, adolescents and adults build the cognitive processes critical for learning how to read or become better readers. Our language and reading software, the Fast ForWord® family, are software products that focus on improving oral language comprehension and the other cognitive skills critical to language and reading. These products are based on scientific research and have been extensively field-tested.

        We offer professional development to educators, speech and language professionals and other professionals. They can learn about recent developments in brain research and their application to education and the practical application of our products, in some cases earning continuing education credits. We also provide technical support services to our customers on the telephone, through the Internet and in some cases on-site.

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        Our primary market is U.S. public schools (K-12 sector). We address this market primarily through a direct sales force. We also sell through other distribution channels including referrals from speech and language professionals in private practice, a limited number of independent sales representatives in the public school and adult education markets and, to a very minor extent, direct-to-consumer sector including through our Websites. Our products and services are sold both individually and in various combinations designed to suit the needs of our customers.

        More than 190,000 students are enrolled in or have used our Fast ForWord language and reading software. We have sold our products and services to over 1,600 school districts in the United States. For the quarter ended September 30, 2002, K-12 sector booked sales increased by 134% to $7.1 million compared to $3.0 million in the third quarter of 2001. K-12 booked sales represented approximately 87% of total booked sales for the quarter compared to 73% for the same quarter in 2001.

        As of September 30, 2002 we had 118 full time employees.

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Results of Operations

        The following table sets forth, for the periods indicated, various financial data expressed as a percentage of revenues (unless otherwise noted).