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

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003

OR

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

For the transition period from _____ to _____

Commission File number # 000-24547

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

Delaware
(State or other jurisdiction of incorporation or
organization)		 94-3234458
(I.R.S. Employer Identification No.)

300 Frank H. Ogawa Plaza, Suite 600
Oakland, California 94612
(510) 444-3500
(Address of Registrant’s 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 |_|

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_|        No |X|

The number of shares of the Registrant’s Common Stock, $.001 par value per share, outstanding at October 31, 2003 was 16,063,084


SCIENTIFIC LEARNING CORPORATION

INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003

PAGE

PART 1. FINANCIAL INFORMATION

Item 1.   Financial Statements    
 
    Condensed Balance Sheets as of September 30, 2003 and December 31, 2002   3
 
    Condensed Statement of Operations for the Three and Nine Months    
            Ended September 30, 2003 and 2002   4
 
    Condensed Statements of Cash Flows for the Nine Months    
            Ended September 30, 2003 and 2002   5
 
    Notes to Condensed Financial Statements   6
 
Item 2.   Management’s Discussion and Analysis of Financial Condition    
            and Results of Operations   10
 
Item 3.   Quantitative and Qualitative Disclosures about Market Risk   21
 
Item 4.   Controls and Procedures   21

PART II. OTHER INFORMATION

Item 1.   Legal Proceedings   21
 
Item 6.   Exhibits and Reports on Form 8-K   21
 
    Signature   25
 
    Certifications    

2


PART I. FINANCIAL INFORMATION

Item 1. Condensed Financial Statements

SCIENTIFIC LEARNING CORPORATION
CONDENSED BALANCE SHEETS
(In thousands)

  September 30,
2003
  December 31,
2002
 
  (Unaudited)      
Assets            
Current assets:    
   Cash and cash equivalents     $ 5,323   $ 4,613  
   Accounts receivable, net       4,915     4,867  
   Prepaid expenses and other current assets       748     1,340  
 
 
 
 
      Total current assets       10,986     10,820  
 
Property and equipment, net       757     1,198  
Loans to officers and former officers       3,114     3,114  
Other assets       2,092     3,511  
 
 
 
 
Total assets     $ 16,949   $ 18,643  
 
 
 
 
Liabilities and stockholders’ deficit    
Current liabilities:    
   Accounts payable     $ 491   $ 287  
   Accrued liabilities       4,409     5,411  
   Borrowings under bank line of credit       1,000     —  
   Deferred revenue       16,231     13,433  
 
 
 
 
      Total current liabilities       22,131     19,131  
 
Borrowings under bank line of credit       —     5,000  
Deferred revenue, long-term       1,273     2,151  
Other liabilities       631     484  
 
 
 
 
      Total liabilities       24,035     26,766  
 
Stockholders’ deficit:    
   Common stock       74,184     73,771  
   Accumulated deficit       (81,270 )   (81,894 )
 
 
 
 
      Total stockholders’ deficit       (7,086 )   (8,123 )
 
 
 
 
Total liabilities and stockholders’ deficit     $ 16,949   $ 18,643  
 
 
 

See accompanying notes to condensed financial statements.

3


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

  Three months ended September 30,   Nine months ended September 30,  
  2003
  2002
  2003
  2002
 
Revenues:                    
 
Products     $ 6,262   $ 5,335   $ 17,810   $ 11,555  
Service and support       1,755     1,061     3,942     2,475  
 
 
 
 
 
    Total revenues       8,017     6,396     21,752     14,030  
 
Cost of revenues:    
 
Cost of products       679     633     1,807     1,443  
Cost of service and support       966     389     2,732     1,118  
 
 
 
 
 
    Total cost of revenues       1,645     1,022     4,539     2,561  
 
Gross profit       6,372     5,374     17,213     11,469  
 
Operating expenses:    
 
    Sales and marketing       3,258     3,587     9,898     10,948  
    Research and development       796     812     2,640     2,231  
    General and administrative       1,140     1,088     3,537     3,722  
    Restructuring charges       —     —     —     880  
 
 
 
 
 
 
   Total operating expenses       5,194     5,487     16,075     17,781  
 
Operating income (loss)       1,178     (113 )   1,138     (6,312 )
 
Other income from related party       425     —     425     —  
Interest expense , net       (301 )   (337 )   (926 )   (926 )
 
 
 
 
 
 
Net income (loss) before income tax provision       1,302     (450 )   637     (7,238 )
Income tax provision       13     —     13     —  
 
 
 
 
 
Net income (loss)     $ 1,289   $ (450 ) $ 624   $ (7,238 )
 
 
 
 
 
 
Basic net income (loss) per share:     $ 0.08   $ (0.03 ) $ 0.04   $ (0.46 )
 
 
 
 
 
 
Shares used in computing basic net income (loss)       16,052,661     15,704,474     15,979,534     15,591,975  
 
 
 
 
 
 
Diluted net income (loss) per share:     $ 0.08   $ (0.03 ) $ 0.04   $ (0.46 )
 
 
 
 
 
 
Shares used in computing diluted net income (loss)       17,123,821     15,704,474     16,827,135     15,591,975  
 
 
 
 
 

Certain 2002 items have been reclassified to conform to the presentation adopted in 2003.

See accompanying notes to condensed financial statements.

4


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

  Nine months ended September 30,  
  2003   2002  
 
 
 
Operating Activities:            
Net income (loss)     $ 624   $ (7,238 )
Adjustments to reconcile net loss to cash used in operating activities:    
     Depreciation and amortization       1,195     1,354  
     Amortization of deferred financing costs       912     912  
     Stock based compensation       217     132  
     Changes in operating assets and liabilities:    
         Accounts receivable       (48 )   613  
         Prepaid expenses and other current assets       323     11  
         Accounts payable       475     177  
         Accrued liabilities       (1,003 )   (426 )
         Deferred revenue       1,920     6,634  
         Other liabilities       147     184  
 
 
 
 
Net cash provided by operating activities       4,762     2,353  
 
Investing Activities:    
     Sale of government securities       —     1,169  
     Purchases of property and equipment, net       (133 )   (64 )
     Other non-current assets       (115 )   (156 )
 
 
 
 
Net cash (used in) provided by investing activities       (248 )   949  
 
Financing Activities:    
Proceeds from issuance of common stock       196     323  
Borrowings under bank line of credit       2,000     3,000  
Repayments on borrowings under bank line of credit       (6,000 )   (6,000 )
 
 
 
 
Net cash used in financing activities       (3,804 )   (2,677 )
 
 
 
 
Increase in cash and cash equivalents       710     625  
 
Cash and cash equivalents at beginning of the period       4,613     4,610  
 
 
 
 
Cash and cash equivalents at end of the period     $ 5,323   $ 5,235  
 
 
 
 
Supplemental disclosure:    
     Interest Paid     $ 118   $ 275  
 
 
 

See accompanying notes to condensed financial statements.

5


Notes to Condensed 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. The Company sells primarily to K-12 public schools through its own direct sales force. The Company also sells through speech and language professionals and to private schools and clinics. The Company also provides on-site and remote training and implementation services, as well as technical, professional and customer support and a wide variety of Web-based resources.

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. To the extent that there are material differences between these estimates and actual results, our financial statements could be affected.

Interim Financial Information

The interim financial information as of September 30, 2003 and for the three and nine months ended September 30, 2003 and 2002 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, 2002, filed with the Securities and Exchange Commission.

Other Assets

Other assets consist of the following (in thousands):

  September 30,
2003 		  December 31,
2002 		 
 
 
 
        Software development costs     $ 3,089   $ 3,089  
        Less accumulated amortization       (2,238 )   (1,616 )
 
 
 
        Software development costs, net       851     1,473  
        Deferred financing cost, net       536     1,447  
        Other non current assets       705     591  
 
 
 
      $ 2,092   $ 3,511  
 
 
 

6


Notes to Condensed Financial Statements

1. Summary of Significant Accounting Policies (continued)

Restructuring and employee termination charges