10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

|X|  Annual Report Pursuant to Section 13 or 15 (d) of the Securities

Exchange Act of 1934

For the fiscal year ended December 31, 2005 or

|_|  Transition Report Pursuant to Section 13 or 15 (d) of the Securities

Exchange Act of 1934

For the transition period from ___________ to _________________

COMMISSION FILE NO. 000-24547

SCIENTIFIC LEARNING CORPORATION

(Exact name of registrant as specified in its charter)

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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes: |_| No: |X|

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

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

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. |_|

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer” in rule12b-2 of the Exchange Act).

Large accelerated filer |_|  Accelerated filer |_|  Non-accelerated filer |X|

Indicate by check mark whether the Registrant is a shell company (as defined Rule 12b-2 of the Act).

Yes: |_| No: |X|

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on June 30, 2005 as reported on the Nasdaq National Market was approximately $40,309,344. Shares of Common Stock held by each director and executive officer and persons who owned 5% or more of the Registrant’s outstanding Common Stock on that date have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of January 31, 2006 the Registrant had outstanding 16,799,058 shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Registrant’s 2006 Annual Meeting of Stockholders are incorporated by reference in Part III.

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TABLE OF CONTENTS

PART I		PAGE NO.
Item 1.	Business	4
Item 1A.	Risk Factors	13
Item 1B	Unresolved Staff Comments	18
Item 2.	Properties	18
Item 3.	Legal Proceedings	18
Item 4.	Submission of Matters to a Vote of Security Holders	18
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	21
Item 6.	Selected Financial Data	22
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	30
Item 8.	Financial Statements and Supplementary Data	31
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	51
Item 9A.	Controls and Procedures	51
Item 9B.	Other Information	52
PART III
Item 10.	Directors and Executive Officers of the Registrant	53
Item 11.	Executive Compensation	53
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	53
Item 13.	Certain Relationships and Related Transactions	53
Item 14.	Principal Accountant Fees and Services	53
PART IV
Item 15.	Exhibits and Financial Statements	54
SIGNATURES		57

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PART I

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,” “continues” and variations and negatives of these words and similar expressions are used to identify forward-looking statements. None of the forward-looking statements, including but not limited to those identified with asterisks(*) in this report is a guarantee of future performance or events, and all 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 Item 1A, Risk Factors and in Item 7, Management’s Discussion and Analysis. We also refer you to the risk factors that are or may be discussed from time to time in our public announcements and our other 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.

ITEM 1. BUSINESS

We develop and distribute the Fast ForWord^® family of reading intervention software. Our patented products build learning capacity by rigorously and systematically applying neuroscience principles to improve the fundamental neuro-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, in 2005 36% of fourth graders in the U.S. had below basic reading scores and 69% were not proficient in reading at grade level. Among students eligible for free or reduced-price lunches, the NAEP found that 84% of fourth graders were not proficient in reading at grade level. According to the NAEP, between 1992 and 2005, there was no statistically significant change in the proportion of fourth graders below basic, despite a national focus on reading and significant and increased federal funding.

Learning to read proficiently is a complex task involving multiple cognitive processes. In recent years, scientists have come to a much better understanding of these processes. Our software products are based on and incorporate learning from more than 30 years of research on the brain, language and reading. Extensive outcomes research by independent researchers, school districts, our founding scientists and our company demonstrates that the Fast ForWord products help students attain fast and enduring gains in the skills critical for reading.

At the end of 2005, our product family included 13 offerings, all focused on building learning capacity. Our Fast ForWord family includes products that develop cognitive skills in the specific contexts of early literacy development, foundational language skills, linking spoken language and print, reading skills from grade levels K through 5 and adolescent intervention. To assist educators in getting the best results from their Fast ForWord implementations, we offer a web-based data analysis and reporting tool that provides diagnostic and prescriptive information and intervention strategies and allows educators to track student progress and move students appropriately through the product sequence. To encourage best practices in the use of our products, we provide on-site and remote services, including product training, professional development, implementation management, consulting and technical installation. We also provide technical, instructional and customer support and a wide variety of web-based resources.

From our inception through the end of 2005, approximately 3,800 schools had purchased at least $10,000 of our Fast ForWord product licenses and services, and during 2005 over 135,000 new students enrolled in one of our products.

MARKETS

K-12 MARKET

Our primary market is K-12 schools in the United States. In each of the last three years, the K-12 sector has represented more than 90% of our booked sales.

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The K-12 market is large. The National Center for Education Statistics, part of the U.S. Department of Education, estimates that in fall 2005 U.S. K-12 schools enrolled more than 54 million students, and projects that K-12 enrollment will continue growing to 56.7 million students in 2014.* Market Data Retrieval, a supplier of market information to the education industry, estimates that there are approximately 14,500 public school districts in the U.S. and 105,000 public and private school buildings, or sites.

The K-12 instructional materials market can be divided along a variety of characteristics based on type of instructional material (for example, basal, supplemental, reference, assessment), subject matter (reading, math, etc.), and medium (for example, print, software, on-line content, manipulatives). Using these categories, our products are best classified as supplemental software for reading intervention. Eduventures, a strategic consulting firm in the education industry, estimates that in 2003, K-12 schools spent $3.3 billion on supplemental content for all subject areas. Education Market Report’s Complete K-12 Newsletter (July 2005) estimated the market for all educational software at approximately $800 million for the 2004 – 2005 school year, growing approximately 10% over 2003-2004, compared to declining or flat sales in the years from 2001 to 2004. The supplemental market is highly fragmented, with numerous suppliers. We believe that we presently have a small share of the reading intervention supplemental market.

Reading achievement, grade level proficiency, and accountability were reconfirmed as important national educational priorities by the federal No Child Left Behind (NCLB) Act of 2001. NCLB also emphasizes the need to use proven practices and products grounded in scientifically based research to improve student performance. Our products align well with the emphases of NCLB. Fast ForWord products improve reading performance by increasing learning capacity through applying proven neuroscience principles to develop cognitive skills. Our products help bring struggling students to grade level and assist educators in meeting their accountability objectives. The results that can be achieved through our products are established by research conducted by independent academic researchers and school districts as well as by our founding scientists and our company. To date, more than 800 publications have described the Fast ForWord products, the results that have been achieved using our products or the foundational research on which the products are based. We believe that our products’ alignment with the important national priorities outlined in NCLB assists us in marketing and selling our products.

K-12 FUNDING

The general availability of funding for public schools fluctuates from time to time. State and local education funding is sensitive to levels of state and local tax revenues, which fluctuate with general economic activity. Substantial federal resources also fund a wide variety of education programs, many of which are focused on reading improvement.

According to a recent survey by the National Conference of State Legislatures, state budget conditions continue to improve following difficult state budgets in earlier years.* State budget overruns are declining, although states still report increasing spending demands for Medicaid and other health care programs, corrections, education and other priorities.*

Among the federal education programs, we believe that Title 1 and IDEA (special education) have been the most significant sources of funds for purchases of Fast ForWord licenses. The 2006 federal appropriations for these programs are at approximately the same level as in 2005. The current federal budget deficit and competing priorities, however, may impact the continuing availability of federal education funding. The President’s 2007 federal budget proposal calls for a decrease in overall federal education funding, particularly in funding for technology, but proposes increases in special education funding and would hold Title 1 funding level.

OTHER MARKETS

In addition to selling to K-12 schools, in the United States and Canada we also sell to and through private practice professionals, learning centers, hospitals and clinics and to correctional institutions. These speech and language and other professionals recommend the use of our products to appropriate clients and then supervise the use of the software, often in connection with their other services. In 2005, over 600 non-school professionals and entities used our products. While these private professionals represent a small percentage of total booked sales, they remain significant to us. Private practice professionals were our first market, and many 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.

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We are also building a network of independent value-added resellers outside the United States and Canada. At December 31, 2005, we had fifteen of these resellers. In 2005, booked sales outside the United States and Canada increased, but to date have not been significant.

PRODUCTS

Our Fast ForWord family of products consists of award-winning reading intervention software that builds learning capacity. Our products systematically and rigorously apply proven neuroscience principles to develop the neuro-cognitive skills required to read and learn effectively, using exercises based on language and reading skills. The results from our products are fast, effective and enduring, and have been demonstrated through brain imaging studies, changes in achievement on standardized reading tests and more than fifty efficacy studies.

COGNITIVE SKILLS DEVELOPMENT

Reading and learning require a variety of foundational neuro-cognitive skills, all functioning together. The Fast ForWord products build learning capacity by developing the prerequisite skills that enable students to take greater advantage of their reading instruction and improve their reading proficiency. Fast ForWord products do this by building the cognitive skills of memory, attention, processing and sequencing, which we call Learning MAPs.

Memory. The ability to hold information short- and long-term, essential for word recognition, 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 to discriminate their differences. Processing skills are an essential prerequisite for phonemic awareness (the ability to distinguish among and manipulate the smallest sounds in language that can change meaning) and reading.

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 LEARNING™ FORMULA

Neuroscience and cognitive research has demonstrated the importance of frequency and intensity, adaptivity, simultaneous development, and timely motivation for learning new tasks and establishing change in brain function. The Fast ForWord products use these principles to achieve results that help students build learning capacity by developing cognitive skills.

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 have established protocols for our major products that require between 48 and 100 minutes of product use a day, five days per week.

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.

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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 special animations that signify milestones as students progress.

PRODUCTS IN THE FAST FORWORD FAMILY

During 2005, our Fast ForWord family of products accounted for 75% 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.

Language Series Products

Fast ForWord Language, our first product, builds learning capacity through developing cognitive skills using exercises that specifically focus on oral language comprehension and listening, including phonological awareness (the understanding that words are composed of sounds and the ability to identify and manipulate the sounds of language), listening accuracy and comprehension, working memory, and familiarity with language structures. The Fast ForWord Language product uses acoustically modified speech, which stretches and emphasizes particular sounds in an adaptive manner, to help children learn to quickly isolate and recognize individual speech sounds, an underlying skill critical to reading.

Fast ForWord Middle and High School software is designed for adolescents and teenagers who lack reading proficiency. Its content and exercises are similar to those in Fast ForWord Language, but are delivered in an age-appropriate sports-themed user interface.

Fast ForWord Language to Reading software builds learning capacity while helping students make the link between spoken language and written language, using exercises that focus on word analysis, listening comprehension, working memory, grammar, syntax, and vocabulary.

Fast ForWord Language Basics product, launched in 2005, targets early literacy development and builds visual and sustained auditory attention and sound sequencing cognitive skills.

Reading Series Products

Fast ForWord to Reading isa series of products that build learning capacity through developing cognitive skills using exercises focused on critical reading abilities. Like the Language Series products, the Reading Series products systematically and rigorously apply fundamental neuroscience principles.

The Reading Series exercises focus on phonemic awareness, phonics and decoding, spelling, vocabulary, fluency and comprehension. At the upper levels of the series, students use these products to build 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.)

At the end of 2005, our Reading series consisted of six products, starting at Fast ForWord to Reading Prep (correlated to generally-accepted standards for kindergarten-level skills) and progressing through Fast ForWord to Reading 5 (correlated to fifth grade skills). Fast ForWord to Reading Prep and Fast ForWord to Reading 5 were introduced in 2005.

PRODUCT EFFECTIVENESS

Research by our school district customers, independent academics and our own scientists has demonstrated that Fast ForWord products improve language and reading skills across a broad spectrum of demographic groups, and we continue to accumulate outcomes data from students in classrooms across the country. During 2005 over 135,000 individuals enrolled in Fast ForWord products, and we have accumulated research outcomes on more than 45,000 individuals, including approximately 22,000 controls. Published studies show outcomes from more than 400 sites. 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

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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 important achievement tests.

The underlying basis for these achievement gains is demonstrated by the Stanford University study published in 2003 in the Proceedings of the National Academy of Sciences. This study confirmed that after using the Fast ForWord Language product, students on average experienced significant changes in brain activation patterns as shown by functional magnetic resonance imaging, coupled with significant improvements in reading performance.

LICENSE TERMS

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

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

FAST FORWORD TO LEARNING SERVICES AND SUPPORT

One of our key strategic goals is to broaden market acceptance of our products as effective reading intervention solutions.* We believe that selling more services is critical to achieving that goal because, in order to achieve successful implementations, many school customers require significant implementation support. In 2005, services and support accounted for 25% of revenue, compared to 26% in 2004 and 18% in 2003. At the end of 2005, our service and support organization included 40 employees supplemented by 33 independent contractors who provide on-site customer training and technical services.

SERVICES

School districts have limited resources to support technology at dispersed sites, so they tend to seek products that are easy to implement and maintain. To facilitate effective implementation, we offer on-site product training, technical installation, implementation management, consulting, and professional development services.

To help our customers obtain the best possible student achievement results, our product training and professional development sessions provide an extensive hands-on introduction to our products, “best practices” implementation strategies, and an introduction to the science behind our products. We also offer implementation management services and consulting on data analysis and interpretation, intervention and motivation strategies, connecting with classroom teachers and other topics of interest to the customer.

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

PROGRESS TRACKER

We offer the Progress Tracker Internet-based data analysis and reporting tool to maximize the effectiveness of implementations of the Language and Reading Series products. This easy-to-use web-based tool provides detailed reports on the student, classroom, school and district level, permitting educators to see exactly how individuals and groups are progressing on specific skills. The Progress Tracker system provides both diagnostic and prescriptive information, giving educators timely and specific intervention strategies. Progress Tracker data can be reported by subgroup, providing a tool for educators to analyze their progress towards their Annual Yearly Progress

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requirements, which are mandated by NCLB. Progress Tracker also provides correlations that align the Fast ForWord products to state learning standards and selected core reading programs. Customers can configure the system to send automatic emails to parents, administrators or others to provide easy periodic updates.

SUPPORT

For customers who purchase our support services, we provide progress monitoring, software maintenance releases, and extensive telephone, email and web-based support. Our progress monitoring services provide customers on-going remote monitoring of their students’ progress by our staff, with periodic out-bound telephone contact tailored to the customer’s level of progress and use. Our Customer Connect Website provides extensive implementation and technical resources, together with Web-based seminars. 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.

WARRANTY

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

STRATEGY

Our strategic growth plan focuses on four key elements. Our first key strategic goal is for the mainstream reading intervention market to accept our products as effectively meeting the needs of struggling readers of all grade levels. Critical elements of our strategy to expand our market acceptance are:

• Expanding our product line through product development, partnering and/or acquisition so that we offer a more complete reading intervention product suite;

• Improving the results achieved by our customers by making our implementation, support and service models more systematic, sustainable and effective; and

• Building brand awareness based on our key differentiator – that our products build learning capacity, as well as our patented neuroscience-based technology, and the fast, effective, enduring and proven results of our products.

Our second key strategy is to increase the size of our K-12 sales force while improving sales force productivity. We focus particularly on selling to districts and geographic areas with a high need for our products and sufficient funding to purchase. Initial sales to a school district are typically small with the goal of then moving to a district-level multi-site transaction.

Third, we seek to build a sustainable competitive advantage by both providing credible research demonstrating the efficacy of our products and establishing the importance of scientific method and outcomes research for selecting educational products and services. Our heritage supports us in accomplishing this strategy. Our products are based on more than 30 years of neuroscience and cognitive research, and the technology on which our initial products were developed grew out of a scientific collaboration between neuroscientists from two major research universities. From the founding of our company, we have devoted significant resources to demonstrating that our products improve learning, and we continue to accumulate outcomes data from students in classrooms across the country.

Our final key strategy is to opportunistically position for growth outside the K-12 reading intervention market in United States and Canada. In 2005, we significantly expanded our network of independent value added resellers outside North America, and focused more resources on the corrections market in the United States.

Although we are pursuing our strategy vigorously, we cannot assure you that we will be able to achieve our strategic objectives.

SALES AND MARKETING

We sell to our principal market, K-12 school districts throughout the United States, primarily using a direct sales force. During 2005, our average number of field sales representatives grew by 33% compared to 2004. These sales personnel typically are experienced professionals with backgrounds in selling technology-based curriculum products to the K-12 market. Most bring strong relationships with educators built over many years. We support our sales representatives with a strong field sales management team with extensive experience in this market and with

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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. Our field sales force also sells to the corrections market.

To market our products, we conduct and participate in sponsored events for educational decision-makers, at which we explain the uniqueness and value of the Fast ForWord solution, conduct direct marketing campaigns and participate in selected trade shows. In our marketing, we emphasize the unique characteristics of our solution, our neuroscience research basis, and our proven impact on student achievement. On our scientificlearning.com website, we post results reports documenting the student gains our customers have achieved at schools throughout the U.S.

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 are also building a network of independent value-added resellers outside North America. At December 31, 2005, we had relationships with fifteen resellers. While to date booked sales outside North America have not been significant, our goal is to build this distribution channel as a base for future growth in the longer term.*

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, reputation, existing relationships with customers, completeness of the product offering, ability to provide effective and efficient product implementation, and ability to complement and supplement the school curriculum. We believe that generally 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 learning capacity through improving cognitive skills. 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 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.

RESEARCH AND DEVELOPMENT

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 $3.9 million, $3.6 million, and $3.5 million for the years ended December 31, 2005, 2004 and 2003, respectively. At December 31, 2005, 23 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 solution. All of our current development efforts are focused on products related to reading and language, principally for use in a school environment.

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

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In 2005 we launched two products in our Fast ForWord to Reading series, Fast ForWord to Reading Prep and Fast ForWord to Reading 5. We also launched Fast ForWord Language Basics and extensive enhancements to our Progress Tracker Internet data system. We expect to launch additional products during 2006. We cannot guarantee that we will meet our intended introduction schedule for future products, or that future products will be free of technical issues or be well received in the market.

RESEARCH

Our company was founded by neuroscientists, and our products are based on the learning from more than 30 years of neuroscience and cognitive research. 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. 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.

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 make results available on our Scientific Learning web site.

Researchers at Stanford University are completing a randomized controlled study on the effects of using multiple Fast ForWord products. The study includes students at a wide variety of skill levels, ranging from just below proficient to well below proficient. An advisory board of reading research experts is monitoring the research design, methods and data analyses procedures. The students have completed their Fast ForWord product use, all data has been collected and the researchers are in the process of analyzing the results. We provided a donation to the Haan Foundation to fund a portion of the study.

In 2005, researchers at Hong Kong Polytechnic University completed a controlled study of the impact of the Fast ForWord Language products on Cantonese-speaking children who were poor readers in both English and Chinese relative to their peers. We supported this study by providing complimentary product licenses. A preliminary report of the results indicates that the students who used the Fast ForWord product improved their reading skills in both English and Chinese.

Product Enhancements and New Products

The data that is uploaded to our database from participants who use our products is a unique and 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. 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

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

At December 31, 2005, we held 51 issued U.S. patents and ten pending U.S. applications. We also held four issued patents from other countries and had 11 applications pending abroad. We were the exclusive licensee under 11 issued U.S. patents, three issued foreign patents, and one pending foreign patent application. The U.S. patents expire between 2014 and 2019.

We also have 15 U.S. trademark registrations, including registrations for marks including “Fast ForWord,” our most important trademark.

The patents and applications that we license are owned by the Regents of the University of California and Rutgers, the State University of New Jersey, and relate to the basic speech and sound modification and adaptive technology

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developed at those institutions. In 2005, approximately 53% of our product booked sales were derived from selling products that use the licensed inventions. This license is exclusive and extends for the life of the University patents, which expire in 2014. If we were to lose our rights under this license, it would materially harm our business. This license requires payment of royalties based upon cumulative net booked sales of our products, subject to certain minimum royalty amounts. In 2006 and each year thereafter, the minimum royalty payment is $150,000. In 2005, 2004 and 2003, we had approximately $1,082,000, $746,000 and $939,000, respectively in royalty expense under the license.

In September 2003, we transferred certain of our technology to Posit Science Corporation (“PSC”) (formerly named Neuroscience Solutions Corporation) for use in the healthcare field. The transaction included a license of the patents we own, a sublicense of the patents we license from the University of California and Rutgers, the license of certain software we developed, and the sale of some research-related assets. All of the rights licensed to PSC are limited to the healthcare field and most of the licenses are exclusive in that field. We 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 specified healthcare field.

The rights were acquired by PSC for a combination of cash, stock, and future royalties. The two companies also have agreed to share certain additional technology as it is developed. PSC is a San Francisco-based company that is developing a series of software-based products for healthcare markets based on research in neuroplasticity. PSC’s first products 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 PSC.

SEASONALITY

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

BACKLOG

Our deferred revenue was approximately $17.0 million and $25.8 million at December 31, 2005 and 2004, respectively. These deferred revenues are primarily composed of the portion of multi-year sales, term-based sales, support and Progress Tracker sales not yet recognized as revenue, and professional development and technical services that have not yet been performed. Approximately $5.8 million of our deferred revenue as of December 31, 2005 is expected to be recognized subsequent to December 31, 2006.

ADDITIONAL INFORMATION

As of December 31, 2005, we had 173 full-time and five 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.

In addition to our Customer Connect support website, we also maintain the scientificlearning.com and brainconnection.com websites. Scientificlearning.com provides information about our company and our products and services, including reports detailing our products’ impact on student achievement. 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.

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ITEM 1A. RISK FACTORS

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

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

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

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

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

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

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

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

It is difficult to accurately forecast our future financial results, and we believe that in 2006, our quarterly revenue has become more difficult to predict. This may cause us to fail to achieve the financial performance anticipated by investors and financial analysts, which could cause the price of our stock to decline.

Our booked sales, revenues and net income or loss are difficult to predict and may fluctuate substantially from quarter to quarter as a result of many factors, including those discussed below.

A significant proportion of our customers’ purchases are made within the last two weeks of each quarter. We therefore have limited visibility on actual booked sales for the quarter until the end of the quarter. If a customer unexpectedly postpones or cancels an expected purchase due to changes in the customer’s objectives, priorities, budget or personnel, we may experience an unexpected booked sales shortfall that cannot be made up in the quarter.

The timing of the recognition of revenue from our booked 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.

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Since our December 2004 pricing change, we recognize revenue from most of our perpetual license sales at the time of sale. Before that change, perpetual license revenue was recognized over the related service period. Because of this transition, in 2005 we recognized substantial revenue from perpetual licenses booked in 2003 and 2004, as well as perpetual license sales in 2005. In 2006, we expect that much more of our perpetual license revenue in each quarter will be derived from sales in that quarter.* Because our booked sales are difficult to predict, our quarterly perpetual license revenue has therefore become more unpredictable.

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

Our expense levels are based on our expectations of future booked sales 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 booked sales shortfall, which could cause our net income to fluctuate unexpectedly.

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

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

We believe that cash flow from operations will be our primary source of funding for our operations during 2006 and the next several years.* In 2003 and 2004 we generated $3.9 and $6.3 million respectively in cash from operating activities. In 2005, we used $2.1 million in cash in our operating activities, reflecting the decline in our booked sales and higher expenses to support our growth goals. We expect to again generate positive cash flow from operations in 2006.* This will require us to achieve certain levels of booked sales and expenses.

In addition, we have a line of credit with Comerica Bank totaling $5.0 million, which expires June 2, 2007. At December 31, 2005 no borrowings were outstanding and we were in compliance with the covenants of that line.

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

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

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

Throughout 2005, we have seen educational decision makers grow more cautious in their decision-making, further lengthening our sales cycle.

The restatement of our financial statements has increased the possibility of legal or administrative proceedings against us.

In December 2004, based on our review of a major contract that we booked in June 2004, our management and the Audit Committee of our Board of Directors concluded that we should change our revenue recognition method for most of our K-12 school contracts. This change in our revenue recognition method reflected a correction in our application of AICPA Statement of Position 97-2, Software Revenue Recognition (as amended by Statement of

Page 14

Position 98-9) to most of our historical K-12 school contracts. As a result, we restated our financial statements for the period from 2000 through June 30, 2004, as described in more detail in our Report on Form 10-K/A for the year ended December 31, 2003, our Reports on Form 10-Q/A for the quarters ended March 31, 2004 and June 30, 2004 and our Report on Form 10-Q for the quarter ended September 30, 2004, all filed February 15, 2005.

In May 2005 our management determined that a portion of 2004 deferred revenue had been misclassified as long-term deferred revenue when it should have been classified as current deferred revenue. As a result, we restated our balance sheet as of December 31, 2004 in our Report on Form 10-K/A for the year ended December 31, 2004, filed on May 26, 2005.

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.

• There is a risk that our investors may bring a class action lawsuit against us and our directors and officers based on the restatement of our historical financial statements. 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. If such actions were brought and we did not prevail, we could be required to pay substantial damages or settlement costs.

• There is a risk that the Securities and Exchange Commission may undertake an investigation of our company in light of the restatement of our 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.

In addition, the restatement reflected a material weakness in our internal control over financial reporting and disclosure controls and procedures. To address this material weakness, we hired additional accounting staff and implemented changes in our processes, procedures and controls relating to revenue and deferred revenue. Although our management has concluded and the Audit Committee has concurred that, at December 31, 2005, we no longer have a material weakness in our internal control over financial reporting, we cannot assure you that we will not detect additional material weaknesses in our internal control over financial reporting in the future, further compounding the risks identified above.

We may be unable to continue to be profitable.

We started operations in February 1996 and through 2002 incurred significant operating losses. We first became profitable in 2003, incurred a net loss in 2004 and were again profitable in 2005. We expect that in 2006 we will record a net loss,* partially because of the implementation of FAS 123(R), which requires us to record compensation expense for employee stock awards. At December 31, 2005, we had an accumulated deficit of approximately $78.1 million from inception.

Our strategic and operating goals include increasing our booked sales and cash flow. In 2005, our booked sales fell approximately 15% from 2004. Our ability to achieve increased booked sales and cash flow depends on many factors, including but not limited to market acceptance of our products, availability of funding, customers’ prior experience with our products, and general economic conditions, some of which are outside of our control. To meet our booked sales targets, we will need to incur substantial expenditures. We cannot assure you that we will meet our targets with respect to booked sales, revenues or operating results.

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

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

• The results of studies depend on schools’ appropriately implementing the products and adhering to the product protocol. If a school does not do so, the study may not show that our products produce substantial student improvements.

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• Some studies on which we rely may be challenged because the studies use a limited sample size, lack a randomly selected control group, include assistance or participation from the Company or its scientists, or have other design characteristics that are not optimal. These challenges may assert that these studies are not sufficiently rigorous or free from bias, and may lead to criticism of the validity of the studies and the conclusions that we draw from them.

• Schools studying the effectiveness of our products use the product with different types of students and use different assessments, sometimes making it difficult to aggregate or compare results.

Our sales and marketing efforts, as well as our reputation, could be adversely impacted if the studies upon which we rely to demonstrate the effectiveness of our products, or the conclusions we draw from those studies, are seen to be insufficient. The recent federal NCLB legislation has placed an increasing emphasis on the need for scientifically-based research. To the extent that scientifically based research becomes more important to the education market, challenges to the research that we use in marketing our products could become more potentially harmful to us.

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

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

We may experience difficulties in launching new products efficiently, without significant technical issues, and on schedule. This could materially slow booked sales or decrease profitability.

We launched three new products in 2005 and we expect to launch additional products in 2006 and future years.* Unexpected challenges could make these development projects longer or more expensive than planned. In addition, new technology products usually contain bugs that are not discovered in the testing process, and tend to be more challenging to implement when they are first introduced, especially in the diverse and challenging K-12 technology environment. Any significant defect or deficiency in our products could cause customers to cancel or delay orders, cause us to incur significant expenses remedying the problem, and harm our reputation.

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

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

We believe that the funding for a substantial portion of our K-12 booked sales comes from federal funding, in particular special education and Title 1 funding. The current federal budget deficit and competing federal priorities may impact the availability of federal education funding. A cutback in federal education funding could slow our booked sales.

State and local school funding can be significantly impacted by fluctuations in tax revenues due to changing economic conditions. We expect that future levels of state and local school spending will continue to be significantly affected by the general economic conditions and outlook. A downturn in the economy might slow our booked sales. Increased energy costs for schools may also affect the level of resources available for purchasing our products.

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

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The market in which we operate is very competitive. While our products are highly differentiated by their neuroscience basis and their focus on the development of cognitive skills, we nevertheless compete vigorously for the funding available to schools. We compete not only against other software-based reading intervention products but also against print and service-based offerings from other companies and against traditional methods of teaching language and reading. Many of the companies providing these competitive offerings are much larger than 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, new competitors may enter our market segment and offer actual or claimed results similar to those achieved by our products. In addition, although traditional approaches to language and reading are fundamentally different from our approach, the traditional methods are more widely known and accepted and, therefore, represent significant competition for available funds.

We are not yet required to comply with Sarbanes-Oxley Section404. We are presently engaged in a process of evaluating and documenting our internal control over financial reporting with the goal of achieving compliance no later than the end of 2007. The process is very costly and requires significant internal resources. If we are unable to comply with Section 404 when we are required to do so or are unable to conclude that our internal control over financial reporting is effective, such non compliance or ineffective controls could have a materially adverse effect on us.

Under Sarbanes-Oxley Section 404, as implemented by the SEC and PCAOB, we will be required to provide a management report and auditors’ attestation and report on our internal control over financial reporting. We have not previously been subject to this requirement. Under current rules, our deadline for compliance will be December 31, 2007, but it could be accelerated to December 31, 2006 if we become an “accelerated filer” under the US securities laws as of December 31, 2006. We will not know whether we will become an “accelerated filer” as of December 31, 2006 until June 30, 2006.

Historically, we have understood the importance of internal control over financial reporting, and on an ongoing basis, we evaluate our controls, assess whether we should improve them and when appropriate, implement improvements. In connection with our restatements in 2005, we concluded that we had a material weakness in our internal controls relating to revenue and deferred revenue. To address this material weakness, we hired additional accounting staff and we implemented changes in our processes, procedures and controls relating to revenue and deferred revenue. In connection with the audit of our financial statements for the year ended December 31, 2005, management concluded and the Audit Committee concurred that, at December 31, 2005, we no longer have a material weakness in our internal control over financial reporting. We cannot assure you that, in the course of implementing our processes to achieve compliance with Section 404, we will not detect additional material weaknesses in our internal control over financial reporting.

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

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

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

Our ability to compete effectively depends in part on whether we are able to maintain the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. It is possible that our issued patents will not offer sufficient protection against competitors with similar technology, that our trademarks will be challenged or infringed by competitors, or that our pending patent applications will not result in the issuance of patents. 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.

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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.

Our directors and executive officers and their affiliates effectively control the voting power of our company.

At December 31, 2005, Warburg, Pincus Ventures, our largest shareholder, owned approximately 46% of the Company’s outstanding stock and, in the aggregate, our directors and executive officers and their affiliates held more than 60% 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 National Market, and our trading volume is low. For example, during 2005, our average daily trading volume was approximately 15,111 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.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable

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

On July 15, 2005, SkyTech, Inc. (“SkyTech”) filed a complaint against us in the District Court for the State of Minnesota, Fourth Judicial District, alleging claims of fraud, breach of contract, breach of duty of good faith and fair dealing, tortious interference, and indemnity. SkyTech alleged that it entered into an independent sales representative agreement (the “Agreement”) with us in October 2002 pursuant to which it has an exclusive right to market our products to the “After School” market. SkyTech further alleged that we prevented SkyTech’s performance of the Agreement and that we wrongly terminated the Agreement. SkyTech asserted that it was entitled to an unspecified amount of damages comprised of lost commissions and other damages, attorney’s fees, costs and punitive damages. In addition to the SkyTech claims, SkyLearn, L.L.C and HEK, Inc., both of which claimed to be subcontractors of SkyTech, claimed that they suffered damages from our alleged actions with respect to SkyTech. In December 2005, the court granted our motion to dismiss the case and to compel arbitration. The Plaintiffs have filed an appeal of the ruling, as well as a motion to amend the ruling and to amend their complaint.

In October 2005, we initiated an arbitration proceeding before the American Arbitration Association in San Francisco, California. Our arbitration complaint alleges that SkyTech owes us for training charges that remain unpaid under the Agreement and seeks declaratory relief regarding SkyTech’s claims against us. SkyTech has asserted counterclaims against us in the arbitration, repeating the claims made in the Minnesota case and asserting damages of $10 million. An arbitrator has been appointed and a schedule for briefing initial motions has been established.

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

None.

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EXECUTIVE OFFICERS

The following table sets forth various information concerning our executive officers, as of March 10, 2006:

NAME	AGE	POSITION
Robert C. Bowen	64	Chairman and Chief Executive Officer
Linda L. Carloni	52	Vice President, General Counsel and Secretary
Glenn G. Chapin	50	Vice President, Sales
Jane A. Freeman	52	Sr. Vice President, Chief Financial Officer, and Treasurer
Dr. William M. Jenkins	55	Sr. Vice President, Product Development
Gillian A. McCormack	50	Vice President, Operations

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

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

Glenn G. Chapin joined the Company 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.

Jane A. Freeman joined us as Vice President, Finance and Treasurer in August 1999 and was named Chief Financial Officer in January 2000. She was appointed Senior Vice President in January 2004. She also served as our Vice President Business Development from August 1999 until June 2000. Prior to joining us, Ms. Freeman spent 20 years in the investment business. From 1988 through 1998, she was employed by Rockefeller & Co., a global investment firm, where she led the global asset allocation process, managed the US Small Cap equity product and served on the Management Committee of the firm. She is a director of 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. Jenkins was 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 the University of California, San Francisco. Dr. Jenkins is the principal developer of our current software products. Dr. Jenkins holds a B.S. in Psychology, an M.A. in Psychobiology and a Ph.D. in Psychobiology from Florida State University, with additional post-doctoral training from UCSF.

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

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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 National Market under the symbol

“SCIL”. From December 31, 2003 until July 2004, our common stock was traded on the Nasdaq Small Cap 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 or the Nasdaq Small Cap Market, as applicable.

2004	High	Low
First Quarter	$7.40	$5.00
Second Quarter	$6.49	$4.96
Third Quarter	$6.84	$5.18
Fourth Quarter	$6.00	$4.71

2005	High	Low
First Quarter	$6.11	$5.25
Second Quarter	$6.58	$5.80
Third Quarter	$6.58	$4.97
Fourth Quarter	$5.65	$4.45

Holders. As of January 31, 2006, the approximate number of stockholders of record of our common stock was 119.

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.

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

(b) Not applicable

(c) Not applicable

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ITEM 6.	SELECTED FINANCIAL DATA
	In thousands, except per share amounts

	2005			2004			2003			2002			2001
Statement of Operations Data:
Revenues:
Products	$	30,263		$	22,802		$	24,491		$	17,879		$	11,702
Service and support		10,056			8,174			5,425			3,958			3,023
Total revenues		40,319			30,976			29,916			21,837			14,725
Cost of revenues:
Products		2,018			1,775			2,127			2,109			1,857
Service and support		5,637			4,981			3,872			1,502			2,402
Total cost of revenues		7,655			6,756			5,999			3,611			4,259
Gross profit		32,664			24,220			23,917			18,226			10,466
Operating expenses:
Sales and marketing		17,619			16,087			12,961			14,554			19,701
Research and development		3,896			3,555			3,500			2,985			3,390
General and administrative		5,841			5,313			4,529			4,776			6,348
Restructuring		—			—			(7	)		3,365			2,608
Total operating expenses		27,356			24,955			20,983			25,680			32,047
Operating income (loss)		5,308			(735	)		2,934			(7,454	)		(21,581	)
Other income from related party		50			99			448			—			—
Interest income (expense), net		421			(100	)		(1,209	)		(1,241	)		(1,032	)
Net income (loss) before income tax		5,779			(736	)		2,173			(8,695	)		(22,613	)
Income tax (benefit) provision		182			(43	)		43			—			—
Net income (loss)	$	5,597		$	(693	)	$	2,130		$	(8,695	)	$	(22,613	)
Basic net income (loss) per share	$	0.33		$	(0.04	)	$	0.13		$	(0.56	)	$	(1.92	)
Shares used in computing basic net income   (loss) per share		16,715			16,408			16,007			15,642			11,777
Diluted net income (loss) per share:	$	0.31		$	(0.04	)	$	0.13		$	(0.56	)	$	(1.92	)
Shares used in computing diluted net income   (loss) per share		18,023			16,408			16,908			15,642			11,777
Balance Sheet Data:
Cash and cash equivalents	$	9,022		$	10,281		$	3,648		$	4,613		$	4,610
Short-term investments		3,043			—			—			—			1,169
Working capital		2,842			(3,986	)		(11,331	)		(10,879	)		(1,010	)
Total assets		18,734			22,958			15,597			18,531			23,228
Long-term debt, including current
portion		—			—			—			5,000			10,000
Stockholders’ deficit (1)		(1,835	)		(8,111	)		(8,544	)		(11,363	)		(3,247	)

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

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

Overview

We develop and distribute the Fast ForWord family of reading intervention software. Our innovative products build learning capacity by vigorously and systematically applying neuroscience principles to improve 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. For the twelve months ended December 31, 2005 and 2004, K-12 schools in the U.S. accounted for 90% and 91% of booked sales, respectively. From our inception to the end of December 2005, approximately 3,800 schools in the US had purchased at least $10,000 of our Fast ForWord product licenses and services, and during 2005 over 135,000 individuals enrolled in one of our products. As of December 31, 2005 we had 173 full-time employees, compared to 160 at December 31, 2004.

Business Highlights

The K-12 education market is large. According to the National Center for Education Statistics, there are 54 million K-12 students with the number growing to nearly 57 million in 2014. Eduventures, a strategic consulting firm in the education industry, has estimated that in 2003, K-12 schools spent $3.3 billion on supplemental content for all subject areas. Another market gauge, provided by the Education Market Report’s Complete K-12 Newsletter (July 2005), estimated the market for all educational software at approximately $800 million for the 2004 – 2005 school year. This represents growth of approximately 10% over 2003-2004, compared to declining or flat sales in the years from 2001 to 2004.

According to a recent survey by the National Conference of State Legislatures, state budget conditions continue to improve.* State budget overruns are declining, although states still report increasing spending demands for Medicaid and other health care programs, corrections, education and other priorities.*

Among the federal education programs, we believe that Title 1 and IDEA (special education) have been the most significant sources of funds for purchases of Fast ForWord licenses. The 2006 federal appropriations for these programs are at approximately the same level as in 2005. The current federal budget deficit and competing priorities, however, may impact the continuing availability of federal education funding.

The federal No Child Left Behind (NCLB) Act of 2001 established reading achievement, grade level proficiency, and accountability through assessment as important national priorities. NCLB also emphasizes the need to use proven practices and products grounded in scientifically based research to improve student performance. Our products align well with the emphases of NCLB, and we believe that this alignment assists us in marketing and selling our products.

Company Highlights

In 2005 total booked sales declined 15% compared to 2004 as K-12 booked sales were down 17%. This compares to a booked sales increase of 21% in 2004 compared to 2003. We attribute our booked sales decline to our earlier sales focus on very large transactions in urban districts, which are extremely unpredictable, as well as to increased caution among buyers, which extended our selling cycle. In addition, funding uncertainty in Texas, one of our key states, and sales management issues in our Southwest region also contributed to the booked sales decline. During 2004, we closed a major contract with the School District of Philadelphia, with a total contract price of $10.4 million, of which $6.0 million was recorded as booked sales in 2004. An additional $1.4 million was recorded as booked sales in 2005 and the remainder of the contract is scheduled to be booked over the next three calendar years.* The School District of Philadelphia transaction represented a major expansion of an existing customer. We had no transactions of similar size in 2005.

One of our major goals continues to be increasing the number of large booked sales, typically expansions of existing implementations, which we believe to be an important indicator of mainstream education industry acceptance and an important factor in the productivity of our sales force.* In 2005, we closed 59 transactions in excess of $100,000

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compared to 66 in 2004 and 59 in 2003. Larger booked sales tend to have a longer sales cycle and involve a more complex decision process. Increases in the proportion of our business from these large booked sales may cause increased fluctuations and unpredictability in the timing of our booked sales and revenue.* As discussed before, the characteristics of our public school market cause us to have a somewhat long and unpredictable sales cycle. During 2005, we saw educational decision makers grow more cautious in their decision-making, which led to the lengthening our sales cycle.

In 2005 our revenue grew 30% over 2004 to $40.3 million. This revenue growth was in contrast to a 15% decline in booked sales. The divergence of booked sales and revenue is primarily attributable to our December 2004 pricing change which has resulted in a higher proportion of booked sales being recognized as revenue up front. As a result of this pricing change, we now recognize revenue for most sales of perpetual licenses at delivery, rather than ratably over the related support period. In 2005, therefore, we recognized substantial revenue both from sales booked in 2004 and 2003 and from sales booked in 2005. Historically, booked sales have been greater than revenue. In 2004 booked sales were $37.3 million and revenue was $31.0 million. Due primarily to the December 2004 pricing change, 2005 was unusual — booked sales were $31.5 million and revenue was $40.3 million.

In 2006 we expect revenue to decline as compared to 2005.* Primarily as a result of our December 2004 pricing change, we began 2006 with significantly less current deferred revenue than at the beginning of 2005. We expect that in 2006 we will recognize substantially less perpetual license revenue from prior years’ booked sales than we did in 2005 and prior years.* We also expect that we will return to our historical pattern of booked sales exceeding revenue, and deferred revenue therefore growing during the 2006 year.*

We reported net income of $5.6 million in 2005, compared to net loss of $0.7 million in 2004. This net income results from higher revenues more than offsetting expense increases in employee compensation, consulting, travel, marketing, legal and audit. Additionally, incentive compensation and commissions decreased from the prior year due to the decrease in booked sales. We expect to report a net loss in 2006, partly because of the implementation of FAS 123(R).

We ended 2005 with $12.1 million in cash and short-term investments, and with no debt. We did not make use of our credit line during 2005. Net cash used in operating activities was $2.1 million. This negative cash flow from operations was the first since 2002 and was the result of the decreased booked sales.

Results of Operations

Revenues

	Year ended December 31,
(dollars in thousands)	2005		Change		2004		Change		2003
Products	$	30,263		33%	$	22,802		-7%	$	24,491
Service and support		10,056		23%		8,174		51%		5,425
Total revenues	$	40,319		30%	$	30,976		4%	$	29,916

2005 revenue compared to 2004: The increase in product revenue primarily reflected our December 2004 pricing change that eliminated the initial license fee for our Progress Tracker online product. This change in our pricing structure resulted in a far higher proportion of booked sales from the current period being recognized into revenue than during the comparable periods in 2004. For the year ended December 31, 2005, approximately $15.5 million, or 49%, of total booked sales were recognized as revenue in the quarter in which the sale occurred. For the comparable periods in 2004, a negligible amount of booked sales was recognized into revenue in the quarter of sale. Our December 2004 strategic pricing change had little impact in 2004, because the software for many December perpetual licenses was not delivered until January 2005. The impact on January 2005 revenue from products shipped in December 2004 was approximately $2.0 million.

Service and support revenues continued to increase, primarily due to increased sales of on-site services. Service and support revenue also increased as a result of the increase in the number of schools purchasing ongoing Progress Tracker access and support

2004 revenue compared to 2003: The decline in 2004 product revenue compared to 2003 was largely attributable to only modest growth in 2003 booked sales coupled with a shift in sales mix in 2004 towards multi year contracts with

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longer revenue recognition periods. During 2003 and 2004, the majority of our product license sales were initially recorded as deferred revenue and recognized to revenue over the support term. Because the support term frequently crosses over two fiscal years, our 2003 license sales affected product revenue in both 2004 and 2003. Product revenue in 2004 was also negatively affected by more volume discounts due to an increasing proportion of large sales in 2004 and 2003.

Service and support revenues increased, primarily due to increased sales of on-site services. Service and support revenue also increased as a result of the increase in the number of schools purchasing ongoing Progress Tracker access and support contracts.

Future revenue: As a result of our December 2004 strategic pricing change, during 2005 we recognized current booked sales from perpetual licenses into revenue substantially more quickly than we did in 2004. See Revenue Recognition below for more detail about our revenue recognition policies. At the same time, we have continued to recognize deferred revenue from prior years’ perpetual license sales. As a result of this non-recurring impact from our transition to a different pricing structure, we expect revenue to decline in 2006.*

Booked sales and selling activity: Booked sales is a non-GAAP financial measure that management uses to evaluate current selling activity. We believe that booked sales is a useful metric for investors as well as management because it is the most direct measure of current demand for our products and services. Booked sales equals the total value (net of allowances) of software, services and support invoiced in the period. Revenue on a GAAP basis is recorded for booked sales when all four of the requirements for revenue recognition have been met; if not, the sale is booked to deferred revenue. We use booked sales information for resource allocation, planning, compensation and other management purposes. We believe that revenue is the most comparable GAAP measure to booked sales. However, booked sales should not be considered in isolation from revenues, 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 twelve months ended December 31, 2005, 2004 and 2003.

	Year ended December 31,
(dollars in thousands)		2005		Change		2004	Change		2003
Booked sales	$	31,538		(15%)	$	37,260	21%	$	30,704
Less revenue	$	40,319		30%	$	30,976	4%	$	29,916
Net increase/(decrease) in deferred revenue		($8,781	)		$	6,284		$	788
Total deferred revenue end of period	$	17,003		(34%)	$	25,784	32%	$	19,500

Booked sales in the K-12 sector, which accounted for 90% of booked sales in 2005, declined 17% to $28.4 million, compared to $34.3 million in 2004. Booked sales in the K-12 sector were $27.9 million in 2003. We sold 673 site license packages over $10,000 in 2005, compared to 1,013 in the same period in 2004 and 862 in 2003.

We believe that the principal reasons for our decline in 2005 booked sales are to our earlier sales focus on very large transactions in urban districts, which are extremely unpredictable, as well as to increased caution among buyers, which extended our selling cycle. In addition, funding uncertainty in Texas, one of our key states, and sales management issues in our Southwest region also contributed to the booked sales decline

We believe large booked sales are an important indicator of mainstream education industry acceptance and an important factor in reaching our goal of increasing sales force productivity.* In 2005 we continued to focus our sales force on multi-site sales. The number of booked sales over $100,000 declined to 59 in 2005 from 66 in 2004 and 59 in 2003. For the twelve months ended December 31, 2005, 59% of our K-12 booked sales were realized from sales over $100,000. For the comparable periods ending December 31, 2004 and 2003, large booked sales accounted for 67% and 56% of booked sales respectively.

Both 2005 and 2004 included large transactions with the School District of Philadelphia. The transaction was $10.4 million, with $6.0 million booked in 2004 and another $1.4 million booked in 2005. The remaining $3.0 million is scheduled to be recorded as booked sales in the coming three years.* Large booked sales include volume discounts but the percentage discount applicable to any given transaction will vary and the relative percentage of large sales and smaller sales in a given quarter may fluctuate. Because we discount product license fees but do not discount service and support fees, product booked sales and revenue are disproportionately affected by discounting. We cannot predict the size, number and timing of large transactions in the future.*

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Booked sales outside the K-12 market (primarily private practice clinicians and international customers) increased by 2% in 2005, compared to a 7% increase in 2004 over 2003. We believe we have stabilized our booked sales to this market and expect to hold near the current level in 2006 and may even experience modest growth due to increased booked sales to international customers.* Our primary focus remains the U.S. K-12 market.

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

Gross Profit and Cost of Revenues

	Year ended December 31,
(dollars in thousands)	2005			2004			2003
Gross profit on products	$	28,245		$	21,027		$	22,364
Gross profit margin on products		93	%		92	%		91	%
Gross profit on service and support		4,419			3,193			1,553
Gross profit margin on services and support		44	%		39	%		29	%
Total gross profit	$	32,664		$	24,220		$	23,917
Total gross profit margin		81	%		78	%		80	%

The overall gross profit margin improved in 2005 compared to 2004, as margin improved in both products and services and support. Revenue mix in 2005 was only slightly different from 2004, as we had 75% of revenues from products in 2005, versus 74% in 2004 and 82% in 2003. The remainder of revenues in each year was from services and support. The overall gross profit margin declined in 2004 compared to 2003, as margin improvements in both products and services and support were more than offset by revenue mix changes. In 2006, we expect that product revenues will comprise a lower percentage of revenues than in either 2004 or 2005.* As a result of the revenue mix shift, in 2006 we expect slightly lower overall gross profit margins than in 2005.*

Service and support margins have improved over the past three years as we have increased the sales of services to our customers, significantly increased Progress Tracker revenues and maintained our support base. Due to the semi fixed cost nature of services and support, revenue growth has resulted in margin improvement.

Product costs consist of manufacturing, packaging and fulfillment costs, amortization of capitalized software and royalties. Product margin improvement of 1% for the twelve months ended December 31, 2005, compared to the same period in 2004, was due to improvement in materials and fulfillment (0.8%), the amortization of software development costs (0.6%), partially offset by an increase in royalties (0.3%). Product margins in 2004 were 1.0% better than in 2003, as improvements in royalties (0.5%) and the amortization of software development (1.0%) were only partially offset by rising materials and fulfillment costs (0.6%).

Operating Expenses

	Year ended December 31,
(dollars in thousands)	2005		Change		2004		Change		2003
Sales and marketing	$	17,619		10%	$	16,087		24%	$	12,961
Research and development		3,896		10%		3,555		2%		3,500
General and administrative		5,841		10%		5,313		17%		4,529
Restructuring		—		n/a		—		n/a		(7	)
Total operating expenses	$	27,356		10%	$	24,955		19%	$	20,983

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Sales and Marketing: In 2005, our sales and marketing expenses increased due to increased sales and marketing staff and marketing activities, partially offset by commissions and incentive compensation which were 49%, or $2.1 million, lower than in 2004 as a result of lower booked sales. In 2004, our sales and marketing expenses increased primarily due to increased sales and marketing staff, more marketing activities and higher commissions reflecting higher booked sales. 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, 2005, we had 36 field-based quota-bearing sales personnel selling to public schools, compared to 32 and 30 at December 31, 2004 and 2003 respectively. We expect to continue to add sales people during 2006 and to continue to invest in marketing activities.*

Research and Development: Research and development expenses increased 10% in 2005 due primarily to compensation expenses related to additional staff. Research and development expenses increased 2% in 2004 compared to 2003, but decreased as a percentage of revenue. 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. We expect research and development expenses to stabilize in 2006 even as we continue to invest in improving our current product suite, demonstrating product efficacy and introducing new products.*

General and Administrative: General and administrative expenses increased in 2005 primarily due to additional accounting staff and audit and tax fees, partially offset by a decline in incentive compensation. General and administrative expenses increased in 2004 over 2003 primarily due to the expenses associated with the restatement of our financial results and to the addition of staff. Accounting and legal fees associated with the restatement that were expensed in 2005 totaled approximately $380,000. 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.

Stock-based Compensation: We are required to implement SFAS 123(R) beginning January 1, 2006. This will require us to record compensation expense for employee stock awards. We expect that the implementation of SFAS 123(R) will significantly increase our operating expenses.*

Restructuring: 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. Compared to the prior lease, 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 was paid in 2004 and all restructuring expenses have been paid as of December 31, 2004. No payments of previously expensed restructuring charges or new restructuring charges occurred in 2005.

Other Income from Related Party

In September 2003, we signed an agreement with Posit Science Corporation (“PSC”), transferring our patented technology to PSC for use in the health field. During the twelve months ended December 31, 2005, 2004 and 2003 we recorded $50,000, $99,000 and $448,000 respectively, for royalties received and services provided to PSC. Amounts received to date and any future receipts are being reported as other income as we do not consider these royalties to be part of our recurring operations.

Interest Expense, net

	Year ended December 31,
(dollars in thousands)	2005		Change		2004			Change		2003
Interest income (expense), net	$	421		-521%		($ 100	)		-92%		($1,209	)

Interest income/(expense), net, increased in 2005 as a result of no borrowings or deferred financing amortization and substantial cash balances during 2005. We received interest on our cash balances and on our outstanding officer loans. The amortization of deferred financing was completed in the third quarter of 2004. Interest expense decreased in 2004, compared to 2003. Deferred financing costs were fully amortized in the quarter ended September 30, 2004. Deferred financing expense was $232,000 in 2004 compared to $1.2 million in 2003.

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Income Tax Provision (Benefit)

We have recorded a tax provision of $182,000 for the year ended December 31, 2005. The tax provision principally consists of federal and state taxes currently payable offset by the utilization of net operating losses resulting in an effective tax rate of 3.1%. We recorded a tax benefit of $43,000 for the year ended December 31, 2004 relating to the reversal of a provision for U.S. federal alternative minimum tax for the year ended December 31, 2003. At December 31, 2005, we had net operating loss carryforwards for federal income tax purposes of approximately $69 million. Unutilized net operating loss carryforwards will expire in the years 2011 through 2024. 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, 2005, we had approximately $30.0 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. Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”) provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and previously reported net losses, at December 31, 2005 we continue to maintain a full valuation allowance against our remaining net deferred tax assets as they are not yet realizable.

Liquidity and Capital Resources

Our cash, cash equivalents and short-term investments were $12.1 million at December 31, 2005 compared to $10.3 million at December 31, 2004 and $3.6 million at December 31, 2003. During 2005, we used cash from operating activities of $2.1 million compared to 2004 and 2003 when we generated cash from operations of $6.3 million and $3.8 million, respectively. At December 31, 2005 there were no borrowings outstanding under our credit line.

Net cash used by operations in 2005 was $2.1 million, compared to cash generated by operations of $6.3 million in 2004 and $3.8 million in 2003. Net cash used in operating activities declined in 2005 due to lower booked sales and higher expenses. Overall, our receivable collection experience remained strong. There were no payments for previously expensed restructuring charges for the twelve months ended December 31, 2005. For the comparable period in 2004 the payments for previously expensed restructuring charges were $1.8 million.

Net cash generated by investing activities in 2005 was $0.4 million, consisting of the purchase of hardware and software of $0.2 million and the purchase of $3.0 million of short-term investments, which were more than offset by the repayment of $3.6 million of officer loans. Net cash used in investing activities in 2004 was $0.6 million and in 2003 was $0.3 million, both consisting of the purchase of computer hardware and software. We intend to make systems investments in 2006.*

Financing activities generated $0.5 million in 2005, compared to $0.9 million in 2004, each from the sale of stock upon option exercises and through purchases of stock through the employee stock purchase plan. In 2003, the sale of stock was offset by the repayment of $5.0 million, net, on our credit line. In 2004, we borrowed and repaid $3.0 million, resulting in no net activity. There was no borrowing on our credit line in 2005.

Because our booked sales tend to be seasonal, we may have negative cash flows in particular quarters, particularly the first quarter, when booked sales tend to be substantially lower than in other quarters. We borrowed money for working capital purposes in the first quarter of 2004 and may borrow again from time to time.* No funds were borrowed in 2005.

We have a line of credit with Comerica Bank totaling $5.0 million which expires June 2, 2007. The line is subject to limitations based on our quick ratio and tangible net worth. Borrowings under the line are subject to various covenants, which may limit our financial and operating flexibility. There was no borrowing outstanding under the line at December 31, 2005 and we have no current intentions of borrowing any funds.*  At December 31, 2005 we were in compliance with all our covenants.

We expect that cash flow from operations will continue to be our primary source of funds for the next several years.* Again, this will require us to achieve certain levels of booked sales. If we are unable to achieve sufficient levels of cash flow from operations, we may seek other sources of debt or equity financing, or may be required to reduce expenses. Reducing our expenses could adversely affect our operations by reducing the resources available

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for sales, marketing, research or development efforts. We cannot assure you that we will be able to secure additional debt or equity financing on acceptable terms.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Contractual Obligations and Commitments

We have a non-cancelable lease agreement for our corporate office facilities. The minimum lease payment is approximately $78,000 per month through 2008. After 2008 the base lease payment increases at a compound annual rate of approximately 5%. The lease expires in December 2013.

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

The following table summarizes our obligations at December 31, 2005 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
Non-cancelable operating leases	$	8,227	$	940	$	1,880	$	2,016	$	3,391
Minimum royalty payments		1,350		150		300		300		600
Total	$	9,577	$	1,090	$	2,180	$	2,316	$	3,991

Our purchase order commitments at December 31, 2005 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. 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 were due December 31, 2005. During the twelve months ended December 31, 2005 we received $3.6 million in loan repayments, including interest. At December 31, 2005 there was a remaining balance due of $297,000. This represents principal and interest from one of the former officers. Subsequent to December 31, 2005, we received the balance due in the form of cash and stock.

Application of Critical Accounting Policies

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

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

Revenue Recognition

We derive revenue from the sale of licenses to our software and from service and support fees. Software license revenue is recognized in accordance with AICPA Statement of Position 97-2, “Software Revenue Recognition,” as amended by Statement of Position 98-9 (SOP 97-2). SOP 97-2 provides specific industry guidance and four basic criteria, which must be met to recognize revenue. These are: 1) persuasive evidence of an arrangement exists; 2)

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delivery of the product has occurred; 3) a fixed or determinable fee; and 4) the probability that the fee will be collected. The application of SOP 97-2 requires us to exercise significant judgment related to our specific transactions and transaction types.

Sales to our school customers typically include multiple elements (e.g., Fast ForWord software licenses, Progress Tracker, our Internet-based participant tracking service, support, training, implementation management, and other services). We allocate revenue to each element of a transaction based upon its fair value as determined in reliance on “vendor specific objective evidence” (“VSOE”), if VSOE exists for each element. If we do not have VSOE for one or more delivered elements in an arrangement (typically software), we recognize revenue using the residual method, whereby the difference between the total arrangement fee and the total fair value of the undelivered elements is recognized as revenue relating to the delivered elements. VSOE of fair value for each element of an arrangement is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is also measured by the renewal price. We are required to exercise judgment in determining whether VSOE exists for each undelivered element based on whether our pricing for these elements is sufficiently consistent.

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

Product revenue

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

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

• Term licenses – software licensed for a specific time period, generally three to twelve months. Revenue is recognized ratably over the license term.

• Individual participant licenses – software licensed for a single participant. Revenue is recognized over the average period of use, typically six weeks.

Service and support revenue

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

Allowance for Doubtful Accounts

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

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 revolving credit facility with Comerica Bank. Interest rates on loans extended under that facility are at a floating prime rate, or a fixed rate of LIBOR plus 2.5%. A hypothetical increase or decrease in market interest rates by 10% from the market interest rates at December 31, 2005 would not have a material affect on our results of operations.

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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 as of December 31, 2005 and 2004 and the related statements of operations, stockholders deficit, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Scientific Learning Corporation as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

San Francisco, California

February 15, 2006

Page 31

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

	December 31, 2005			December 31, 2004
Assets
Current assets:
Cash and cash equivalents	$	9,022		$	10,281
Short-term investments		3,043			—
Accounts receivable, net of allowance for doubtful accounts        $81 and $121 at December 31, 2005 and 2004, respectively		3,519			5,661
Notes and interest receivable from current and former officers		297			3,688
Prepaid expenses and other current assets		1,312			1,306
Total current assets		17,193			20,936
Property and equipment, net		469			755
Other assets		1,072			1,267
Total assets	$	18,734		$	22,958
Liabilities and stockholders’ deficit
Current liabilities:
Accounts payable	$	214		$	603
Accrued liabilities		2,966			4,338
Deferred revenue		11,171			19,981
Total current liabilities		14,351			24,922
Deferred revenue, long-term		5,832			5,803
Other liabilities		386			344
Total liabilities		20,569			31,069
Commitments and contingencies
Stockholders’ deficit:
Preferred stock, $0.01 par value; 1,000,000 shares authorized,        no shares issued or outstanding		—			—
Common stock, $0.01 par value; 40,000,000 authorized,        16,799,058 and 16,657,589 shares issued and outstanding        at December 31, 2005 and 2004, respectively, and        additional paid-in capital		76,265			75,586
Accumulated deficit		(78,100	)		(83,697	)
Total stockholders’ deficit:		(1,835	)		(8,111	)
Total liabilities and stockholders’ deficit	$	18,734		$	22,958

See accompanying notes.

Page 32

SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)

	Year ended December 31,
	2005		2004			2003
Revenues:
Products	$	30,263	$	22,802		$	24,491
Service and support		10,056		8,174			5,425
Total revenues		40,319		30,976			29,916
Cost of revenues:
Cost of products		2,018		1,775			2,127
Cost of service and support		5,637		4,981			3,872
Total cost of revenues		7,655		6,756			5,999
Gross profit		32,664		24,220			23,917
Operating expenses:
Sales and marketing		17,619		16,087			12,961
Research and development		3,896		3,555			3,500
General and administrative		5,841		5,313			4,529
Restructuring		—		—			(7	)
Total operating expenses		27,356		24,955			20,983
Operating income (loss)		5,308		(735	)		2,934
Other income from related party		50		99			448
Interest income (expense), net		421		(100	)		(1,209	)
Net income (loss) before income tax		5,779		(736	)		2,173
Income tax provision (benefit)		182		(43	)		43
Net income (loss)	$	5,597	$	(693	)	$	2,130
Basic net income (loss) per share:	$	0.33	$	(0.04	)	$	0.13
Shares used in computing basic net income (loss) per share		16,715,446		16,408,039			16,006,565
Diluted net income (loss) per share:	$	0.31	$	(0.04	)	$	0.13
Shares used in computing diluted net income (loss) per share		18,023,211		16,408,039			16,908,361

See accompanying notes.

Page 33

Scientific Learning Corporation

Statements of Stockholders’ Deficit
(In thousands, except share amounts)

	Common Stock and Additional Paid-In Capital				Accumulated Deficit			Total Stockholders’ Deficit
	Shares		Amount
Balance December 31, 2002		15,879,083	$	73,771		($ 85,134	)		($ 11,363	)
Issuance of common stock under stock option plan		207,438		264		—			264
Issuance of common stock under employee stock purchase plan		52,912		180		—			180
Compensation charge relating to granting of common stock options		—		198		—			198
Stock issued in exchange for services		11,118		47		—			47
Net income and comprehensive income		—		—		2,130			2,130
Balance December 31, 2003		16,150,551		74,460		(83,004	)		(8,544	)
Issuance of common stock under stock option plan		417,773		645		—			645
Issuance of common stock under employee stock purchase plan		78,468		300		—			300
Compensation charge relating to granting of common stock options		—		110		—			110
Stock issued in exchange for services		10,797		71		—			71
Net loss and comprehensive loss		—		—		(693	)		(693	)
Balance December 31, 2004		16,657,589		75,586		(83,697	)		(8,111	)
Issuance of common stock under stock option plan		71,778		215					215
Issuance of common stock under employee stock purchase plan		58,795		259					259
Compensation charge relating to granting of common stock options		—		137					137
Stock issued in exchange for services		10,896		68					68
Net income and comprehensive income		—				5,597			5,597
Balance December 31, 2005		16,799,058	$	76,265		(78,100	)		(1,835	)

See accompanying notes

Page 34

Scientific Learning Corporation
Statements of Cash Flows
(In thousands)

	Year ended December 31,
	2005			2004			2003
Operating Activities:
Net income (loss)	$	5,597		$	(693	)	$	2,130
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Depreciation and amortization		728			779			1,338
Increase in interest receivable from current and former officers		(169	)		(387	)		(703	)
Increase in interest receivable on short term investments		(44	)
Amortization of deferred financing costs		—			232			1,215
Stock based compensation		205			181			245
Changes in operating assets and liabilities:
Accounts receivable		2,142			(544	)		(250	)
Prepaid expenses and other current assets		(6	)		(162	)		428
Other assets		(67	)		—			—
Accounts payable		(389	)		122			194
Accrued liabilities		(1,372	)		463			(1,339	)
Deferred revenue		(8,781	)		6,284			788
Other liabilities		42			59			(199	)
Net cash provided by (used in) operating activities		(2,114	)		6,334			3,847
Investing Activities:
Purchases of property and equipment, net		(181	)		(646	)		(256	)
Purchases of investments		(2,999	)		—			—
Repayment on officer loan and accrued interest		3,561			—			—
Net cash provided by (used in) investing activities		381			(646	)		(256	)
Financing Activities:
Proceeds from issuance of common stock, net		474			945			444
Borrowings under bank line of credit		—			3,000			2,000
Repayments of borrowings under bank line of credit		—			(3,000	)		(7,000	)
Net cash provided by (used in) financing activities		474			945			(4,556	)
Increase (decrease) in cash and cash equivalents		(1,259	)		6,633			(965	)
Cash and cash equivalents at beginning of year		10,281			3,648			4,613
Cash and cash equivalents at end of year	$	9,022		$	10,281		$	3,648
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes	$	422		$	—		$	—

See accompanying notes.

Page 35

Notes to Financial Statements

1. Summary of Significant Accounting Policies

Description of Business

Scientific Learning Corporation provides neuroscience-based software products that build learning capacity by developing the underlying cognitive skills required for reading and learning. We operate in one operating segment. Our 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. We also sell 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.

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

Use of Estimates

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

Revenue Recognition

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

Booked sales to our school customers typically include multiple elements (e.g., Fast ForWord software licenses, Progress Tracker, our Internet-based participant tracking service, support, training, implementation management, and other services). We allocate revenue to each element of a transaction based upon its fair value as determined in reliance on “vendor specific objective evidence” (“VSOE”), if VSOE exists for each element. If we do not have VSOE for one or more delivered elements in an arrangement (typically software), we recognize revenue using the residual method, whereby the difference between the total arrangement fee and the total fair value of the undelivered elements is recognized as revenue relating to the delivered elements. VSOE of fair value for each element of an arrangement is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is also measured by the renewal price. We are required to exercise judgment in determining whether VSOE exists for each undelivered element based on whether our pricing for these elements is sufficiently consistent.

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

Product revenue

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

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

Page 36

Notes to Financial Statements

1. Summary of Significant Accounting Policies (continued)

• Term licenses – software licensed for a specific time period, generally three to twelve months. Revenue is recognized ratably over the license term.

• Individual participant licenses – software licensed for a single participant. Revenue is recognized over the average period of use, typically six weeks.

Service and support revenue

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

Cash and Cash Equivalents

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

Short-Term Investments

We determine the appropriate classification of investments at the time of purchase in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and reevaluate such determination at each balance sheet date. In August 2005 we purchased for $2,999,000 an investment in debt securities issued by the US Treasury that mature in February 2006. We classified this investment as held-to-maturity and it is carried at amortized cost of $3,043,000. The carrying value of short-term investments approximates fair value due to their short-term nature.

Accounts Receivable

We conduct 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. We maintain an allowance for doubtful accounts for estimated losses due to the inability of customers to make payments. We adjust this allowance periodically based on our historical experience of bad debt write offs.

Inventories

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

Fair Value of Financial Instruments

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

Concentration of Credit Risk

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

Page 37

Notes to Financial Statements

1. Summary of Significant Accounting Policies (continued)

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

The accounts receivable of the Company are derived from booked sales to customers located primarily in the United States. The Company performs ongoing credit evaluations of its customers. The Company does not require collateral.

An allowance for doubtful accounts is determined with respect to those accounts that the Company has determined to be doubtful of collection. At December 31, 2005, one customer accounted for 12% of the Company’s accounts receivable. At December 31, 2004, no customer accounted for more than 10% of the Company’s accounts receivable.

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

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 (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” under which certain software development costs incurred subsequent to the establishment of technological feasibility are capitalized and amortized over the estimated lives of the related products. Technological feasibility is established upon completion of a working model. In 2003, 2004 and 2005 costs incurred subsequent to the establishment of technological feasibility were not significant, and were charged to research and development expense. Software costs are amortized to cost of product revenues over the estimated useful life of the software, which is three years. Amortization was $261,000, $351,000, and $617,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

Long-Lived Assets

The Company regularly reviews the carrying value of long-lived assets. We continually make estimates regarding future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, 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 using the intrinsic value method 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 Emerging Issues Task Force (‘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 38

Notes to Financial Statements

1. Summary of Significant Accounting Policies (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 and employee stock purchase plan stock using the fair value method. The fair value of each option granted and employee stock purchase plan stock issued is estimated on the date of grant using the Black Scholes valuation model with the following assumptions:

	Year Ended December 31,
Employee & Director Stock Options	2005	2004	2003
Weighted average expected life of option (in years)	4	4	4
Risk-free interest rate	3.7%	3.1%	2.4%
Dividend yield	0.0%	0.0%	0.0%
Volatility	106%	129%	122%

The weighted average fair value of options granted during the years ended December 31, 2005, 2004 and 2003 was $4.31, $4.77 and $2.37, respectively.

	Year Ended December 31,
Employee Stock Purchase Plan	2005	2004	2003
Weighted average expected life (in years)	0.5 - 1.0	0.5 - 1.0	0.5 - 1.0
Risk-free interest rate	4.2%	2.0%	1.1%
Dividend yield	0.0%	0.0%	0.0%
Volatility	64%	110%	120%

The weighted average fair value of Employee Stock Purchase Plan shares issued during the years ended December 31, 2005, 2004 and 2003 was $1.80, $2.34 and $1.92, respectively.

We have elected to use the intrinsic value method in accounting for our employee stock options because, as discussed below, the alternative fair value method 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 our 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.

Page 39

Notes to Financial Statements

1. Summary of Significant Accounting Policies (continued)

Had compensation cost for our 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, our 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,
	2005			2004			2003
Net income (loss), as reported	$	5,597		$	(693	)	$	2,130
Add: Stock-based compensation costs included in the determination of net income (loss)		205			181			245
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(1,998	)		(1,977	)		(1,816	)
Pro forma net income (loss), per share	$	3,804		$	(2,489	)	$	559
Basic, as reported	$	0.33		$	(0.04	)	$	0.13
Diluted, as reported	$	0.31		$	(0.04	)	$	0.13
Basic, pro forma	$	0.23		$	(0.15	)	$	0.03
Diluted, pro forma	$	0.21		$	(0.15	)	$	0.03

During the second quarter of 2005, we modified our approach and revised certain assumptions with respect to determining the estimated fair value of option grants and shares granted under our employee stock purchase plan. The previously reported amounts for the years ended December 31, 2004 and 2003 have been revised to reflect these corrections. The pro forma stock-based compensation expense under the fair value method was previously reported as $1.7 million and $1.5 million for the years ended December 31, 2004 and 2003, respectively.

The pro forma impact of options on the net income (loss) for the years ended December 31, 2005, 2004 and 2003 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.

Advertising

Advertising costs are expensed as incurred. Advertising expense was $18,000, $13,000 and $1,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

Income Taxes

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

Net Income (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 (computed using the treasury stock method) 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 loss per share as their inclusion is antidilutive.

Page 40

Notes to Financial Statements

1. Summary of Significant Accounting Policies (continued)

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,
	2005		2004			2003
Net income (loss)	$	5,597	$	(693	)	$	2,130
Weighted average shares used in calculation of basic net income (loss) per share		16,715,446		16,408,039			16,006,565
Effect of dilutive securities:
Employee stock options		1,307,765		—			901,796
Weighted-average diluted common share		18,023,211		16,408,039			16,908,361
Net income (loss) per common share- basic:	$	0.33	$	(0.04	)	$	0.13
Net income (loss) per common share- diluted:	$	0.31	$	(0.04	)	$	0.13

If we had reported net income in 2004, 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 1,101,352 common equivalent shares (computed using the treasury stock method) related to outstanding stock options not included in the calculations above for the year ended December 31, 2004.

For the years ended December 31, 2005 and 2003, respectively, 1,058,652 and 856,568 options with exercise prices greater than the average market price for our common stock were excluded from the calculation of diluted net income per share because their effect is anti-dilutive.

Recent Accounting Pronouncements

SFAS 123(R), “Share-Based Payment”

On December 16, 2004 the FASB issued SFAS 123 (revised 2004), “Share-Based Payment,” which is a revision of SFAS 123. Statement 123(R) supersedes APB 25 and amends SFAS 95, “Statement of Cash Flows.” Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options and purchases under employee stock purchase plans, to be recognized in the statement of operations based on their fair values. Pro forma disclosure of fair value recognition will no longer be an alternative. SFAS 123(R) is effective for public companies for annual periods beginning after June 15, 2005, with earlier adoption permitted. We are required to adopt this new standard no later than our fiscal year beginning January 1, 2006.

Although the adoption of the fair value method under SFAS 123(R) will have no adverse impact on our balance sheet (other than its effect on retained earnings) or net cash flows, it will have a significant adverse impact on our results from operations and earnings per share. The pro forma effects on results from operations and earnings per share if we had applied the above fair value recognition provisions of SFAS 123 to share-based payments to employees in prior periods are disclosed in this Note 1 under “Stock-Based Compensation.” Although the pro forma effects of applying SFAS 123 may be indicative of the effects of applying SFAS 123(R), the provisions of these two statements differ in some important respects. The actual effects of adopting SFAS 123(R) will depend on numerous factors including the form of stock-based incentive compensation, valuation model we use to value future share-based payments to employees, estimated forfeiture rates and the accounting policies we adopt concerning the method of recognizing the fair value of awards over the requisite service period.

Page 41

Notes to Financial Statements

2. Restructuring, Lease and Asset Impairment Write Downs

In 2004, we completed lease termination payments of $1.8 million. There were no other restructuring activities during 2004 or 2005 and no accrued restructuring costs as of December 31, 2004 or December 31, 2005.

In October 2003 we entered into a lease termination agreement with our 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 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. 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 three years ended December 31, 2005

(in thousands):

	Accrued restructuring costs, December 31, 2002		Restructuring Charges		Asset write-down			Cash paid			Accrued restructuring costs, December 31, 2003		Cash paid			Accrued restructuring costs, December 31, 2004 and 2005
Lease obligation	$	3,005	$	154				$	(1,386	)	$	1,773	$	(1,773	)	$	—
Asset write-down		—		196		(196	)		—			—
Severance benefits		509		—					(509	)		—
Total	$	3,514	$	350	$	(196	)	$	(1,895	)	$	1,773	$	(1,773	)	$	—

3. Prepaid Expenses and Other Current Assets

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

	Year Ended December 31,
	2005		2004
Prepaid expenses	$	1,093	$	1,025
Product inventory		190		273
Other receivables		29		8
	$	1,312	$	1,306

4. Property and Equipment

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

	Year Ended December 31,
	2005			2004
Computer equipments	$	4,528		$	4,517
Office furniture and equipments		1,518			1,489
Leasehold improvements		487			453
		6,533			6,459
Less accumulated depreciation		(6,064	)		(5,704	)
	$	469		$	755

Depreciation expense for the years ended December 31, 2005, 2004, and 2003 was $467,000, $428,000, and $721,000, respectively.

Page 42

Notes to Financial Statements

5. Notes Receivable from Current and Former Officers

Notes receivable from current and former officers consist of the following (in thousands):

	Year Ended December 31,
	2005		2004
Principal	$	236	$	3,114
Accrued interest		61		574
	$	297	$	3,688

The Notes are full recourse loans secured by shares of our common stock owned by the current and former officers and bear interest at 4.94%. Principal and interest were due on December 31, 2005. The outstanding amount at December 31, 2005 was settled in full during the first quarter of 2006.

6. Other Assets

Other Assets consist of the following (in thousands):

	Year Ended December 31,
	2005			2004
Software development costs	$	3,089		$	3,089
Less accumulated amortization		(2,959	)		(2,697	)
Software development costs, net		130			392
Other non current assets		942			875
	$	1,072		$	1,267

The amortization expense for software development costs for the years ended December 31, 2005, 2004, and 2003 was $262,000, $351,000, and $617,000, respectively.

7. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

	Year Ended December 31,
	2005		2004
Accrued vacation	$	1,194	$	1,036
Accrued commissions and bonus		532		2,093
Accounts payable accruals		441		671
Other accrued liabilities		799		538
	$	2,966	$	4,338

8. Deferred Revenue

Deferred revenue consists of the following (in thousands):

	Year Ended December 31,
	2005		2004
Current:
Products	$	4,568	$	13,361
Service and support		6,603		6,620
	$	11,171	$	19,981
Long term:
Products	$	1,917	$	2,297
Service and support		3,915		3,506
	$	5,832	$	5,803

Page 43

Notes to Financial Statements

9. Bank Line of Credit

On December 2, 2005 we amended and extended our existing revolving line of credit agreement with Comerica Bank. The maximum that can be borrowed under the agreement is $5.0 million. The line expires on June 2, 2007. Borrowing under the line of credit bears interest at a floating prime rate, or a fixed rate of LIBOR plus 2.5%. To secure the line we granted Comerica a security interest in all of our assets other than our intellectual property, and agreed not to restrict our ability to grant a security interest in our intellectual property. Borrowings under the line are subject to various covenants. There were no borrowings outstanding on the line of credit at December 31, 2005.

10. Income Taxes

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

	Year Ended December 31,
	2005		2004			2003
Current:
Federal	$	159	$	(43	)	$	43
State		23		—			—
Foreign		—		—			—
Total Current		182		(43	)		43
Deferred:
Federal		—		—			—
State		—		—			—
Foreign		—		—			—
Total Deferred		—		—			—
Total provision (benefit) for income taxes	$	182	$	(43	)	$	43

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

	Year Ended December 31,
	2005			2004			2003
Computed tax at statutory rate	$	1,965		$	(250	)	$	761
State taxes, net of federal benefit		23			—			—
Current year net operating losses, temporary differences and credits for which no benefit was recognized		—			—			—
Federal Alternative Minimum Tax		159			(43	)		—
Change in valuation allowance, net operating loss carryover and tax credit carryover for which no benefit was recognized previously		(2,015	)		183			(718	)
Other permanent differences		50			67			—
Provision (benefit) for income taxes	$	182		$	(43	)	$	43

Page 44

Notes to Financial Statements

10. Income Taxes (continued)

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

	Year Ended December 31,
	2005			2004
Deferred tax assets:
Net operating losses	$	25,215		$	27,637
Capitalized software and development costs		315			389
Deferred revenue		1,617			395
Research credits carry forwards		1,521			1,195
Other		1,109			1,361
Total gross deferred tax assets		29,777			30,977
Valuation allowance	$	(29,777	)	$	(30,977	)
Total 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, 2004 to December 31, 2005 in the amount of $1,200,000.

Approximately $736,000 of valuation allowance relates to tax benefits for stock option deductions, for which a full valuation allowance has been recorded, the benefit of which will be credited to additional paid-in capital if and when realized.

As of December 31, 2005, we had net operating loss carryforwards for federal income tax purposes of approximately $69,389,000, which expire in the years 2011 through 2024 and federal research tax credits of approximately $1,031,000, which expire in the years 2011 through 2025. We also had net operating loss carryforwards for state income tax purposes of approximately $35,872,000 expiring in the years 2006 through 2014 and state research tax credits of approximately $490,000 which carry forward indefinitely.

Utilization of our 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 carryforwards before utilization.

11. Stockholders’ Deficit

Common Stock

At December 31, 2005, we had reserved shares of common stock for future issuance as follows:

Stock Options outstanding	3,380,325
Stock Options available for future grants	755,655
Employee stock purchase plan	166,880
Common stock warrants	1,375,000
	5,677,860

Page 45

Notes to Financial Statements

11. Stockholders’ Deficit (continued)

Stock Options

Our employee stock option plans provide for the issuance of incentive stock options (ISO), nonstatutory stock options (NSO) and stock awards 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 us. Options and unvested shares granted generally vest over a period of four years. Options under the employee plans have a maximum term of ten years. In the event option holders cease to be employed by us, 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 option holder, which could result in a modification charge to operations.

In May 1999, our stockholders approved the 1999 Equity Incentive Plan, which amended and restated our 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, our Board of Directors approvedand in May 2003, the shareholders subsequently approved, adding 1,350,000 shares to the 1999 Equity Incentive Plan. In January 2004, our Board of Directors approved and in June 2004, the shareholders subsequently approved, adding an additional 850,000 shares to the 1999 Equity Plan. The total number of shares authorized for issuance under the plan is now 5,492,666. 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, our 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, our 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.

We have, on occasion, granted stock options and stock to non-employees and directors. A compensation charge has been recorded in these instances. In the years ended December 31, 2005 and 2004 10,896 and 10,797 shares were issued to directors as payment for their services and expenses of $68,000 and $71,000 were recorded, respectively.

A summary of our stock option activity under the plans is as follows:

Page 46

Notes to Financial Statements

11. Stockholders’ Deficit (continued)

	Outstanding Options
	Number of Shares	Weighted-Average Exercise Price Per Share
Outstanding at December 31, 2002	2,989,304	$             4.20
Granted	501,834	$             3.08
Exercised	(207,445)	$             1.27
Canceled	(238,666)	$             9.85
Outstanding at December 31, 2003	3,045,027	$             3.76
Granted	552,497	$             5.71
Exercised	(417,773)	$             1.54
Canceled	(76,739)	$             7.88
Outstanding at December 31, 2004	3,103,012	$             4.33
Granted	575,200	$             5.80
Exercised	(71,778)	$             2.95
Canceled	(226,109)	$             9.73
Outstanding at December 31, 2005	3,380,325	$             4.26

The following table summarizes information concerning outstanding and exercisable stock options at December 31, 2005:

	Outstanding						Exercisable
Price Range		Number of Shares	Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Life (Years)		Number of Shares		Weighted Average Exercise Price Per Share
$ 0.26 – $ 1.39		1,132,382	$	1.37		6.35		309,881	$	1.33
$ 1.40 – $ 3.00		455,643	$	1.74		6.40		353,720	$	1.75
$ 3.50 – $5.00		427,581	$	4.18		6.20		366,124	$	4.16
$ 5.03 – $6.13		1,033,986	$	5.85		8.36		410,979	$	5.87
$ 6.25 – $ 39.88		330,733	$	12.75		4.65		301,900	$	13.37
		3,380,325	$	4.26		6.79		1,742,604	$	5.17

There were 1,407,373 and 1,417,970 options exercisable under our stock option plans at December 31, 2004 and December 31, 2003 with weighted average exercise prices of $6.18 and $5.76, respectively.

Common Stock Warrants

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

Page 47

Notes to Financial Statements

11. Stockholders’ Deficit (continued)

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 our common stock. We initially reserved a total of 350,000 shares of common stock for issuance under the plan. In May 2002 our 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 our common stock on the first day of the applicable one-year offering period or the last day of the applicable six-month purchase period. We issued 58,795 and 78,468 shares of common stock under the plan during the years ended December 31, 2005 and 2004, respectively. At December 31, 2005, 166,880 shares were available for issuance under the Plan.

12. Commitments and Contingencies

Leases

We lease our 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, 2005 are as follows (in thousands):

2006	$	940
2007		940
2008		940
2009		984
2010 and thereafter		4,423
	$	8,227

Rent expense under all operating leases was $1 million for each of the years ended December 31, 2005, 2004 and 2003.

License Agreement

In September 1996, we entered into a license agreement with a university for the use of the intellectual property underlying its most significant current products. In exchange for the license, which expires in 2014, we issued stock and paid a license-issue fee. The agreement also provided for milestone payments, all of which have been made, and for royalties based on booked sales of products using the licensed technology. Royalty expenses were $1,082,000, $746,000 and $939,000 for the years ended December 31, 2005, 2004 and 2003, respectively, and are included in cost of revenues. Annual minimum guaranteed royalty payments are $150,000.

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

Litigation

On July 15, 2005, SkyTech, Inc. (“SkyTech”) filed a complaint against us in the District Court for the State of Minnesota, Fourth Judicial District, alleging claims of fraud, breach of contract, breach of duty of good faith and fair dealing, tortious interference, and indemnity. SkyTech alleged that it entered into an independent sales representative agreement (the “Agreement”) with us in October 2002 pursuant to which it has an exclusive right to market our products to the “After School” market. SkyTech further alleged that we prevented SkyTech’s performance of the Agreement and that we wrongly terminated the Agreement. SkyTech asserted that it was entitled to an unspecified amount of damages comprised of lost commissions and other damages, attorney’s fees, costs and punitive damages. In addition to the SkyTech claims, SkyLearn, L.L.C and HEK, Inc., both of which claimed to be subcontractors of SkyTech, claimed that they suffered damages from our alleged actions with respect to SkyTech. In December 2005, the court granted our motion to dismiss the case and to compel arbitration. The Plaintiffs have filed an appeal of the ruling, as well as a motion to amend the ruling and to amend their complaint.

Page 48

Notes to Financial Statements

12. Commitments and Contingencies (continued)

In October 2005, we initiated an arbitration proceeding before the American Arbitration Association in San Francisco, California. Our arbitration complaint alleges that SkyTech owes us for training charges that remain

unpaid under the Agreement and seeks declaratory relief regarding SkyTech’s claims against us. SkyTech has asserted counterclaims against us in the arbitration, repeating the claims made in the Minnesota case and asserting damages of $10 million. An arbitrator has been appointed and a schedule for briefing initial motions has been established.

We believe that we have meritorious defenses to SkyTech’s claims and intend to defend ourselves vigorously.

We do not believe that the resolution of this matter will have a material adverse effect on our financial position or results of operations.

13. Warranties; Indemnification

We generally provide a warranty that our software products substantially operate as described in the manuals and guides that accompany the software for a period of 90 days. The warranty does not apply in the event of misuse, accident, and certain other circumstances. To date, we have not incurred any material costs associated with these warranties and have no accrual for such items at December 31, 2005.

From time to time, we enter into contracts that require us, upon the occurrence of certain contingencies, to indemnify parties against third party claims. These contingent obligations primarily relate to (i) claims against our customers for violation of third party intellectual property rights caused by our products; (ii) claims resulting from personal injury or property damage resulting from our activities or products; (iii) claims by our office lessor arising out of our use of the premises; and (iv) agreements with our officers and directors under which we may be required to indemnify such persons for liabilities arising out of their activities on our behalf. Because the obligated amounts for these types of agreements usually are not explicitly stated, the overall maximum amount of theseobligations cannot be reasonably estimated. No liabilities have been recorded for these obligations on our balance sheet as of December 31, 2005 or 2004.

14. Employee Retirement and Benefit Plan

We have a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code, which covers substantially all employees. Eligible employees may contribute amounts to the plan, via payroll withholding, subject to certain limitations. We do not presently match contributions by plan participants.

15. Related Party Transaction

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

The rights were acquired by PSC for a combination of cash, stock and future royalties. PSC paid $500,000 cash, of which $448,000 was recognized as other income during the year ended December 31, 2003. The balance was recognized over the next nine months as services were provided to PSC. Amounts received to date and any future receipts are being reported as other income as we do not consider the sale of these rights to be part of our recurring operations. Under the agreement, we will receive net royalties between 2% to 4% on products sold by PSC that use our patents or software. We did not record a value for the 1.8 million shares of PSC received in the transaction, because PSC was a private start-up venture, the shares of which had no determinable value. We have a 3.5% equity interest in PSC.

Page 49

Notes to Financial Statements (continued)

16. Interim Financial Information (unaudited)

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

	2005
	March 31			June 30			Quarter Ended September 30		December 31			Total
Total revenues	$	10,245		$	13,279		$	9,812	$	6,983		$	40,319
Gross profit		8,452			11,158			8,006		5,048			32,664
Net income (loss)		1,290			3,593			2,262		(1,548	)		5,597
Net income (loss) per share:
Basic		0.08			0.22			0.14		(0.09	)		0.33
Diluted		0.07			0.20			0.13		(0.09	)		0.31
	2004
	March 31			June 30			Quarter Ended September 30		December 31			Total
Total revenues	$	7,036		$	7,497		$	8,290	$	8,153		$	30,976
Gross profit		5,477			5,803			6,512		6,428			24,220
Net income (loss)		(290	)		(52	)		667		(1,018	)		(693	)
Net income (loss) per share:
Basic		(0.02	)		0.00			0.04		0.09			(0.04	)
Diluted		(0.02	)		0.00			0.04		0.08			(0.04	)

Page 50

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

As required under Rule 13a-15(b) of the Exchange Act, our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K, and concluded that our disclosure controls and procedures were effective as of December 31, 2005.

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

Changes in Internal Controls over Financial Reporting

In December 2004, based on our review of a major contract that we booked in June 2004, our management and the Audit Committee of our Board of Directors concluded that we should change our revenue recognition method for most of our K-12 school contracts. This change in our revenue recognition method reflected a correction in our application of AICPA Statement of Position 97-2, “Software Revenue Recognition (as amended by Statement of Position 98-9) to our historical K-12 school contracts. As a result of this change, our management and the Audit Committee of our Board of Directors concluded that we should restate our historical financial statements for the period from 2000 through June 30, 2004. Controls over the application of accounting policies are within the scope of our internal control over financial reporting. Therefore, our management concluded that, for our Form 10-K for the fiscal year ended December 31, 2004, filed on April 15, 2005, there was a material weakness in our internal control over financial reporting, as defined by the Public Company Accounting Oversight Board.

In addition, in May 2005, in the course of preparing financial statements for our first quarter of 2005, our management determined that our balance sheets at June 30, September 30, and December 31, 2004 incorrectly classified a portion of deferred revenue as “long term” deferred revenue when this deferred revenue should have been classified as “current” deferred revenue. As a result, our management and the Audit Committee of our Board of Directors concluded that we should restate our balance sheet at December 31, 2004, which restatement we completed in connection with the filing of our Form 10-K/A on May 26, 2005.

During our review of the material weakness in our internal control over financial reporting, we identified the causes of this material weakness to be the result of the following factors:

• Lack of experience within our finance group in applying accounting guidance to complex revenue transactions;

• Inadequate review of VSOE for all elements in our transactions with customers;

• Lack of a formal process for identifying, reviewing and approving non-standard revenue transactions; and

• Lack of formal documentation and communication of our revenue recognition policies and procedures.

In order to eliminate the material weakness in our internal control over financial reporting for purposes of future

Page 51

reporting, we undertook significant efforts to improve our processes and procedures as they relate to the application of revenue recognition. These efforts included the following:

1. We hired a Revenue Accounting Manager with relevant experience to assume full responsibility for all revenue accounting activities.

2. We expanded the size of our finance staff by adding two additional members. As a result, those members of the finance staff who are directly responsible for revenue accounting are able to devote more attention to this area.

3. We implemented additional training in our policies and procedures on revenue recognition for both accounting staff and sales personnel.

4. We developed a review and documentation process for large contracts that has become a permanent part of our internal control over financial reporting.

5. We hired a member of the AICPA’s Center for Public Company Audit firms to assist with technical accounting issues.

6. We commissioned a review of our financial close process by a consulting firm to advise us on best practices, and we have implemented their recommendations.

In addition, we are in the process of developing a comprehensive revenue recognition manual to, among other things, define and document our revenue recognition policy, clarify the approval process for all standard and non-standard transactions, and document other revenue related tasks, such as the maintenance and tracking of VSOE data.

Except as described above, there was no change in our internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

In December 2005, we entered into an amendment to our line of credit agreement with Comerica Bank. This amendment extended the expiration date of the line to June 2, 2007 and amended the covenants and borrowing limits. The amendment is filed as Exhibit 10.19 hereto.

Page 52

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 2006 Annual Meeting of Stockholders (the “Proxy Statement”) and is incorporated by reference into this Form 10-K Report. The Proxy Statement will be filed with the Securities and Exchange Commission in accordance with Rule 14a-6(c) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). With the exception of the foregoing information and other information specifically incorporated by reference into this Form 10-K Report, the Proxy Statement is not being filed as a part hereof.

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

ITEM 11. EXECUTIVE COMPENSATION

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

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

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

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

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

Page 53

ITEM IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) Documents filed as part of this report:

(1) Financial Statements

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

Balance Sheet – December 31, 2005 and 2004

Statements of Operations – Years Ended December 31, 2005, 2004 and 2003

Statements of Stockholders’ Deficit – Years Ended December 31, 2005, 2004 and 2003

Statements of Cash Flows – Years Ended December 31, 2005, 2004 and 2003

Notes to Financial Statements

(2) Financial Statement Schedules

As required under Item 8, Financial Statements and Supplementary Data, the financial statement schedule of the Company is provided in this separate section. The financial statement schedule included in this section is as follows:

Schedule II – Valuation and Qualifying Accounts (in thousands):

	Allowance for Doubtful Accounts Years Ended December 31,
	Opening Balance		Charges to Operating Expenses			Charges to Allowance			Additions (deductions) to Allowance			Closing Balance
2005	$	121	$	—		$	(40	)	$	—		$	81
2004	$	139	$	(3	)	$	(100	)	$	85		$	121
2003	$	270	$	—		$	89		$	(220	)	$	139

Page 54

(3) EXHIBITS

Exhibit No. Description of Document

3.1(1) Restated Certificate of Incorporation.

3.2 (9) Amended and Restated Bylaws.

4.1 Reference is made to Exhibits 3.1 and 3.2.

4.2(1) Specimen Stock Certificate.

4.3(2) Amended and Restated Registration Rights Agreement, dated as of December 31, 1998.

4.4(3) Amendment No. 1 to Amended and Restated Registration Rights Agreement listed as Exhibit 4.4.

4.5(5) Amendment No. 2 to Amended and Restated Registration Rights Agreement listed as Exhibit 4.4.

10.1(1)* Form of Indemnity Agreement with each of our directors and executive officers.

10.2* 1999 Equity Incentive Plan, as amended.

10.3* Forms of Restricted Stock Unit Grant Notice and Restricted Stock Unit Agreement under the Incentive Plan

10.4(7)* Forms of Stock Option Grant Notice, Stock Option Agreement and Stock Award Agreement under the Incentive Plan.

10.5 (14) 1999 Non-Employee Directors’ Stock Option Plan, as amended.

10.6 (7)* Forms of Nonstatutory Stock Option Agreements under the Non-Employee Directors’ Stock Option Plan.

10.7(7)* 1999 Employee Stock Purchase Plan, as amended.

10.8* Form of 1999 Employee Stock Purchase Plan Offering under the Employee Stock Purchase Plan.

10.9(11)* Milestone Equity Incentive Plan.

10.10(6)* 2002 CEO Option Plan.

10.11(6)* Employment Agreement dated as of May 31, 2002 by and between Scientific Learning Corporation and Robert C. Bowen.

10.12(11)* Letter Agreement dated January 2004 by and between the Company and Robert C. Bowen amending the Employment Agreement listed as Exhibit 10.26.

10.13(13)* Independent Contractor Agreement dated April l7, 2003 between the Company and Paula A. Tallal and Project Assignment thereunder dated December 17, 2004.

10.14(12)* 2005 Management Incentive Plan

10.15 2006 Management Incentive Plan

10.16 (12)* Summary of 2005 base salary and 2004 bonuses payable to Named Executive Officers

10.17 (15)* Summary of compensation payable to directors.

10.17 (10) Loan and Security Agreement dated as of January 15, 2004 by and between Scientific Learning Corporation and Comerica Bank.

10.18 (14) First Amendment to Loan and Security Agreement, dated as of September 29, 2004, by and between Comerica Bank and the Company, amending the Loan and Security Agreement filed as Exhibit 10.17.

10.19 Second Amendment to Loan and Security Agreement, dated as of December 2, 2005, by and between Comerica Bank and the Company, amending the Loan and Security Agreement filed as Exhibit 10.17.

10.20(1)† Exclusive License Agreement, dated September 27, 1996, with the Regents of the University of California.

10.21 (9) 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.

10.22 (9) Lease, dated as of October 1, 2003, with Rotunda Partners II.

10.23 (1) Securities Purchase Agreement, dated September 24, 1996, with Warburg, Pincus Ventures, L.P.

10.24(3) Agreement to Issue Warrant and Grant of Security Interest dated as of March 9, 2001 by and between Scientific Learning Corporation and WPV, Inc.

10.25(3) Warrant to Purchase 1,375,000 Shares of Common Stock of Scientific Learning Corporation.

10.26(4) Stock Purchase Agreement dated November 9, 2001 between Scientific Learning Corporation and Warburg Pincus Ventures, L.P.

Page 55

10.27(8) Technology Transfer Agreement dated as of September 30, 2003 by and between the Company and Neuroscience Solutions Corporation (now renamed Posit Science Corporation) (“NSC”).

10.28(8) SLC License Agreement dated as of September 30, 2003 by and between the Company and NSC.

10.29(8) NSC License Agreement dated as of September 30, 2003 by and between NSC and the Company.

23.1 Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.

31.1 Certification of Chief Executive Officer (Section 302).

31.2 Certification of Chief Financial Officer (Section 302).

32.1 Certification of Chief Executive Officer (Section 906).

32.2 Certification of Chief Financial Officer (Section 906).

(1) Incorporated by reference to the exhibits previously filed with the Company’s Registration Statement on Form S-1.

(2) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-K for the year ended December 31, 1999

(3) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K on March 12, 2001.

(4) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-Q for the quarter ended September 30, 2001.

(5) Incorporated by reference to the exhibits previously filed with the Company’s Form 8-K on December 7, 2001.

(6) Incorporated by reference to the exhibits previously filed with the Company’s Form 8-K on June 7, 2002.

(7) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-Q for the quarter ended June 30, 2003.

(8) Incorporated by reference to the exhibits previously filed with the Company’s Form 8-K on October 1, 2003.

(9) Incorporated by reference to the exhibits filed with the Company’s Form 10-Q for the quarter ended September 30, 2003.

(10) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K on February 5, 2004.

(11) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-Q for the quarter ended March 31, 2004.

(12) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K filed on March 25, 2005.

(13) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K filed on December 20, 2004.

(14) Incorporated by reference to exhibits previously filed with the Company’s Form 10-K for he year ended December 31, 2004.

(15) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K filed on May 27, 2005.

†      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 56

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SCIENTIFIC LEARNING CORPORATION

By /s/ Robert C. Bowen March 10, 2006

Robert C. Bowen

Chief Executive Officer

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

SIGNATURES TITLE DATE

/s/ Robert C. Bowen

Robert C. Bowen	Chairman, Chief Executive Officer	March 10, 2006
	and Director (Principal Executive
	Officer)

/s/ Jane A. Freeman
Jane A. Freeman	Senior Vice President, Chief Financial Officer,	March 10, 2006
	and Treasurer (Principal Financial and
	Accounting Officer)

/s/ Dr. Michael M. Merzenich

Dr. Michael M. Merzenich Director March 10, 2006

/s/ Dr. Paula A. Tallal

Dr. Paula A. Tallal Director March 10, 2006

/s/ Carleton A. Holstrom

Carleton A. Holstrom Director March 10, 2006

/s/ Rodman W. Moorhead, III

Rodman W. Moorhead, III Director March 10, 2006

/s/ Ajit Dalvi

Ajit Dalvi Director March 10, 2006

/s/ Dr. Joseph Martin

Dr. Joseph Martin Director March 10, 2006

/s/ Edward Vermont Blanchard, Jr.

Edward Vermont Blanchard, Jr. Director March 10, 2006

/s/ David W. Smith                            

David W. Smith Director March 10, 2006

INDEX TO EXHIBITS

Exhibit No. Description of Document

3.1(1) Restated Certificate of Incorporation.

3.2 (9) Amended and Restated Bylaws.

4.1 Reference is made to Exhibits 3.1 and 3.2.

4.2(1) Specimen Stock Certificate.

4.3(2) Amended and Restated Registration Rights Agreement, dated as of December 31, 1998.

4.4(3) Amendment No. 1 to Amended and Restated Registration Rights Agreement listed as Exhibit 4.4.

4.5(5) Amendment No. 2 to Amended and Restated Registration Rights Agreement listed as Exhibit 4.4.

10.1(1)* Form of Indemnity Agreement with each of our directors and executive officers.

10.2* 1999 Equity Incentive Plan, as amended.

10.3* Forms of Restricted Stock Unit Grant Notice and Restricted Stock Unit Agreement under the Incentive Plan

10.4(7)* Forms of Stock Option Grant Notice, Stock Option Agreement and Stock Award Agreement under the Incentive Plan.

10.5 (14) 1999 Non-Employee Directors’ Stock Option Plan, as amended.

10.6 (7)* Forms of Nonstatutory Stock Option Agreements under the Non-Employee Directors’ Stock Option Plan.

10.7(7)* 1999 Employee Stock Purchase Plan, as amended.

10.8* Form of 1999 Employee Stock Purchase Plan Offering under the Employee Stock Purchase Plan.

10.9(11)* Milestone Equity Incentive Plan.

10.10(6)* 2002 CEO Option Plan.

10.11(6)* Employment Agreement dated as of May 31, 2002 by and between Scientific Learning Corporation and Robert C. Bowen.

10.12(11)* Letter Agreement dated January 2004 by and between the Company and Robert C. Bowen amending the Employment Agreement listed as Exhibit 10.26.

10.13(13)* Independent Contractor Agreement dated April l7, 2003 between the Company and Paula A. Tallal and Project Assignment thereunder dated December 17, 2004.

10.14(12)* 2005 Management Incentive Plan

10.15 2006 Management Incentive Plan

10.16 (12)* Summary of 2005 base salary and 2004 bonuses payable to Named Executive Officers

10.17 (15)* Summary of compensation payable to directors.

10.17 (10) Loan and Security Agreement dated as of January 15, 2004 by and between Scientific Learning Corporation and Comerica Bank.

10.18 (14) First Amendment to Loan and Security Agreement, dated as of September 29, 2004, by and between Comerica Bank and the Company, amending the Loan and Security Agreement filed as Exhibit 10.17.

10.19 Second Amendment to Loan and Security Agreement, dated as of December 2, 2005, by and between Comerica Bank and the Company, amending the Loan and Security Agreement filed as Exhibit 10.17.

10.20(1)† Exclusive License Agreement, dated September 27, 1996, with the Regents of the University of California.

10.21 (9) 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.

10.22 (9) Lease, dated as of October 1, 2003, with Rotunda Partners II.

10.23 (1) Securities Purchase Agreement, dated September 24, 1996, with Warburg, Pincus Ventures, L.P.

10.24(3) Agreement to Issue Warrant and Grant of Security Interest dated as of March 9, 2001 by and between Scientific Learning Corporation and WPV, Inc.

10.25(3) Warrant to Purchase 1,375,000 Shares of Common Stock of Scientific Learning Corporation.

10.26(4) Stock Purchase Agreement dated November 9, 2001 between Scientific Learning Corporation and Warburg Pincus Ventures, L.P.

10.27(8) Technology Transfer Agreement dated as of September 30, 2003 by and between the Company and Neuroscience Solutions Corporation (now renamed Posit Science Corporation) (“NSC”).

10.28(8) SLC License Agreement dated as of September 30, 2003 by and between the Company and NSC.

10.29(8) NSC License Agreement dated as of September 30, 2003 by and between NSC and the Company.

23.1 Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.

31.1 Certification of Chief Executive Officer (Section 302).

31.2 Certification of Chief Financial Officer (Section 302).

32.1 Certification of Chief Executive Officer (Section 906).

32.2 Certification of Chief Financial Officer (Section 906).

(1) Incorporated by reference to the exhibits previously filed with the Company’s Registration Statement on Form S-1.

(2) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-K for the year ended December 31, 1999

(3) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K on March 12, 2001.

(4) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-Q for the quarter ended September 30, 2001.

(5) Incorporated by reference to the exhibits previously filed with the Company’s Form 8-K on December 7, 2001.

(6) Incorporated by reference to the exhibits previously filed with the Company’s Form 8-K on June 7, 2002.

(7) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-Q for the quarter ended June 30, 2003.

(8) Incorporated by reference to the exhibits previously filed with the Company’s Form 8-K on October 1, 2003.

(9) Incorporated by reference to the exhibits filed with the Company’s Form 10-Q for the quarter ended September 30, 2003.

(10) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K on February 5, 2004.

(11) Incorporated by reference to the exhibits previously filed with the Company’s Form 10-Q for the quarter ended March 31, 2004.

(12) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K filed on March 25, 2005.

(13) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K filed on December 20, 2004.

(14) Incorporated by reference to exhibits previously filed with the Company’s Form 10-K for he year ended December 31, 2004.

(15) Incorporated by reference to exhibits previously filed with the Company’s Form 8-K filed on May 27, 2005.

†      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.

EX-10.2

Exhibit 10.2

SCIENTIFIC LEARNING CORPORATION

1999 EQUITY INCENTIVE PLAN

Adopted February 19, 1996

Approved By Stockholders March 30, 1996

Amended and Restated September 27, 1996

Approved By Stockholders June 11, 1997

Amended March 11, 1999

Amended and Restated May 17, 1999

Approved By Stockholders May 28, 1999

Amended March 8, 2000

Approved By Stockholders May 18, 2000

Amended May 30, 2002

Amended October 9, 2002

Amended February 25, 2003

Approved By Stockholders May 21, 2003

Amended January 28, 2004

Approved By Stockholders June 7, 2004¶

Amended and Restated March 8, 2006

Termination Date: May 17, 2009

1. PURPOSES.

(a)The Plan initially was established effective as of February 19, 1996 (the “Prior Plan”). The Prior Plan hereby is amended and restated in its entirety as the Plan, effective as of the date of the closing of the initial public offering (“IPO”) of the common stock of the Company (“Common Stock”). The terms of the Prior Plan shall remain in effect and apply to all options granted pursuant to the Prior Plan.

(b)The purpose of the Plan is to provide a means by which selected Employees, Directors and Consultants may be given an opportunity to benefit from increases in value of the Common Stock through the granting of (i) Incentive Stock Options, (ii) Nonstatutory Stock Options, (iii) stock bonuses, (iv) rights to purchase restricted stock, (v) Restricted Stock Unit Awards and (vi) Stock Appreciation Rights.

(c)The Company, by means of the Plan, seeks to retain the services of persons who are now Employees, Directors or Consultants, to secure and retain the services of new Employees, Directors and Consultants and to provide incentives for such persons to exert maximum efforts for the success of the Company and its Affiliates.

(d)The Company intends that the Stock Awards issued under the Plan shall, in the discretion of the Board or any Committee to which responsibility for administration of the Plan has been delegated pursuant to subsection 3(c), be either (i) Options granted pursuant to Section 6 hereof, including Incentive Stock Options and Nonstatutory Stock Options, (ii) stock bonuses and rights to purchase restricted stock granted pursuant to Section 7 hereof, (iii) Restricted Stock Unit Awards granted pursuant to Section 8 hereof, or (iv) Stock Appreciation Rights granted pursuant to Section 9

1.

hereof. All Options shall be separately designated Incentive Stock Options or Nonstatutory Stock Options at the time of grant, and in such form as issued pursuant to Section 6, and a separate certificate or certificates will be issued for shares purchased on exercise of each type of Option.

2. DEFINITIONS.

(a)“Affiliate” means any parent corporation or subsidiary corporation, whether now or hereafter existing, as those terms are defined in Sections 424(e) and (f) respectively, of the Code.

(b)	“Board” means the Board of Directors of the Company.
(c)	“Code” means the Internal Revenue Code of 1986, as amended.

(d)“Committee” means a Committee appointed by the Board in accordance with subsection 3(c) of the Plan.

(e) “Company” means Scientific Learning Corporation, a Delaware corporation.

(f)“Consultant” means any person, including an advisor, engaged by the Company or an Affiliate to render consulting services and who is compensated for such services, provided that the term “Consultant” shall not include Directors who are paid only a director’s fee by the Company or who are not compensated by the Company for their services as Directors.

(g)“Continuous Service” means that the Optionee’s employment or service with the Company or an Affiliate of the Company, whether in the capacity of an Employee, a Director or a Consultant, is not interrupted or terminated. The Optionee’s Continuous Service shall not be deemed to have terminated merely because of a change in the capacity in which the Optionee renders employment or service to the Company or an Affiliate or the Company or a change in the entity for which the Optionee renders such employment or service, provided that there is no interruption or termination of the Optionee’s Continuous Service. The Board or the Chief Executive Officer of the Company, in that party’s sole discretion, may determine whether Continuous Service shall be considered interrupted in the case of any leave of absence approved by the Board or the Chief Executive Officer of the Company, including sick leave, military leave, or any other personal leave.

(h)“Covered Employee” means the Chief Executive Officer and the four (4) other highest compensated officers of the Company for whom total compensation is required to be reported to stockholders under the Exchange Act, as determined for purposes of Section 162(m) of the Code.

(i) “Director” means a member of the Board.

(j)“Disability” means the inability of a person, in the opinion of a qualified physician acceptable to the Company, to perform the major duties of that person’s position with the Company or an Affiliate of the Company because of the sickness or injury of the person.

(k)“Employee” means any person, including Officers and Directors, employed by the Company or any Affiliate of the Company. Neither service as a Director nor payment of a director’s fee by the Company shall be sufficient to constitute “employment” by the Company.

2.

(l) “Exchange Act” means the Securities Exchange Act of 1934, as amended.

(m)“Fair Market Value” means, as of any date, the value of the Common Stock of the Company determined as follows:

(1)If the Common Stock is listed on any established stock exchange, traded on the Nasdaq National Market or the Nasdaq SmallCap Market, or quoted on the OTC Bulletin Board, the Fair Market Value of a share of Common Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange, market or board (or the exchange or market with the greatest volume of trading in Common Stock) on the trading day prior to the day of determination, as reported in the Wall Street Journal or such other source as the Board deems reliable;

(2)In the absence of such markets for the Common Stock, the Fair Market Value shall be determined in good faith by the Board and to the extent that the Company is subject to Section 260.140.50 of Title 10 of the California Code of Regulations at the time a Stock Award is granted, in a manner consistent with Section 260.140.50 of Title 10 of the California Code of Regulations.

(n)“Incentive Stock Option” means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder.

(o)“Non-Employee Director”means a Director who either (i) is not a current Employee or Officer of the Company or its parent or subsidiary, does not receive compensation (directly or indirectly) from the Company or its parent or subsidiary for services rendered as a consultant or in any capacity other than as a Director (except for an amount as to which disclosure would not be required under Item 404(a) of Regulation S-K promulgated pursuant to the Securities Act), does not possess an interest in any other transaction as to which disclosure would be required under Item 404(a) of Regulation S-K, and is not engaged in a business relationship as to which disclosure would be required under Item 404(b) of Regulation S-K; or (ii) is otherwise considered a “non-employee director” for purposes of Rule 16b-3.

(p)“Nonstatutory Stock Option” means an Option not intended to qualify as an Incentive Stock Option.

(q)“Officer” means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder.

(r) “Option” means a stock option granted pursuant to the Plan.

(s)“Option Agreement” means a written agreement between the Company and an Optionee evidencing the terms and conditions of an individual Option grant. Each Option Agreement shall be subject to the terms and conditions of the Plan.

(t)“Optionee” means a person to whom an Option is granted pursuant to the Plan, or if applicable, such other person who holds an outstanding Option.

3.

(u)“Outside Director” means a Director who either (i) is not a current employee of the Company or an “affiliated corporation” (within the meaning of Treasury regulations promulgated under Section 162(m) of the Code), is not a former employee of the Company or an “affiliated corporation” receiving compensation for prior services (other than benefits under a tax qualified pension plan), was not an officer of the Company or an “affiliated corporation” at any time, and is not currently receiving direct or indirect remuneration from the Company or an “affiliated corporation” for services in any capacity other than as a Director, or (ii) is otherwise considered an “outside director” for purposes of Section 162(m) of the Code.

(v)“Participant” means a person to whom a Stock Award is granted pursuant to the Plan or, if applicable, such other person who holds an outstanding Stock Award.

(w) “Plan” means this Scientific Learning Corporation 1999 Equity Incentive Plan.¶

(x)“Restricted Stock Unit Award” means a Stock Award denominated in shares of Common Stock equivalents granted pursuant to the terms and conditions of Section 8 in which the Participant has the right to receive a specified number of shares of Common Stock over a specified period of time. ¶

(y)“Restricted Stock Unit Award Agreement” means a written agreement between the Company and a holder of a Restricted Stock Unit Award evidencing the terms and conditions of an individual Restricted Stock Unit Award. Each Restricted Stock Unit Award Agreement shall be subject to the terms and conditions of the Plan.

(z)“Rule 16b-3” means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan.

(aa) “Securities Act” means the Securities Act of 1933, as amended.

(bb)“Stock Appreciation Right” means any of the various types of rights which may be granted under Section 9 of the Plan.

(cc)“Stock Award” means any right granted under the Plan, including any Option, any stock bonus, any right to purchase restricted stock, any Restricted Stock Unit Award and any Stock Appreciation Right.

(dd)“Stock Award Agreement” means a written agreement between the Company and a holder of a Stock Award evidencing the terms and conditions of an individual Stock Award grant. Each Stock Award Agreement shall be subject to the terms and conditions of the Plan.

(ee)“Ten Percent Stockholder” means a person who owns (or is deemed to own pursuant to Section 424(d) of the Code) stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any of its Affiliates.

3. ADMINISTRATION.

(a)The Board shall administer the Plan unless and until the Board delegates administration to a Committee, as provided in subsection 3(c).

4.

(b)The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan:

(1)To determine from time to time which of the persons eligible under the Plan shall be granted Stock Awards; when and how each Stock Award shall be granted; whether a Stock Award will be an Incentive Stock Option or a Nonstatutory Stock Option, a stock bonus, a right to purchase restricted stock, a Restricted Stock Unit Award or a Stock Appreciation Right or a combination of the foregoing; the provisions of each Stock Award granted (which need not be identical), including the time or times when a person shall be permitted to receive stock pursuant to a Stock Award; whether a person shall be permitted to receive stock upon exercise of an Independent Stock Appreciation Right; and the number of shares with respect to which a Stock Award shall be granted to each such person.

(2)To construe and interpret the Plan and Stock Awards granted under it, and to establish, amend and revoke rules and regulations for its administration. The Board, in the exercise of this power, may correct any defect, omission or inconsistency in the Plan or in any Stock Award Agreement, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective.

(3) To amend the Plan or a Stock Award as provided in Section 14.

(4)Generally, to exercise such powers and to perform such acts as the Board deems necessary or expedient to promote the best interests of the Company which are not in conflict with the provisions of the Plan.

(c)The Board may delegate administration of the Plan to a Committee or Committees of one or more members of the Board. In the discretion of the Board, a Committee may consist solely of two or more Outside Directors, in accordance with Code Section 162(m), or solely of two or more Non-Employee Directors, in accordance with Rule 16b-3. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board (and references in this Plan to the Board shall thereafter be to the Committee), subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. Notwithstanding anything in this Section 3 to the contrary, the Board or the Committee may delegate to a committee of one or more members of the Board the authority to grant Options to eligible persons who (1) are not then subject to Section 16 of the Exchange Act and/or (2) are either (i) not then Covered Employees and are not expected to be Covered Employees at the time of recognition of income resulting from such Option, or (ii) not persons with respect to whom the Company wishes to comply with Section 162(m) of the Code.

5.

4. SHARES SUBJECT TO THE PLAN.

(a)Subject to the provisions of subsection 13(a) relating to adjustments upon changes in stock and subject to Section 4(c) below, the stock that may be issued pursuant to Stock Awards shall not exceed in the aggregate Five Million Four Hundred Ninety-Two Thousand Six Hundred Sixty Six (5,492,666) shares of Common Stock, less any shares which are subject to Stock Awards granted under the Company’s Milestone Equity Incentive Plan, as then in effect. If any Stock Award shall for any reason expire or otherwise terminate, in whole or in part, without having been exercised in full, the stock not acquired under such Stock Award shall revert to and again become available for issuance under the Plan. Shares subject to Stock Appreciation Rights exercised in accordance with Section 9 of the Plan shall not be available for subsequent issuance under the Plan.

(b)The stock subject to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise.

(c)Notwithstanding any provision herein to the contrary, in the event the Plan is not approved by holders of at least two-thirds of the Company’s outstanding common stock within twelve months of the date a Stock Award is first granted hereunder following the October 2002 amendment of the Plan, then, unless an exemption from qualification is available with respect to such grant that does not require compliance with the provisions of 260.140.45 of the California Code of Regulations, any Stock Award granted hereunder which (i) followed the October 2002 amendment of the Plan and (ii) was granted at a time when the total number of securities issuable upon exercise of all outstanding options [exclusive of rights described in Section 260.140.40 and warrants described in Sections 260.140.43 and 260.140.44 of the California Code of Regulations, and any purchase plan or agreement as described in Section 260.140.42 of the California Code of Regulations (provided that the purchase plan or agreement provides that all securities will have a purchase price of 100% of the fair value, as determined in accordance with Section 260.140.50 of the California Code of Regulations, of the security either at the time the person is granted the right to purchase securities under the plan or agreement or at the time the purchase is consummated)] and the total number of securities called for under any bonus or similar plan or agreement exceeded 30% of the Company’s then outstanding securities, calculated on an as-converted to common stock basis, shall be void.

5. ELIGIBILITY.

(a)Incentive Stock Options and Stock Appreciation Rights appurtenant thereto may be granted only to Employees. Stock Awards other than Incentive Stock Options and Stock Appreciation Rights appurtenant thereto may be granted to Employees, Directors and Consultants.

(b)No Ten Percent Stockholder shall be eligible for the grant of an Incentive Stock Option unless the exercise price of such Option is at least one hundred ten percent (110%) of the Fair Market Value of such stock at the date of grant and the Option is not exercisable after the expiration of five (5) years from the date of grant.

(c)Subject to the provisions of Section 13 relating to adjustments upon changes in stock, no employee shall be eligible to be granted Options and Stock Appreciation Rights covering more than One Million Four Hundred Thousand (1,400,000)shares of the Common Stock in any calendar year.

6.

6. OPTION PROVISIONS.

Each Option shall be in such form and shall contain such terms and conditions as the Board shall deem appropriate. The provisions of separate Options need not be identical, but each Option shall include (through incorporation of provisions hereof by reference in the Option or otherwise) the substance of each of the following provisions:

(a)Term. No Incentive Stock Option shall be exercisable after the expiration of ten (10) years from the date it was granted.

(b)Price. Subject to the provisions of Section 5(b) regarding Ten Percent Stockholders, the exercise price of each Option shall be not less than one hundred percent (100%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted; provided, however, that to the extent the Company is subject to Section 260.140.41 of Title 10 of the California Code of Regulations at the time the Nonstatutory Stock Option is granted, the exercise price of each Nonstatutory Stock Option granted to a Ten Percent Stockholder shall be at least (i) one hundred ten percent (110%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted or (ii) such lower percentage of the Fair Market Value of the stock subject to the Option on the date the Option is granted as is permitted by Section 260.140.41 of Title 10 of the California Code of Regulations at the time of the grant of the Option.

(c)Consideration. The purchase price of stock acquired pursuant to an Option shall be paid, to the extent permitted by applicable statutes and regulations, either (i) in cash or (ii) at the discretion of the Board (A) by delivery to the Company of other Common Stock of the Company, (B) according to a deferred payment (however, payment of the common stock’s “par value,” as defined in the Delaware General Corporation Law, shall not be made by deferred payment), or other arrangement (which may include, without limiting the generality of the foregoing, the use of other Common Stock of the Company) with the person to whom the Option is granted or to whom the Option is transferred pursuant to subsection 6(d), or (C) in any other form of legal consideration that may be acceptable to the Board.

In the case of any deferred payment arrangement, interest shall be compounded at least annually and shall be charged at the minimum rate of interest necessary to avoid the treatment as interest, under any applicable provisions of the Code, of any amounts other than amounts stated to be interest under the deferred payment arrangement.

(d)Transferability. An Incentive Stock Option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during the lifetime of the person to whom the Option is granted only by such person. A Nonstatutory Stock Option shall not be transferable except by will or by the laws of descent and distribution and, to the extent provided in the Option Agreement, to such further extent as permitted by Section 260.140.41(d) of Title 10 of the California Code of Regulations at the time of the grant of the Option, and shall be exercisable during the lifetime of the Optionee only by the Optionee. If the Nonstatutory Stock Option does not provide for transferability, then the Nonstatutory Stock Option shall not be transferable except by will or by the laws of descent and distribution and shall be exercisable during the lifetime of the Optionee only by the Optionee. Notwithstanding the foregoing, the Optionee may, by delivering written notice to

7.

the Company, in a form satisfactory to the Company, designate a third party who, in the event of the death of the Optionee, shall thereafter be entitled to exercise the Option.

(e)Vesting. The total number of shares of stock subject to an Option may, but need not, be allotted in periodic installments (which may, but need not, be equal). The Option Agreement may provide that from time to time during each of such installment periods, the Option may become exercisable (“vest”) with respect to some or all of the shares allotted to that period, and may be exercised with respect to some or all of the shares allotted to such period and/or any prior period as to which the Option became vested but was not fully exercised. The Option may be subject to such other terms and conditions on the time or times when it may be exercised (which may be based on performance or other criteria) as the Board may deem appropriate. The vesting provisions of individual Options may vary. The provisions of this subsection 6(e) are subject to any Option provisions governing the minimum number of shares as to which an Option may be exercised, including the following subsection 6(f).

(f)Minimum Vesting. Notwithstanding the foregoing Section 6(e), to the extent that the following restrictions on vesting are required by Section 260.140.41(f) of Title 10 of the California Code of Regulations at the time of the grant of the Option, then:

(i)Options granted to an Employee who is not an Officer, Director or Consultant shall provide for vesting of the total number of shares of Common Stock at a rate of at least twenty percent (20%) per year over five (5) years from the date the Option was granted, subject to reasonable conditions such as continued employment; and

(ii)Options granted to Officers, Directors or Consultants may be made fully exercisable, subject to reasonable conditions such as continued employment, at any time or during any period established by the Company.

(g)Termination of the Optionee’s Continuous Service. In the event an Optionee’s Continuous Service terminates (other than upon the Optionee’s death or Disability), the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination) but only within such period of time ending on the earlier of (i) the date three (3) months after the termination of the Optionee’s Continuous Service (or such longer or shorter period specified in the Option Agreement, which, to the extent the Company is subject to Section 260.140.41 of Title 10 of the California Code of Regulations at the time the Option is granted, shall not be less than thirty (30) days), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, after termination, the Optionee does not exercise his or her Option within the time specified in the Option Agreement, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan.

An Optionee’s Option Agreement may also provide that, if the exercise of the Option following the termination of the Optionee’s Continuous Service (other than upon the Optionee’s death or Disability) would be prohibited at any time solely because the issuance of shares would violate the registration requirements under the Securities Act, then the Option shall terminate on the earlier of (i) the expiration of the term of the Option as described in subsection 6(a) or (ii) the expiration of a period of three (3) months after the termination of the Optionee’s Continuous Service during which the exercise of the Option would not be in violation of such registration requirements

8.

(if such provisions would result in an extension of the time during which the Option may be exercised beyond the period described in the first paragraph of this subsection 6(g)).

(h)Disability of Optionee. In the event an Optionee’s Continuous Service terminates as a result of the Optionee’s Disability, the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination), but only within such period of time ending on the earlier of (i) the date twelve (12) months following such termination (or such longer or shorter period specified in the Option Agreement, which, to the extent the Company is subject to Section 260.140.41 of Title 10 of the California Code of Regulations at the time the Option is granted, shall not be less than six (6) months), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, at the date of termination, the Optionee is not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan.

(i)Death of Optionee. In the event of the death of an Optionee during, or within a period specified in the Option after the termination of, the Optionee’s Continuous Service, the Option may be exercised (to the extent the Optionee was entitled to exercise the Option at the date of death) by the Optionee’s estate, by a person who acquired the right to exercise the Option by bequest or inheritance or by a person designated to exercise the option upon the Optionee’s death pursuant to subsection 6(d), but only within the period ending on the earlier of (i) the date eighteen (18) months following the date of death (or such longer or shorter period specified in the Option Agreement, which, to the extent the Company is subject to Section 260.140.41 of Title 10 of the California Code of Regulations at the time the Option is granted, shall not be less than six (6) months), or (ii) the expiration of the term of such Option as set forth in the Option Agreement. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after death, the Option is not exercised within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan.

(j)Early Exercise. The Option may, but need not, include a provision whereby the Optionee may elect at any time before the Optionee’s Continuous Service terminates to exercise the Option as to any part or all of the shares subject to the Option prior to the full vesting of the Option. Any unvested shares so purchased may be subject to a repurchase right in favor of the Company or to any other restriction the Board determines to be appropriate.

7. TERMS OF STOCK BONUSES AND PURCHASES OF RESTRICTED STOCK.

Each stock bonus or restricted stock purchase agreement shall be in such form and shall contain such terms and conditions as the Board shall deem appropriate. The terms and conditions of stock bonus or restricted stock purchase agreements may change from time to time, and the terms and conditions of separate agreements need not be identical, but each stock bonus or restricted stock purchase agreement shall include (through incorporation of provisions hereof by reference in the agreement or otherwise) the substance of each of the following provisions as appropriate:

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(a)Purchase Price. The purchase price under each restricted stock purchase agreement shall be such amount as the Board shall determine and designate in such agreement, which, to the extent the Company is subject to Section 260.140.42 of Title 10 of the California Code of Regulations at the time the restricted Stock Award is granted, shall be at least eighty-five percent (85%) of the Fair Market Value of the stock subject to the agreement, except that for any Ten Percent Stockholder, the purchase price shall be at least one hundred percent (100%) of the Fair Market Value of the stock subject to the agreement. Notwithstanding the foregoing, the Board may determine that eligible participants in the Plan may be awarded stock pursuant to a stock bonus agreement in consideration for past services actually rendered to the Company for its benefit.

(b)Transferability. Rights under a stock bonus or restricted stock purchase agreement shall not be transferable except by will or by the laws of descent and distribution and shall be exercisable during the lifetime of the Participant only by the Participant.

(c)Consideration. The purchase price of stock acquired pursuant to a stock purchase agreement shall be paid either: (i) in cash; (ii) at the discretion of the Board, according to a deferred payment or other arrangement with the person to whom the stock is sold; or (iii) in any other form of legal consideration that may be acceptable to the Board in its discretion. Notwithstanding the foregoing, the Board to which administration of the Plan has been delegated may award stock pursuant to a stock bonus agreement in consideration for past services actually rendered to the Company or for its benefit.

(d)Vesting. Subject to the “Repurchase Limitation” in Section 12(g), shares of stock sold or awarded under the Plan may, but need not, be subject to a repurchase option in favor of the Company in accordance with a vesting schedule to be determined by the Board.

(e)Termination of Continuous Service. Subject to the “Repurchase Limitation” in Section 12(g), in the event the Stock Award recipient’s Continuous Service terminates, the Company may repurchase or otherwise reacquire any or all of the shares of stock held by that person which have not vested as of the date of termination under the terms of the stock bonus or restricted stock purchase agreement between the Company and such person.¶

8. RESTRICTED STOCK UNIT AWARDS.

Each Restricted Stock Unit Award Agreement shall be in such form and shall contain such terms and conditions as the Board shall deem appropriate. The terms and conditions of Restricted Stock Unit Award Agreements may change from time to time, and the terms and conditions of separate Restricted Stock Unit Award Agreements need not be identical, but each Restricted Stock Unit Award Agreement shall include (through incorporation of the provisions hereof by reference in the agreement or otherwise) the substance of each of the following provisions:

(a)Consideration. At the time of grant of a Restricted Stock Unit Award, the Board will determine the consideration, if any, to be paid by the Participant upon delivery of each share of Common Stock subject to the Restricted Stock Unit Award. To the extent required by applicable law, the consideration to be paid by the Participant for each share of Common Stock subject to a Restricted Stock Unit Award will not be less that the par value of a share of Common Stock. Such consideration may be paid in any form permitted under applicable law.

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(b)Vesting. At the time of grant of a Restricted Stock Unit Award, the Board shall impose such restrictions or conditions to the vesting of the Restricted Stock Unit Award as it, in its absolute discretion, deems appropriate. The Board may condition the vesting of the Restricted Stock Unit Award upon the attainment of specified performance objectives or such other factors as the Board may determine in its sole discretion, including time-based vesting.

(c)Payment. A Restricted Stock Unit Award will be denominated in shares of Common Stock equivalents. A Restricted Stock Unit Award will be settled by the delivery of shares of Common Stock.

(d)Dividend Equivalents. Dividend equivalents may be credited in respect of shares of Common Stock equivalents covered by a Restricted Stock Unit Award, as determined by the Board and contained in the Restricted Stock Unit Award Agreement. At the discretion of the Board, such dividend equivalents may be converted into additional shares of Common Stock equivalents covered by the Restricted Stock Unit Award by dividing (1) the aggregate amount or value of the dividends paid with respect to that number of shares of Common Stock equivalents covered by the Restricted Stock Unit Award then credited by (2) the Fair Market Value per share of Common Stock on the payment date for such dividend, or in such other manner as determined by the Board. Any additional share equivalents covered by the Restricted Stock Unit Award credited by reason of such dividend equivalents shall be subject to all the terms and conditions of the underlying Restricted Stock Unit Award Agreement to which they relate.

(e)Termination of Participant’s Continuous Service. Except as otherwise provided in the applicable Restricted Stock Unit Award Agreement, such portion of the Restricted Stock Unit Award that has not vested will be forfeited upon the Participant’s termination of Continuous Service for any reason.

(f)Transferability. Restricted Stock Units shall be transferable by the Participant only upon such terms and conditions as are set forth in the Restricted Stock Unit Agreement, as the Board shall determine in its discretion.

9. STOCK APPRECIATION RIGHTS.

(a)Exercise. To exercise any outstanding Stock Appreciation Right, the holder must provide written notice of exercise to the Company in compliance with the provisions of the Stock Award Agreement evidencing such right. Except as provided in subsection 5(c), no limitation shall exist on the aggregate amount of cash payments the Company may make under the Plan in connection with the exercise of a Stock Appreciation Right.

(b)Awards. Three types of Stock Appreciation Rights shall be authorized for issuance under the Plan:

(1)Tandem Stock Appreciation Rights. Tandem Stock Appreciation Rights will be granted appurtenant to an Option, and shall, except as specifically set forth in this Section 9, be subject to the same terms and conditions applicable to the particular Option grant to which it pertains. Tandem Stock Appreciation Rights will require the holder to elect between the exercise of the underlying Option for shares of stock and the surrender, in whole or in part, of such

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Option for an appreciation distribution. The appreciation distribution payable on the exercised Tandem Right shall be in cash (or, if so provided, in an equivalent number of shares of stock based on Fair Market Value on the date of the Option surrender) in an amount up to the excess of (A) the Fair Market Value (on the date of the Option surrender) of the number of shares of stock covered by that portion of the surrendered Option in which the Optionee is vested over (B) the aggregate exercise price payable for such vested shares.

(2)Concurrent Stock Appreciation Rights. Concurrent Rights will be granted appurtenant to an Option and may apply to all or any portion of the shares of stock subject to the underlying Option and shall, except as specifically set forth in this Section 9, be subject to the same terms and conditions applicable to the particular Option grant to which it pertains. A Concurrent Right shall be exercised automatically at the same time the underlying Option is exercised with respect to the particular shares of stock to which the Concurrent Right pertains. The appreciation distribution payable on an exercised Concurrent Right shall be in cash (or, if so provided, in an equivalent number of shares of stock based on Fair Market Value on the date of the exercise of the Concurrent Right) in an amount equal to such portion as shall be determined by the Board or the Committee at the time of the grant of the excess of (A) the aggregate Fair Market Value (on the date of the exercise of the Concurrent Right) of the vested shares of stock purchased under the underlying Option which have Concurrent Rights appurtenant to them over (B) the aggregate exercise price paid for such shares.

(3)Independent Stock Appreciation Rights. Independent Rights will be granted independently of any Option and shall, except as specifically set forth in this Section 9, be subject to the same terms and conditions applicable to Nonstatutory Stock Options as set forth in Section 6. They shall be denominated in share equivalents. The appreciation distribution payable on the exercised Independent Right shall be not greater than an amount equal to the excess of (A) the aggregate Fair Market Value (on the date of the exercise of the Independent Right) of a number of shares of Company stock equal to the number of share equivalents in which the holder is vested under such Independent Right, and with respect to which the holder is exercising the Independent Right on such date, over (B) the aggregate Fair Market Value (on the date of the grant of the Independent Right) of such number of shares of Company stock. The appreciation distribution payable on the exercised Independent Right shall be in cash or, if so provided, in an equivalent number of shares of stock based on Fair Market Value on the date of the exercise of the Independent Right.

10. COVENANTS OF THE COMPANY.

(a)During the terms of the Stock Awards, the Company shall keep available at all times the number of shares of stock required to satisfy such Stock Awards.

(b)The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares under Stock Awards; provided, however, that this undertaking shall not require the Company to register under the Securities Act the Plan, any Stock Award or any stock issued or issuable pursuant to any such Stock Award. If, after reasonable efforts, the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability

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for failure to issue and sell stock upon exercise of such Stock Awards unless and until such authority is obtained.

11. USE OF PROCEEDS FROM STOCK.

Proceeds from the sale of stock pursuant to Stock Awards shall constitute general funds of the Company.

12. MISCELLANEOUS.

(a)The Board shall have the power to accelerate the time at which a Stock Award may first be exercised or the time during which a Stock Award or any part thereof will vest, notwithstanding the provisions in the Stock Award stating the time at which it may first be exercised or the time during which it will vest.

(b)Neither the recipient of a Stock Award nor any person to whom a Stock Award is transferred in accordance with the Plan shall be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to such Stock Award unless and until such person has satisfied all requirements for exercise of the Stock Award pursuant to its terms.

(c)Nothing in the Plan or any instrument executed or Stock Award granted pursuant thereto shall confer upon any recipient or other holder of Stock Awards any right to continue in the employ of the Company or any Affiliate or to continue serving as a Consultant or a Director, or shall affect the right of the Company or any Affiliate to terminate the employment of any Employee with or without notice and with or without cause, or the right to terminate the relationship of any Consultant pursuant to the terms of such Consultant’s agreement with the Company or Affiliate or service as a Director pursuant to the Company’s Bylaws and the provisions of the corporate law of the state in which the Company is incorporated.

(d)To the extent that the aggregate Fair Market Value (determined at the time of grant) of stock with respect to which Incentive Stock Options are exercisable for the first time by any Optionee during any calendar year under all plans of the Company and its Affiliates exceeds one hundred thousand dollars ($100,000), the Options or portions thereof which exceed such limit (according to the order in which they were granted) shall be treated as Nonstatutory Stock Options.

(e)The Company may require any person to whom a Stock Award is granted, or any person to whom a Stock Award is transferred in accordance with the Plan, as a condition of exercising or acquiring stock under any Stock Award, (1) to give written assurances satisfactory to the Company as to such person’s knowledge and experience in financial and business matters and/or to employ a purchaser representative reasonably satisfactory to the Company who is knowledgeable and experienced in financial and business matters, and that he or she is capable of evaluating, alone or together with the purchaser representative, the merits and risks of exercising the Stock Award; and (2) to give written assurances satisfactory to the Company stating that such person is acquiring the stock subject to the Stock Award for such person’s own account and not with any present intention of selling or otherwise distributing the stock. The foregoing requirements, and any assurances given pursuant to such requirements, shall be inoperative if (i) the issuance of the shares upon the exercise or acquisition of stock under the Stock Award has been registered under a then currently effective

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registration statement under the Securities Act, or (ii) as to any particular requirement, a determination is made by counsel for the Company that such requirement need not be met in the circumstances under the then applicable securities laws. The Company may, upon advice of counsel to the Company, place legends on stock certificates issued under the Plan as such counsel deems necessary or appropriate in order to comply with applicable securities laws, including, but not limited to, legends restricting the transfer of the stock.

(f)To the extent provided by the terms of a Stock Award Agreement, the person to whom a Stock Award is granted may satisfy any federal, state or local tax withholding obligation relating to the exercise or acquisition of stock under a Stock Award by any of the following means (in addition to the Company’s right to withhold from any compensation paid to such person by the Company) or by a combination of such means: (1) tendering a cash payment; (2) authorizing the Company to withhold shares from the shares of the Common Stock otherwise issuable to the participant as a result of the exercise or acquisition of stock under the Stock Award; or (3) delivering to the Company owned and unencumbered shares of the Common Stock of the Company.

(g)Repurchase Limitation. The terms of any repurchase option shall be specified in the Stock Award, and the repurchase price may be either the Fair Market Value of the shares of Common Stock on the date of termination of Continuous Service or the lower of (i) the Fair Market Value of the shares of Common Stock on the date of repurchase or (ii) their original purchase price. To the extent required by Section 260.140.41 and Section 260.140.42 of Title 10 of the California Code of Regulations at the time a Stock Award is made, any repurchase option contained in a Stock Award granted to a person who is not an Officer, Director or Consultant shall be upon the terms described below:

(i)Fair Market Value. If the repurchase option gives the Company the right to repurchase the shares of Common Stock upon termination of Continuous Service at not less than the Fair Market Value of the shares of Common Stock to be purchased on the date of termination of Continuous Service, then (i) the right to repurchase shall be exercised for cash or cancellation of purchase money indebtedness for the shares of Common Stock within ninety (90) days of termination of Continuous Service (or in the case of shares of Common Stock issued upon exercise of Stock Awards after such date of termination, within ninety (90) days after the date of the exercise) or such longer period as may be agreed to by the Company and the Participant (for example, for purposes of satisfying the requirements of Section 1202(c)(3) of the Code regarding “qualified small business stock”) and (ii) the right terminates when the shares of Common Stock become publicly traded.

(ii)Original Purchase Price. If the repurchase option gives the Company the right to repurchase the shares of Common Stock upon termination of Continuous Service at the lower of (i) the Fair Market Value of the shares of Common Stock on the date of repurchase or (ii) their original purchase price, then (x) the right to repurchase at the original purchase price shall lapse at the rate of at least twenty percent (20%) of the shares of Common Stock per year over five (5) years from the date the Stock Award is granted (without respect to the date the Stock Award was exercised or became exercisable) and (y) the right to repurchase shall be exercised for cash or cancellation of purchase money indebtedness for the shares of Common Stock within ninety (90) days of termination of Continuous Service (or in the case of shares of Common Stock issued upon exercise of Options after such date of termination, within ninety (90) days after the date of the exercise) or such longer period as may be agreed to by the Company and the Participant (for example, for purposes of

14.

satisfying the requirements of Section 1202(c)(3) of the Code regarding “qualified small business stock”).

(h)INFORMATION OBLIGATION. To the extent required by Section 260.140.46 of Title 10 of the California Code of Regulations, the Company shall deliver financial statements to Participants at least annually. This Section 12(h) shall not apply to key Employees whose duties in connection with the Company assure them access to equivalent information.

13. ADJUSTMENTS UPON CHANGES IN STOCK.

(a)If any change is made in the stock subject to the Plan, or subject to any Stock Award, without the receipt of consideration by the Company (through merger, consolidation, reorganization, recapitalization, reincorporation, stock dividend, dividend in property other than cash, stock split, liquidating dividend, combination of shares, exchange of shares, change in corporate structure or other transaction not involving the receipt of consideration by the Company), the Plan will be appropriately adjusted in the class(es) and maximum number of shares subject to the Plan pursuant to subsection 4(a) and the maximum number of shares subject to award to any person during any calendar year pursuant to subsection 5(c), and the outstanding Stock Awards will be appropriately adjusted in the class(es) and number of shares and price per share of stock subject to such outstanding Stock Awards. Such adjustments shall be made by the Board, the determination of which shall be final, binding and conclusive. (The conversion of any convertible securities of the Company shall not be treated as a “transaction not involving the receipt of consideration by the Company”.)

(b)In the event of a proposed dissolution or liquidation of the Company, the Board shall notify the Stock Award holder at least fifteen (15) days prior to such proposed action. To the extent it has not been previously exercised, the Stock Award shall terminate immediately prior to the consummation of such proposed action.

(c)In the event of: (1) a dissolution, liquidation or sale of substantially all of the assets of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; or (3) a reverse merger in which the Company is the surviving corporation but the shares of Common Stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, then (i) any surviving corporation or acquiring corporation shall assume any Stock Awards outstanding under the Plan or shall substitute similar stock awards (including an award to acquire the same consideration paid to the stockholders in the transaction described in this subsection 13(b)) for those outstanding under the Plan, or (ii) in the event any surviving corporation or acquiring corporation refuses to assume such Stock Awards or to substitute similar stock awards for those outstanding under the Plan, (A) with respect to Stock Awards held by persons whose Continuous Service has not terminated, the vesting of such Stock Awards (and, if applicable, the time during which such Stock Awards may be exercised) shall be accelerated prior to such event and the Stock Awards terminated if not exercised (if applicable) after such acceleration and at or prior to such event, and (B) with respect to any other Stock Awards outstanding under the Plan, such Stock Awards shall be terminated if not exercised (if applicable) prior to such event.

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(d)In the event of the acquisition by any person, entity or group within the meaning of Section 13(d) or 14(d) of the Exchange Act, or any comparable successor provisions (excluding any employee benefit plan, or related trust, sponsored or maintained by the Company or any Affiliate of the Company) of the beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act, or comparable successor rule) of securities of the Company representing at least fifty percent (50%) of the combined voting power entitled to vote in the election of directors, then, with respect to Stock Awards held by persons whose Continuous Service has not terminated, the vesting of such Stock Awards (and, if applicable, the time during which such Stock Awards may be exercised) shall be accelerated immediately upon the happening of such event.

14. AMENDMENT OF THE PLAN AND STOCK AWARDS.

(a)The Board at any time, and from time to time, may amend the Plan. However, except as provided in Section 13 relating to adjustments upon changes in stock, no amendment shall be effective unless approved by the stockholders of the Company to the extent stockholder approval is necessary for the Plan to satisfy the requirements of Section 422 of the Code, Rule 16b-3 or any Nasdaq or securities exchange listing requirements.

(b)The Board may in its sole discretion submit any other amendment to the Plan for stockholder approval, including, but not limited to, amendments to the Plan intended to satisfy the requirements of Section 162(m) of the Code and the regulations thereunder regarding the exclusion of performance-based compensation from the limit on corporate deductibility of compensation paid to certain executive officers.

(c)It is expressly contemplated that the Board may amend the Plan in any respect the Board deems necessary or advisable to provide eligible Optionees with the maximum benefits provided or to be provided under the provisions of the Code and the regulations promulgated thereunder relating to Incentive Stock Options and/or to bring the Plan and/or Incentive Stock Options granted under it into compliance therewith.

(d)Rights under any Stock Award granted before amendment of the Plan shall not be impaired by any amendment of the Plan unless (i) the Company requests the consent of the person to whom the Stock Award was granted and (ii) such person consents in writing.

(e)The Board at any time, and from time to time, may amend the terms of any one or more Stock Awards; provided, however, that the rights under any Stock Award shall not be impaired by any such amendment unless (i) the Company requests the consent of the person to whom the Stock Award was granted and (ii) such person consents in writing.

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15. TERMINATION OR SUSPENSION OF THE PLAN.

(a)The Board may suspend or terminate the Plan at any time. Unless sooner terminated, the Plan shall terminate ten (10) years from the date the Plan is adopted by the Board or approved by the stockholders of the Company, whichever is earlier. No Stock Awards may be granted under the Plan while the Plan is suspended or after it is terminated. Notwithstanding the foregoing, all Incentive Stock Options shall be granted, if at all, no later than the last day preceding the tenth (10th) anniversary of the earlier of (i) the date on which the latest increase in the maximum number of shares issuable under the Plan was approved by the stockholders of the Company or (ii) the date such amendment was adopted by the Board.

(b)Rights and obligations under any Stock Award granted while the Plan is in effect shall not be impaired by suspension or termination of the Plan, except with the consent of the person to whom the Stock Award was granted.

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16. EFFECTIVE DATE OF PLAN.

The Plan shall become effective as of the date of the closing of the IPO, but no Options or rights to purchase restricted stock granted under the Plan shall be exercised, and no stock bonuses shall be granted under the Plan, unless and until the Plan has been approved by the stockholders of the Company, which approval shall be within twelve (12) months before or after the date the Plan was adopted by the Board.

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EX-10.3

Exhibit 10.3

STANDARD FORM OF

SCIENTIFIC LEARNING CORPORATION

RESTRICTED STOCK UNIT AWARD AGREEMENT

SCIENTIFIC LEARNING CORPORATION

1999 EQUITY INCENTIVE PLAN

RESTRICTED STOCK UNIT AWARD AGREEMENT

Pursuant to your Restricted Stock Unit Grant Notice (“Grant Notice”) and this Restricted Stock Unit Award Agreement (collectively, the “Award”) and in consideration of your past services, Scientific Learning Corporation (the “Company”) has awarded you a Restricted Stock Unit Award under its 1999 Equity Incentive Plan (the “Plan”) for the number of Company common stock share equivalents subject to the Award as indicated in the Grant Notice. Defined terms not explicitly defined in this Restricted Stock Unit Award Agreement but defined in the Plan shall have the same definitions as in the Plan.

The details of your Award are as follows:

1.Vesting. Subject to the limitations contained herein, your Award will vest as provided in the Grant Notice, provided that vesting will cease upon the termination of your Continuous Service.

2.Number of Share Equivalents. The number of common stock share equivalents subject to your Award may be adjusted from time to time for Capitalization Adjustments, as provided in Section 10 of the Plan.

3.Payment. Your Award shall be settled by the delivery of shares of Company common stock.

4.Dividend Equivalents. Dividend equivalents shall be credited in respect of Company common stock share equivalents covered by your Award. Such dividend equivalents shall be converted into additional common stock share equivalents covered by your Award by dividing (1) the aggregate amount or value of the dividends paid with respect to that number of share equivalents covered by your Award then credited by (2) the Fair Market Value per share of Common Stock on the payment date for such dividend. Any additional share equivalents covered by your Award credited by reason of such dividend equivalents shall be subject to all the terms and conditions of this underlying Restricted Stock Unit Award Agreement to which they relate.

5.Securities Law Compliance. You may not be issued any shares under your Award unless the shares are either (i) then registered under the Securities Act or (ii) the Company has determined that such issuance would be exempt from the registration requirements of the Securities Act. Your Award also must comply with other applicable laws and regulations governing the Award, and you will not receive any shares of Company common stock upon the payment of your Award if the Company determines that such receipt would not be in material compliance with such laws and regulations.

6.Award not a Service Contract. Your Award is not an employment or service contract, and nothing in your Award shall be deemed to create in any way whatsoever any obligation on your part to continue in the employ of the Company or on the part of the

1.

Company to continue your employment. In addition, nothing in your Award shall obligate the Company, its stockholders, board of directors, officers or employees to continue any relationship that you might have as a Director.

7. Withholding Obligations.

(a)At the time your Award is vested, or at any time thereafter as requested by the Company, you hereby authorize withholding from payroll and any other amounts payable to you, and otherwise agree to make adequate provision for any sums required to satisfy the federal, state or local tax withholding obligations of the Company, if any, which arise in connection with your Award.

(b)Unless the tax withholding obligations of the Company are satisfied, the Company shall have no obligation to issue a certificate for any shares pursuant to the vesting of your Award.

8.Tax Consequences. Restricted Stock Unit Awards are deferred compensation and subject to the design limitations and requirements of Code Section 409A. If the limitations and requirements of Code Section 409A are violated, deferred amounts will be subject to tax at ordinary income rates immediately upon such violation and will be subject to penalties equal to (i) 20% of the amount deferred and (ii) interest at a specified rate on the under-payment of tax that would have occurred had the deferred compensation been included in gross income in the taxable year in which it was first deferred.

9.Notices. Any notices provided for in your Award or the Plan shall be given in writing and shall be deemed effectively given upon receipt or, in the case of notices delivered by the Company to you, five (5) days after deposit in the United States mail, postage prepaid, addressed to you at the last address you provided to the Company.

10. Miscellaneous.

(a)The rights and obligations of the Company under your Award shall be transferable to any one or more person or entities, and all covenants and agreements hereunder shall inure to the benefit of, and be enforceable by the Company’s successors and assigns. Your rights and obligations under your Award may only be assigned with the prior written consent of the Company.

(b)You agree upon request to execute further documents or instruments necessary or desirable in the sole determination of the Company to carry out the purpose of your Award.

(c)You acknowledge and agree that you have reviewed your Award in its entirety, have had an opportunity to obtain advice of counsel prior to executing and accepting your Award and fully understand all of the provisions of your Award.

11.Governing Plan Document. Your Award is subject to all of the provisions of the Plan, the provisions of which are hereby made a part of your Award, and is further subject to all interpretations, amendments, rules and regulations which may from time to time be promulgated and adopted pursuant to the Plan. In the event of any conflict between the provisions of your Award and those of the Plan, the provisions of the Plan shall control.

2.

STANDARD FORM OF

SCIENTIFIC LEARNING CORPORATION

NOTICE OF GRANT OF RESTRICTED STOCK UNITS

Notice of Grant of Restricted Stock Unit	Scientific Learning Corporation
and Restricted Stock Unit Award Agreement	ID: 94-3234458
	300 Frank H. Ogawa Plaza
	Suite 600
	Oakland, CA 94612-2040

Name	Award Number:
Address	Plan: 1999

City, State, Country, Zip Code

Effective XXXX200X, you have been granted a restricted stock unit award for X common share equivalents of Scientific Learning Corporation (the Company). These restricted stock units will vest according to the schedule below. Consideration for this award is past services.

Share Equivalents Full Vest              

By your signature and the Company’s signature below, you and the Company agree that this award is granted under and governed by the terms and conditions of the Company’s 1999 Equity Incentive Plan, as amended, which has been made available to you, and the Restricted Stock Unit Award Agreement, which is attached.

_________________________________
Scientific Learning Corporation _________________________________
Date

_________________________________
<Name> _________________________________
Date

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EX-10.8

Exhibit 10.8

SCIENTIFIC LEARNING CORPORATION

1999 EMPLOYEE STOCK PURCHASE PLAN OFFERING

ADOPTED BY BOARD OF DIRECTORS APRIL 22, 1999;

AS AMENDED THROUGH OCTOBER 26, 2005

1. GRANT; OFFERING DATE.

(a)The Board of Directors of Scientific Learning Corporation, a Delaware corporation (the “Company”), pursuant to the Company’s 1999 Employee Stock Purchase Plan (the “Plan”), hereby authorizes the grant of rights to purchase shares of the common stock of the Company (“Common Stock”) to all Eligible Employees (an “Offering”). The first day of an Offering is that Offering’s “Offering Date.” An Offering may consist of one (1) or more consecutive “Purchase Periods.” The last day of each Purchase Period during an Offering shall be a “Purchase Date” for that Offering. If an Offering Date or Purchase Date does not fall on a day during which the Company’s Common Stock is actively traded, then the Offering Date or Purchase Date, as the case may be, shall be the next subsequent day during which the Company’s Common Stock is actively traded.

(b)Unless otherwise specifically provided herein, the first Purchase Period of an Offering shall begin on the Offering Date and shall end approximately six (6) months thereafter on the next November 30 or May 31, as the case may be. Subsequent Purchase Periods during the Offering shall begin each December 1 and June 1 and shall end six (6) months thereafter on May 31 or November 30, as the case may be.

(c)Effective commencing September 1, 2002, an Offering (the “Re-StartOffering”) shall commence on June 1, 2003 and shall end 12 months thereafter, unless terminated sooner as herein provided. Thereafter, an Offering shall begin each year on the anniversary date of the commencement of the Re-Start Offering and shall end twelve (12) months later on the day prior to the next Offering Date. Each Offering will be divided into two (2) consecutive shorter Purchase Periods of six (6) months in duration.

(d)Prior to the commencement of any Offering, the Board of Directors (or the Committee described in subparagraph 2(c) of the Plan, if any) may change any or all terms of such Offering and any subsequent Offerings. The granting of rights pursuant to each Offering hereunder shall occur on each respective Offering Date unless, prior to such date (a) the Board of Directors (or such Committee) determines that such Offering shall not occur, or (b) no shares remain available for issuance under the Plan in connection with the Offering.

2. ELIGIBLE EMPLOYEES.

All employees of the Company and each of its Affiliates (as defined in the Plan) incorporated in the United States, shall be granted rights to purchase Common Stock under each Offering on the Offering Date (an “Eligible Employee”). Notwithstanding the foregoing, the following employees shall NOT be Eligible Employees or be granted rights under an Offering: (i) part-time or seasonal employees whose customary employment is less than 20 hours per week

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or five months per calendar year or (ii) 5% stockholders (including ownership through unexercised options) described in subparagraph 5(c) of the Plan.

3. RIGHTS.

(a)Subject to the limitations contained herein and in the Plan, on each Offering Date each Eligible Employee shall be granted the right to purchase the number of shares of Common Stock purchasable with up to fifteen percent (15%) of such Eligible Employee’s Earnings paid during such Offering; provided, however, that no employee may purchase Common Stock on a particular Purchase Date that would result in more than fifteen percent (15%) of such employee’s Earnings in the period from the Offering Date to such Purchase Date having been applied to purchase shares under all ongoing Offerings under the Plan and all other Company plans intended to qualify as “employee stock purchase plans” under Section 423 of the Internal Revenue Code of 1986, as amended (the “Code”).

(b)For purposes of this Offering, “Earnings” means the total compensation paid to an employee, including all salary, wages (including amounts elected to be deferred by the employee, that would otherwise have been paid, under any cash or deferred arrangement established by the Company), overtime pay, commissions, bonuses, and other remuneration paid directly to the employee, but excluding profit sharing, the cost of employee benefits paid for by the Company, education or tuition reimbursements, imputed income arising under any Company group insurance or benefit program, traveling expenses, business and moving expense reimbursements, income received in connection with stock options, contributions made by the Company under any employee benefit plan, and similar items of compensation.

(c)Subject to the limitations contained herein and in the Plan, each employee who was not eligible on the Offering Date but who first becomes an Eligible Employee during the Offering and prior to the November 21 during the Offering shall, on Dec  1 during that Offering, be granted the right to purchase the number of shares of Common Stock purchasable with up to fifteen percent (15%) of such employee’s Earnings paid during his or her participation in such Offering, which right shall be deemed to be a part of the Offering. Such right shall have the same characteristics as any rights originally granted under the Offering, except that (i) the date on which such a right is granted shall be the “Offering Date” of such right for all purposes, including determination of the exercise price of such right; and (ii) the Offering for such right shall begin on its Offering Date and end coincident with the end of the ongoing Offering.

(d)The maximum number of shares of Common Stock an Eligible Employee may purchase on any Purchase Date in an Offering shall be such number of shares as has a fair market value (determined as of the Offering Date for such Offering) equal to (x) $25,000 multiplied by the number of calendar years in which the right under such Offering has been outstanding at any time, minus (y) the fair market value of any other shares of Common Stock (determined as of the relevant Offering Date with respect to such shares) which, for purposes of the limitation of Section 423(b)(8) of the Code, are attributed to any of such calendar years in which the right is outstanding. The amount in clause (y) of the previous sentence shall be determined in accordance with regulations applicable under Section 423(b)(8) of the Code based on (i) the number of shares previously purchased with respect to such calendar years pursuant to such Offering or any other Offering under the Plan, or pursuant to any other Company plans intended

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to qualify as “employee stock purchase plans” under Section 423 of the Code, and (ii) the number of shares subject to other rights outstanding on the Offering Date for such Offering pursuant to the Plan or any other such Company plan.

(e)The maximum aggregate number of shares available to be purchased by all Eligible Employees under an Offering shall be the number of shares remaining available under the Plan on the Offering Date. If the aggregate purchase of shares of Common Stock upon exercise of rights granted under the Offering would exceed the maximum aggregate number of shares available, the Board shall make a pro rata allocation of the shares available in a uniform and equitable manner.

4. PURCHASE PRICE.

The purchase price of the Common Stock under the Offering shall be the lesser of eighty-five percent (85%) of the fair market value of the Common Stock on the Offering Date or eighty-five percent (85%) of the fair market value of the Common Stock on the Purchase Date, in each case rounded up to the nearest whole cent per share. For the Initial Offering, the fair market value of the Common Stock at the time when the Offering commences shall be the price per share at which shares of Common Stock are first sold to the public in the Company’s initial public offering as specified in the final prospectus with respect to that offering.

5. PARTICIPATION.

(a)An Eligible Employee may elect to participate in an Offering only at the beginning of the Offering, or such later date specified in subparagraph 3(c). An Eligible Employee shall become a participant in an Offering by delivering an agreement authorizing payroll deductions. Such deductions must be in whole dollars or whole percentages, with a maximum percentage of fifteen percent (15%) of Earnings. A participant may not make additional payments into his or her account. The agreement shall be made on such enrollment form as the Company or a designated Affiliate provides, and must be delivered to the Company or designated Affiliate at least ten (10) days before the Offering Date, or before such later date specified in subparagraph 3(c), to be effective, unless a later time for filing the enrollment form is set by the Board for all Eligible Employees with respect to a given Offering Date. For the Initial Offering, the time for filing an enrollment form and commencing participation for individuals who are Eligible Employees on the Offering Date for the Initial Offering may be after the Offering Date, as determined by the Company and communicated to such Eligible Employees. (If the agreement authorizing payroll deductions is required to be delivered to the Company or designated Affiliate a specified number of days before the Offering Date to be effective, then an employee who becomes eligible during the required delivery period shall not be considered to be an Eligible Employee at the beginning of the Offering but may elect to participate during the Offering as provided in subparagraph 3(c).)

(b)A participant may increase or reduce his or her participation level effective as of the Dec 1 following the November 30 Purchase Date during the course of an Offering. In addition, a participant may increase or decrease his or her participation level prior to the beginning of a new Offering to be effective at the beginning of such new Offering. A participant may also reduce his or her participation level to zero at any time during an Offering, excluding

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only each ten (10) day period immediately preceding a Purchase Date (or such shorter period of time determined by the Company and communicated to participants). Any such change in participation shall be made by delivering a notice to the Company or a designated Affiliate in such form and at such time as the Company provides. Except as otherwise specifically provided herein, a participant may not increase or decrease his or her participation level during the course of an Offering.

(c)A participant may withdraw from an Offering and receive his or her accumulated payroll deductions from the Offering (reduced to the extent, if any, such deductions have been used to acquire Common Stock for the participant on any prior Purchase Dates), without interest, at any time prior to the end of the Offering, excluding only each ten (10) day period immediately preceding a Purchase Date (or such shorter period of time determined by the Company and communicated to participants) by delivering a withdrawal notice to the Company in such form as the Company provides. A participant who has withdrawn from an Offering shall not again participate in such Offering but may participate in subsequent Offerings under the Plan by submitting a new participation agreement in accordance with the terms thereof.

(d)A participant shall automatically participate in the Offering commencing immediately after the final Purchase Date of each Offering in which the participant participates until such time as such participant (i) ceases to be an Eligible Employee, (ii) withdraws from the Offering or (iii) terminates employment. A participant who automatically participates in a subsequent Offering is not required to file any additional enrollment form for such subsequent Offering in order to continue participation in the Plan. However, a participant may file an enrollment form with respect to such subsequent Offering if the participant desires to change any of the participant’s elections contained in the participant’s then effective enrollment form.

6. PURCHASES.

Subject to the limitations contained herein, on each Purchase Date, each participant’s accumulated payroll deductions (without any increase for interest) shall be applied to the purchase of whole shares of Common Stock, up to the maximum number of shares permitted under the Plan and the Offering.

7. NOTICES AND AGREEMENTS.

Any notices or agreements provided for in an Offering or the Plan shall be given in writing, in a form provided by the Company, and unless specifically provided for in the Plan or this Offering shall be deemed effectively given upon receipt or, in the case of notices and agreements delivered by the Company, five (5) days after deposit in the United States mail, postage prepaid.

8. EXERCISE CONTINGENT ON STOCKHOLDER APPROVAL.

The rights granted under an Offering are subject to the approval of the Plan by the stockholders as required for the Plan to obtain treatment as a tax-qualified employee stock purchase plan under Section 423 of the Code.

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9. OFFERING SUBJECT TO PLAN.

Each Offering is subject to all the provisions of the Plan, and its provisions are hereby made a part of the Offering, and is further subject to all interpretations, amendments, rules and regulations which may from time to time be promulgated and adopted pursuant to the Plan. In the event of any conflict between the provisions of an Offering and those of the Plan (including interpretations, amendments, rules and regulations that may from time to time be promulgated and adopted pursuant to the Plan), the provisions of the Plan shall control.

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EX-10.15

Exhibit 10.15

Adopted by the Compensation Committee of the Board March 7, 2006

Scientific Learning Corporation

2006 Management Incentive Plan

Purpose

To provide significant cash awards to participants for the achievement and over-achievement of Scientific Learning’s collective financial goals, as well as each participant’s individual goals and overall performance in adding value for shareholders, customers and employees.

Participants

All members of the Leadership Team, director-level employees and selected manager-level employees. The total number of participants at March 2006 is approximately 39 persons. The regional sales directors who are included in sales incentive compensation plans are excluded from this Plan.

Target Incentive Awards

Intended to deliver market average incentive compensation at 100% achievement of goals. Awards increase for overachievement.

Title	Target Award (% of Base Salary Awarded at 100% Achievement of Goals)	Max Award (Max % of Base Salary Awarded on Overachievement)
CEO	50%	100%
VP, Sales K-12	50%	100%
CFO	40%	80%
Chief Ed. Officer, Other VPs	30%	60%
Directors	20%	30%
Managers	10%	15%

Goals

All participants in the Plan will have shared Company financial goals and individual goals closely related to the individual’s own area of responsibility.

Shared Goals

Shared goals for the 2006 Plan are:

	Hurdle Level (Minimum for Payment of Bonus)	Target Level (100% Goal Achievement)	Max. Overachievement Level
Operating Cash Flow*	Break even	$2.5 million	$5.4 million
Booked sales	$38.0 million	$47.5 million	$50.0 million

*Operating cash flow is defined as GAAP net cash from operating activities less capital spending.

Individual Goals

Individual goal performance under the 2006 Plan is based on both the following:

• Achievement of agreed-upon individual goals closely related to the individual’s area of responsibility. These goals will be agreed in writing between the participant and his/her manager.

• Contribution to adding value for shareholders, customers and employees.

• Hurdle level for individual goals is 80%. Maximum overachievement level is 200%.

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Adopted by the Compensation Committee of the Board March 7, 2006

Weighting of Shared Goals and Individual Performance

Goal	% of Target Award Allocated to Goal
Operating cash flow	30%
Booked sales	40%
Individual performance	30%

Note: For managers and director-level employees, the CEO has discretion to allocate the bonus opportunity differently among the various goals to reflect the priorities and responsibilities of that particular person.

Hurdles and Scaling

The bonus payout starts for each goal when the specified hurdle level for that goal is achieved. At the hurdle level, 50% of that goal’s portion of the target award is earned. At 100% of the goal, then 100% of that goal’s target award is earned. Between the hurdle level and 100% achievement of the goal, the portion of the award earned is scaled ratably.

Overachievement

• Officers can double their bonus through overachievement and directors and managers can increase their bonuses by 50% through overachievement.

• The overachievement potential is divided among the goals in the same percentage as the bonus for achievement.

• The maximum overachievement award is paid at the maximum overachievement levels specified above.

• Between 100% achievement and the maximum bonus overachievement level, each goal’s portion of the award is scaled ratably.

Illustration

The attached chart illustrates, for particular positions, the percentage of base salary payable for each goal, at the hurdle, 100% and maximum overachievement levels.

Timing

Awards will be paid in the first quarter of 2007, following the completion of the 2006 audit. Plan participants must be employed at Scientific Learning in a position that is eligible for an award under this Plan when the awards are paid in order to receive an award. Participants hired or promoted into a MIP eligible position prior to October 1, 2006 will be eligible for a pro-rated award (unless otherwise agreed to, in writing, at the time of the employment action).

Compensation Committee Discretion

The Compensation Committee has discretion to pay awards to reflect achievement even if specific goals are not met, and to interpret the terms of the Plan.

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Adopted by the Compensation Committee of the Board March 7, 2006

% of Base Salary Available as MIP Award at Specified Levels of Achievement of Goals

	% of Base Salary Available as Bonus
	Operating Cash Flow			Booked Sales			Individual Goals			Total
	At Hurdle	100%	Max Over	At Hurdle	100%	Max Over	At Hurdle	100%	Max Over	At Hurdle	100%	Max Over
CEO VP Sales K-12	7.5%	15%	30%	10%	20%	40%	7.5%	15%	30%	25%	50%	100%
CFO	6%	12%	24%	8%	16%	32%	6%	12%	24%	20%	40%	80%
Chief Ed Officer, other VPs	4.5%	9%	18%	6%	12%	24%	4.5%	9%	18%	15%	30%	60%
Directors*	3%	6%	9%	4%	8%	12%	3%	6%	9%	10%	20%	30%
Managers*	1.5%	3%	4.5%	2%	4%	6%	1.5%	3%	4.5%	5%	10%	15%

* Subject to adjustment by the CEO, as described above.

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EX-10.19

Exhibit 10.19

SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT

This Second Amendment to Loan and Security Agreement (this “Amendment”) is entered into as of December 2, 2005, by and between COMERICA BANK (“Bank”) and SCIENTIFIC LEARNING CORPORATION (“Borrower”).

RECITALS

Borrower and Bank are parties to that certain Loan and Security Agreement dated as of January 15, 2004, as amended from time to time including by that certain First Amendment to Loan and Security Agreement dated as of September 29, 2004 (the “Agreement”). The parties desire to amend the Agreement in accordance with the terms of this Amendment.

NOW, THEREFORE, the parties agree as follows:

1.             The following defined terms in Section 1.1 of the Agreement hereby are amended or restated as follows:

“Effective Tangible Net Worth” means at any date as of which the amount thereof shall be determined, the sum of the capital stock, partnership interest or limited liability company interest of Borrower and its Subsidiaries plus Subordinated Debt, minus intangible assets, determined in accordance with GAAP.

“Revolving Maturity Date” means June 2, 2007.

2.             Section 2.1(a)(i) of the Agreement is hereby amended and restated in its entirety to read as follows:

“Subject to and upon the terms and conditions of this Agreement (1) Borrower may request Advances in an aggregate outstanding amount not to exceed the Revolving Line and (2) amounts borrowed pursuant to this Section 2.1(a) may be repaid and reborrowed at any time prior to the Revolving Maturity Date, at which time all Advances under this Section 2.1(a) shall be immediately due and payable. Borrower may prepay any Advances without penalty or premium.”

3.	Section 2.2 of the Agreement is hereby amended and restated in its entirety to read as follows:
	“Intentionally Omitted.”
4.	Section 2.3(a) of the Agreement is hereby amended and restated in its entirety to read as follows:

“Advances. Except as set forth in Section 2.3(b), the Advances shall bear interest, on the outstanding daily balance thereof as set forth in the LIBOR/Prime Rate Addendum to Loan & Security Agreement attached as Exhibit C.”

5. Section 2.5(a) of the Agreement is hereby amended and restated in its entirety to read as follows:

“Facility Fee. On the Closing Date and on each anniversary of the Closing Date, through the termination of Bank’s obligation to make Credit Extensions under this Agreement, a fee equal to $20,000, which shall be nonrefundable; and”

6.	Section 5.4 of the Agreement is hereby amended and restated in its entirety to read as follows:
	“Intentionally Omitted.”

7.             The second paragraph of Section 6.3 of the Agreement is hereby amended and restated in its entirety to read as follows:

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“Within twenty five (25) days after the last day of each month, Borrower shall deliver to Bank aged listings of accounts receivable.”

8.	The number “1.25” in Section 6.8 of the Agreement is hereby replace with the number “1.50”.
9.	Section 6.9 of the Agreement is hereby amended and restated in its entirety to read as follows:

“Measured as of the last day of each month, if Borrower’s Adjusted Quick Ratio (calculated pursuant to Section 6.8) is less than 1.75 to 1.00, Borrower shall maintain an Effective Tangible Net worth as follows: a) greater than or equal to negative Five Million Dollars (($5,000,000)) through June 30, 2006 and b) greater than or equal to One Dollar ($1.00) thereafter.”

10.	Exhibit C to the Agreement is hereby replaced with Exhibit C attached hereto.
11.	Exhibit D to the Agreement is hereby replace with Exhibit D attached hereto.
12.	The Schedule to the Agreement is hereby replaced with the Schedule attached hereto.

13.           No course of dealing on the part of Bank or its officers, nor any failure or delay in the exercise of any right by Bank, shall operate as a waiver thereof, and any single or partial exercise of any such right shall not preclude any later exercise of any such right. Bank’s failure at any time to require strict performance by a Borrower of any provision shall not affect any right of Bank thereafter to demand strict compliance and performance. Any suspension or waiver of a right must be in writing signed by an officer of Bank.

14.           Unless otherwise defined, all initially capitalized terms in this Amendment shall be as defined in the Agreement. The Agreement, as amended hereby, shall be and remain in full force and effect in accordance with its respective terms and hereby is ratified and confirmed in all respects. Except as expressly set forth herein, the execution, delivery, and performance of this Amendment shall not operate as a waiver of, or as an amendment of, any right, power, or remedy of Bank under the Agreement, as in effect prior to the date hereof.

15.          Borrower represents and warrants that the Representations and Warranties contained in the Agreement (as qualified by the Schedule attached hereto) are true and correct as of the date of this Amendment, and that no Event of Default has occurred and is continuing.

16.           As a condition to the effectiveness of this Amendment, Bank shall have received, in form and substance satisfactory to Bank, the following:

(a) this Amendment, duly executed by Borrower;

(b)           a Certificate of the Secretary of Borrower with respect to incumbency and resolutions authorizing the execution and delivery of this Amendment;

(c)           all reasonable Bank Expenses incurred through the date of this Amendment, which may be debited from any of Borrower’s accounts; and

(d)           such other documents, and completion of such other matters, as Bank may reasonably deem necessary or appropriate.

17.           This Amendment may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one instrument.

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IN WITNESS WHEREOF, the undersigned have executed this Amendment as of the first date above written.

SCIENTIFIC LEARNING CORPORATION

By: /s/ Jane A. Freeman
      ——————————————————

Title: CFO
         —————————————————

COMERICA BANK

By: /s/ Rod Werner
      ——————————————————

Title: SVP
        —————————————————

[Signature Page to Second Amendment to Loan & Security Agreement]

EXHIBIT C

LIBOR/PRIME RATE

Addendum To Loan and Security Agreement

This LIBOR/Prime Rate Addendum to Loan and Security Agreement (this “Addendum”) is entered into as of December 2, 2005, by and between COMERICA BANK (“Bank”) and SCIENTIFIC LEARNING CORPORATION (“Borrower”). This Addendum supplements the terms of the Loan and Security Agreement of even date herewith.

1. Definitions.

(a)           Advance. As used herein, “Advance” means a borrowing requested by Borrower and made by Bank under the Loan Agreement, including a LIBOR Option Advance and/or a Prime Rate Option Advance.

(b)           Business Day. As used herein, “Business Day” means any day except a Saturday, Sunday or any other day designated as a holiday under Federal or California statute or regulation.

(c)           LIBOR. As used herein, “LIBOR” means the rate per annum (rounded upward if necessary, to the nearest whole 1/8 of 1 %) and determined pursuant to the following formula:

LIBOR =                      Base LIBOR                   100% - LIBOR Reserve Percentage

(i)            “Base LIBOR” means the rate per annum determined by Bank at which deposits for the relevant LIBOR Period would be offered to Bank in the approximate amount of the relevant LIBOR Option Advance in the inter-bank LIBOR market selected by Bank, upon request of Bank at 10:00 a.m. California time, on the day that is the first day of such LIBOR Period.

(ii)           “LIBOR Reserve Percentage” means the reserve percentage prescribed by the Board of Governors of the Federal Reserve System (or any successor) for “Eurocurrency Liabilities” (as defined in Regulation D of the Federal Reserve Board, as amended), adjusted by Bank for expected changes in such reserve percentage during the applicable LIBOR Period.

(d)           LIBOR Business Day. As used herein, “LIBOR Business Day” means a Business day on which dealings in Dollar deposits may be carried out in the interbank LIBOR market.

(e)           LIBOR Period. As used herein, “LIBOR Period” means, with respect to a LIBOR Option Advance:

(i)            initially, the period commencing on, as the case may be, the date the Advance is made or the date on which the Advance is converted to a LIBOR Option Advance, and continuing for, in every case, a period of 30, 60 or 90 days thereafter so long as the LIBOR Option Advance is quoted for such period in the applicable interbank LIBOR market, as such period is selected by Borrower in the notice of Advance as provided in the Loan Agreement or in the notice of conversion as provided in this Addendum; and

(ii)           thereafter, each period commencing on the last day of the next preceding LIBOR Period applicable to such LIBOR Option Advance and continuing for, in every case, a period of 30, 60 or 90 days thereafter so long as the LIBOR Option Advance is quoted for such period in the applicable interbank LIBOR market, as such period is selected by Borrower in the notice of continuation as provided in this Addendum.

(f)           Loan Agreement. As used herein, “Loan Agreement” means the Loan and Security Agreement between Borrower and Bank dated as of January 15, 2004, as amended from time to time including by that certain First Amendment to Loan and Security Agreement dated as of September 29, 2004 and that certain Second Amendment to Loan and Security Agreement dated as of December 2, 2005.

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(g)           Regulation D. As used herein, “Regulation D” means Regulation D of the Board of Governors of the Federal Reserve System as amended or supplemented from time to time.

(h)           Regulatory Development. As used herein, “Regulatory Development” means any or all of the following: (i) any change in any law, regulation or interpretation thereof by any public authority (whether or not having the force of law); (ii) the application of any existing law, regulation or the interpretation thereof by any public authority (whether or not having the force of law); and (iii) compliance by Bank with any request or directive (whether or not having the force of law) of any public authority.

2.             Interest Rate Options. Borrower shall have the following options regarding the interest rate to be paid by Borrower on Advances under the Loan Agreement:

(a)           A rate equal to two and one half percent (2.50%) above Bank’s LIBOR, (the “LIBOR Option Advance”), which LIBOR Option Advance shall be in effect during the relevant LIBOR Period; or

(b)           A rate equal to the “Prime Rate” as referenced in the Loan Agreement and quoted from time to time by Bank as such rate may change from time to time (the “Prime Rate Option”).

3.            LIBOR Option Advance. The minimum LIBOR Option Advance will not be less than One Million Dollars ($1,000,000) for any LIBOR Option Advance.

4.             Payment of Interest on LIBOR Option Advances. Interest on each LIBOR Option Advance shall be payable pursuant to the terms of the Loan Agreement. Interest on such LIBOR Option Advance shall be computed on the basis of a 360-day year and shall be assessed for the actual number of days elapsed from the first day of the LIBOR Period applicable thereto but not including the last day thereof.

5.            Bank’s Records Re: LIBOR Option Advances. With respect to each LIBOR Option Advance, Bank is hereby authorized to note the date, principal amount, interest rate and LIBOR Period applicable thereto and any payments made thereon on Bank’s books and records (either manually or by electronic entry) and/or on any schedule attached to the Loan Agreement, which notations shall be prima facie evidence of the accuracy of the information noted.

6.             Selection/Conversion of Interest Rate Options. At the time any Advance is requested under the Loan Agreement and/or Borrower wishes to select the LIBOR Option Advance for all or a portion of the outstanding principal balance of the Loan Agreement, and at the end of each LIBOR Period, Borrower shall give Bank notice specifying (a) the interest rate option selected by Borrower; (b) the principal amount subject thereto; and (c) if the LIBOR Option Advance is selected, the length of the applicable LIBOR Period. Any such notice may be given by telephone so long as, with respect to each LIBOR Option Advance selected by Borrower, (i) Bank receives written confirmation from Borrower not later than three (3) LIBOR Business Days after such telephone notice is given; and (ii) such notice is given to Bank prior to 10:00 a.m., California time, on the first day of the LIBOR Period. For each LIBOR Option Advance requested hereunder, Bank will quote the applicable fixed LIBOR Rate to Borrower at approximately 10:00 a.m., California time, on the first day of the LIBOR Period. If Borrower does not immediately accept the rate quoted by Bank, any subsequent acceptance by Borrower shall be subject to a redetermination of the rate by Bank; provided, however, that if Borrower fails to accept any such quotation as given, then the quoted rate shall expire and Bank shall have no obligation to permit a LIBOR Option Advance to be selected on such day. If no specific designation of interest is made at the time any Advance is requested under the Loan Agreement or at the end of any LIBOR Period, Borrower shall be deemed to have selected the Prime Rate Option for such Advance or the principal amount to which such LIBOR Period applied. At any time the LIBOR Option Advance is in effect, Borrower may, at the end of the applicable LIBOR Period, convert to the Prime Rate Option. At any time the Prime Rate Option is in effect, Borrower may convert to the LIBOR OPTION ADVANCE, and shall designate a LIBOR Period.

7.             Default Interest Rate. From and after the maturity date of the Loan Agreement, or such earlier date as all principal owing hereunder becomes due and payable by acceleration or otherwise, the outstanding principal balance of the Loan Agreement shall bear interest until paid in full at an increased rate per annum (computed on the basis of a 360-day year, actual days elapsed) equal to five percent (5.00%) above the rate of interest from time to time applicable to the Loan Agreement.

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8.             Prepayment. In the event that the LIBOR Option Advance is the applicable interest rate for all or any part of the outstanding principal balance of the Loan Agreement, and any payment or prepayment of any such outstanding principal balance of the Loan Agreement shall occur on any day other than the last day of the applicable LIBOR Period (whether voluntarily, by acceleration, required payment, or otherwise), or if Borrower elects the LIBOR Option Advance as the applicable interest rate for all or any part of the outstanding principal balance of the Loan Agreement in accordance with the terms and conditions hereof, and, subsequent to such election, but prior to the commencement of the applicable LIBOR Period, Borrower revokes such election for any reason whatsoever, or if the applicable interest rate in respect of any outstanding principal balance of the Loan Agreement hereunder shall be changed, for any reason whatsoever, from the LIBOR Option Advance to the Prime Rate Option prior to the last day of the applicable LIBOR Period, or if Borrower shall fail to make any payment of principal or interest hereunder at any time that the LIBOR Option Advance is the applicable interest rate hereunder in respect of such outstanding principal balance of the Loan Agreement, Borrower shall reimburse Bank, on demand, for any resulting loss, cost or expense incurred by Bank as a result thereof, including, without limitation, any such loss, cost or expense incurred in obtaining, liquidating, employing or redeploying deposits from third parties. Such amount payable by Borrower to Bank may include, without limitation, an amount equal to the excess, if any, of (a) the amount of interest which would have accrued on the amount so prepaid, or not so borrowed, refunded or converted, for the period from the date of such prepayment or of such failure to borrow, refund or convert, through the last day of the relevant LIBOR Period, at the applicable rate of interest for such outstanding principal balance of the Loan Agreement, as provided under this Loan Agreement, over (b) the amount of interest (as reasonably determined by Bank) which would have accrued to Bank on such amount by placing such amount on deposit for a comparable period with leading banks in the interbank eurodollar market. Calculation of any amounts payable to Bank under this paragraph shall be made as though Bank shall have actually funded or committed to fund the relevant outstanding principal balance of the Loan Agreement hereunder through the purchase of an underlying deposit in an amount equal to the amount of such outstanding principal balance of the Loan Agreement and having a maturity comparable to the relevant LIBOR Period; provided, however, that Bank may fund the outstanding principal balance of the Loan Agreement hereunder in any manner it deems fit and the foregoing assumptions shall be utilized only for the purpose of the calculation of amounts payable under this paragraph. Upon the written request of Borrower, Bank shall deliver to Borrower a certificate setting forth the basis for determining such losses, costs and expenses, which certificate shall be conclusively presumed correct, absent manifest error. Any prepayment hereunder shall also be accompanied by the payment of all accrued and unpaid interest on the amount so prepaid. Any outstanding principal balance of the Loan Agreement which is bearing interest at such time at the Prime Rate Option may be prepaid without penalty or premium. Partial prepayments hereunder shall be applied to the installments hereunder in the inverse order of their maturities.

BY INITIALING BELOW, BORROWER ACKNOWLEDGE(S) AND AGREE(S) THAT: (A) THERE IS NO RIGHT TO PREPAY ANY LIBOR OPTION ADVANCE, IN WHOLE OR IN PART, WITHOUT PAYING THE PREPAYMENT AMOUNT SET FORTH HEREIN (“PREPAYMENT AMOUNT”), EXCEPT AS OTHERWISE REQUIRED UNDER APPLICABLE LAW; (B) BORROWER SHALL BE LIABLE FOR PAYMENT OF THE PREPAYMENT AMOUNT IF BANK EXERCISES ITS RIGHT TO ACCELERATE PAYMENT OF ANY LIBOR OPTION ADVANCE AS PART OR ALL OF THE OBLIGATIONS OWING UNDER THE NOTE, INCLUDING WITHOUT LIMITATION, ACCELERATION UNDER A DUE-ON-SALE PROVISION; (C) BORROWER WAIVES ANY RIGHTS UNDER SECTION 2954.10 OF THE CALIFORNIA CIVIL CODE, OR ANY SUCCESSOR STATUTE; AND (D) BANK HAS MADE EACH LIBOR OPTION ADVANCE PURSUANT TO THE NOTE IN RELIANCE ON THESE AGREEMENTS.

            /s/ JF                        

BORROWER’S INITIALS

9.             Hold Harmless and Indemnification. Borrower agrees to indemnify Bank and to hold Bank harmless from, and to reimburse Bank on demand for, all losses and expenses which Bank sustains or incurs as a result of (i) any payment of a LIBOR Option Advance prior to the last day of the applicable LIBOR Period for any reason, including, without limitation, termination of the Loan Agreement, whether pursuant to this Addendum or the occurrence of an Event of Default; (ii) any termination of a LIBOR Period prior to the date it would otherwise end in accordance with this Addendum; or (iii) any failure by Borrower, for any reason, to borrow any portion of a LIBOR Option Advance.

10.           Funding Losses. The indemnification and hold harmless provisions set forth in this Addendum shall include, without limitation, all losses and expenses arising from interest and fees that Bank pays to lenders of funds it

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obtains in order to fund the loans to Borrower on the basis of the LIBOR Option Advance(s) and all losses incurred in liquidating or re-deploying deposits from which such funds were obtained and loss of profit for the period after termination. A written statement by Bank to Borrower of such losses and expenses shall be conclusive and binding, absent manifest error, for all purposes. This obligation shall survive the termination of this Addendum and the payment of the Loan Agreement.

11.          Regulatory Developments Or Other Circumstances Relating To Illegality or Impracticality of LIBOR. If any Regulatory Development or other circumstances relating to the interbank Euro-dollar markets shall, at any time, in Bank’s reasonable determination , make it unlawful or impractical for Bank to fund or maintain, during any LIBOR Period, to determine or charge interest rates based upon LIBOR, Bank shall give notice of such circumstances to Borrower and:

(a)           In the case of a LIBOR Period in progress, Borrower shall, if requested by Bank, promptly pay any interest which had accrued prior to such request and the date of such request shall be deemed to be the last day of the term of the LIBOR Period; and

(b)           No LIBOR Period may be designated thereafter until Bank determines that such would be practical.

12.           Additional Costs. Borrower shall pay to Bank from time to time, upon Bank’s request, such amounts as Bank determines are needed to compensate Bank for any costs it incurred which are attributable to Bank having made or maintained a LIBOR Option Advance or to Bank’s obligation to make a LIBOR Option Advance, or any reduction in any amount receivable by Bank hereunder with respect to any LIBOR Option Advance or such obligation (such increases in costs and reductions in amounts receivable being herein called “Additional Costs”), resulting from any Regulatory Developments, which (i) change the basis of taxation of any amounts payable to Bank hereunder with respect to taxation of any amounts payable to Bank hereunder with respect to any LIBOR Option Advance (other than taxes imposed on the overall net income of Bank for any LIBOR Option Advance by the jurisdiction where Bank is headquartered or the jurisdiction where Bank extends the LIBOR Option Advance; (ii) impose or modify any reserve, special deposit, or similar requirements relating to any extensions of credit or other assets of, or any deposits with or other liabilities of, Bank (including any LIBOR Option Advance or any deposits referred to in the definition of LIBOR); or (iii) impose any other condition affecting this Addendum (or any of such extension of credit or liabilities). Bank shall notify Borrower of any event occurring after the date hereof which entitles Bank to compensation pursuant to this paragraph as promptly as practicable after it obtains knowledge thereof and determines to request such compensation. Determinations by Bank for purposes of this paragraph, shall be conclusive, provided that such determinations are made on a reasonable basis.

13.          Legal Effect. Except as specifically modified hereby, all of the terms and conditions of the Loan Agreement remain in full force and effect.

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IN WITNESS WHEREOF, the parties have agreed to the foregoing as of the date first set forth above.

SCIENTIFIC LEARNING CORPORATION	COMERICA BANK
By: /s/ Jane A. Freeman        —————————————————	By: /s/ Rod Werner       ——————————————————
Title: CFO           ————————————————	Title: SVP           —————————————————
By: /s/ Linda L. Carloni        —————————————————
Title: VP           ————————————————

[Signature Page toLIBOR Addendum to Loan and Security Agreement]

-8-

PRIME RATE/LIBOR RATE ADVANCE REQUEST FORM

The undersigned hereby certifies as follows:

I, ____________________________, am the duly elected and acting _____________________ of SCIENTIFIC LEARNING CORPORATION (“Borrower”).

This Prime Rate/LIBOR Rate Advance Request Form is delivered on behalf of Borrower to Comerica Bank, pursuant to that certain Loan and Security Agreement between Borrower and Comerica Bank dated as of January 15, 2004, as amended from time to time including by that certain First Amendment to Loan and Security Agreement dated as of September 29, 2004 and that certain Second Amendment to Loan and Security Agreement dated as of December 2, 2005 (the “Agreement”). The terms used herein which are defined in the Agreement have the same meaning herein as ascribed to them therein.

Borrower hereby requests on __________________, 20___, an Advance/conversion from one rate to another, as follows:

(a) The date on which the Advance is to be made/converted is ____________, 20___.

(b)           The amount of the Advance/conversion is to be __________________ ($______________), in the form of a Prime Rate Advance of $______________________; and/or a LIBOR Rate Advance of $_______________ for a LIBOR Interest Period of ___________ days.

All representations and warranties of Borrower stated in the Agreement are true, correct and complete in all material respects as of the date of this request; provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date.

IN WITNESS WHEREOF, this Prime Rate/LIBOR Rate Advance Request Form is executed by the undersigned as of this _______ day of _____________, 20____.

SCIENTIFIC LEARNING CORPORATION

By:

Title:

EXHIBIT D

COMPLIANCE CERTIFICATE

TO: COMERICA BANK

FROM: SCIENTIFIC LEARNING CORPORATION

The undersigned authorized officer of SCIENTIFIC LEARNING CORPORATION hereby certifies that in accordance with the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the “Agreement”), (i) Borrower is in compliance for the period ending _______________ with all required covenants except as noted below and (ii) all representations and warranties of Borrower stated in the Agreement are true and correct in all material respects as of the date hereof provided, however, that those representations and warranties the date expressly referring to another date shall be true, correct and complete in all material respects as of such date. Attached herewith are the required documents supporting the above certification. The Officer further certifies that these are prepared in accordance with Generally Accepted Accounting Principles (GAAP) and are consistently applied from one period to the next except as explained in an accompanying letter or footnotes (subject to year-end adjustments with the absence of footnotes).

Please indicate compliance status by circling Yes/No under “Complies” column.

	Reporting Covenant		Required		Complies
	Monthly financial statements		Monthly within 25 days		Yes		No
	Annual (CPA Audited)		FYE within 90 days		Yes		No
	10K and 10Q		(as applicable)		Yes		No
	A/R Agings		Monthly within 25 days		Yes		No
	A/R Audit		Upon Bank Request		Yes		No
	Total amount of Borrower’s cash and investments		Amount: $________		Yes		No
	Total amount of Borrower’s cash and investments maintained with Bank		Amount: $________		Yes		No
	Financial Covenant		Required	Actual	Complies
	Adjusted Quick Ratio		1.50:1.00	_____:1.00	Yes		No
	ETNW (only if AQR < 1.75)
	Through 6/30/06		($5,000,000)	$_________	Yes		No
	After 6/30/06		$1.00	$_________	Yes		No
Comments Regarding Exceptions: See Attached.		BANK USE ONLY
		Received by:
Sincerely,		AUTHORIZED SIGNER
		Date:
		Verified:
SIGNATURE		AUTHORIZED SIGNER
		Date:
TITLE
		Compliance Status				Yes		No
DATE

SCHEDULE OF EXCEPTIONS

Permitted Indebtedness (Section 1.1)

Obligations of Borrower under Borrower’s Lease Agreement with Rotunda Partners II dated October 1, 2003 and related Lease Termination Agreement of the same date.

Obligations to pay royalties and patent expenses on patents licensed from the University of California and Rutgers, the State University of New Jersey, under the Exclusive License Agreement, dated September 27, 1996, between Borrower and the Regents of the University of California, as amended. These patents cover most of our products and revenue.

Indebtedness to IKON and Konica relating to lease of copiers.

Indebtedness to Neopost relating to lease of mailing machine.

Permitted Investments (Section 1.1)

Notes receivable from current and former officers of Borrower, in principal amount of approximately $1.5 million at October 31, 2005, and all interest accrued thereon.

1,772,727 shares of Series A Preferred Stock of Neuroscience Solutions Corporation (“NSC”), issued pursuant to the Technology Transfer Agreement dated September 30, 2003, between Borrower and NSC and the related Series A Preferred Stock Purchase Agreement.

Permitted Liens (Section 1.1)

Security interests of IKON, Konica and Neopost with respect to the Indebtedness to them listed above.

Intellectual Property (Section  5.6)

Certain patents and patent applications are jointly owned by Borrower and the University of California and/or the University of Texas, Dallas. These jointly owned cases are listed on Exhibit A to this Schedule of Exceptions.

In August 1999, Oklahoma State University wrote Borrower suggesting that Borrower’s advertising materials indicated that the Fast ForWord Language product might employ concepts covered by US Patent No. 5,711,671, which is owned by the University. Borrower reviewed that patent, concluded that Borrower’s products were not within the scope of the patent, and so notified the University. Borrower has not had any discussions or correspondence with this University since August 2000.

Prior Names; Locations of Assets (Section 5.7)

Borrower was originally incorporated in California under the name Scientific Learning Principles Corporation. Borrower changed its name to Scientific Learning Corporation when it reincorporated in Delaware in May 1997.

In addition to Borrower’s chief executive offices, Inventory and/or Equipment of Borrower is also located at:

• Alom Technologies,48105 Warm Springs Blvd Fremont, CA  94539. Alom is Borrower’s fulfillment contractor, and as such much of Borrower’s inventory is located at Alom.

• Raging Wire Enterprise Solutions, 1200 Stryker Avenue, Sacramento, CA 95834-1157. Raging Wire hosts Borrower’s primary internet operations site and certain of Borrower’s computer equipment is located there.

• Homes of Borrower’s field sales and service personnel. Borrower’s field sales and service personnel work from their homes, located throughout the US. These personnel have possession of personal computer equipment and limited quantities of software used for demonstration and display purposes.

• Research sites with which Borrower is working from time to time have limited amounts of computer equipment at their premises, on loan from Borrower.

Litigation (Section 5.8)

SkyTech, Inc. is a former independent sales representative of Borrower. In November 2004, Borrower gave SkyTech notice that Borrower was terminating the sales representative agreement because SkyTech had not achieved its quota during the prior two years. In February 2005, Borrower stopped taking orders placed through SkyTech. SkyTech has disputed Borrower’s rights to take such actions. SkyTech has also expressed dissatisfaction about SLC’s actions during the agreement, the functioning of the products, and the support that they and their customers have received.

On May 16, 2005 we received from SkyTech’s counsel a Demand for Arbitration relating to this dispute. The Demand for Arbitration claimed damages of $10 million. SLC was never served with this demand. SLC has now been informed by the American Arbitration Association that, because SkyTech did not agree to a filing fee arrangement, the AAA returned the arbitration demand to SkyTech’s counsel.

On July 28, 2005, Borrower was served with a Summons and Complaint relating to this dispute. The case is filed in Minnesota state court, in the county of Hennepin. The complaint makes substantially the same allegations as the arbitration claim. The plaintiffs are Skytech as well as SkyLearn, LLC and HEK, Inc, d/b/a/ SkyLearn Digital Systems, who claim to be contractors to SkyTech and third-party beneficiaries of the sales representative agreement.

SLC has filed a motion to compel arbitration and to stay or, in the alternative, to dismiss the complaint. The motion was heard on November 14, 2005 and the parties are awaiting the ruling. SLC has also filed and served its own Demand for Arbitration. This Demand seeks to recover the unpaid balance for orders placed by SkyTech and a declaratory judgment that SLC did not violate its agreement with SkyTech.

Borrower believes that the SkyTech claims are not valid, and that Scientific Learning does not have any significant liability to SkyTech.

Transactions with Affiliates (Section 7.8)

Warburg, Pincus Ventures, holds warrants to purchase a total of 1,375,000 shares of Borrower’s common stock at an exercise price of $8.00 per share. The warrants were issued in 2001 in connection with the provision of a loan guarantee to Borrower and expire in 2008.

Borrower holds notes receivable from current and former officers of Borrower, in principal amount of $1.5 million at October 31, 2005, plus accrued interest. Principal and interest under the notes are due December 31, 2005.

Under a Technology Transfer Agreement with Posit Science Corporation (formerly Neuroscience Solutions Corporation (“PSC”), Borrower licensed to PSC patents owned by Borrower, patents licensed by Borrower from universities, and certain software developed by Borrower. All of the licenses are limited to the health field, and most are exclusive for that field. PSC and Borrower also agreed to license to one another certain patents that may be issued in the future. Dr. Michael M. Merzenich, who is a founder, director, significant stockholder and former officer of Borrower, is also a founder, director, significant stockholder and officer of PSC. Drs. Paula A. Tallal, Steven L. Miller and William Jenkins, each of whom is a founder, director, officer, and/or significant shareholder of Borrower, are consultants to Posit Science Corporation and/or members of Posit’s Scientific Advisory Board.

Exhibit A to Schedule of Exceptions

Jointly Owned Patents

Docket	Country	Serial Number	Patent No.	Title	Owner	Status
701	US	08/852,651	6,109,107	Method and Apparatus for Diagnosing and Remediating Language Based Learning Impairments	UC/SLC	ISSUED
701-D1	US	09/617,585	6,349,598	Method and Apparatus for Diagnosing and Remediating Language-Based Learning Impairments	UC/SLC	ISSUED
701-D2	US	10/027,518	6,457,362	Method and Apparatus for Diagnosing and Remediating Language-Based Learning Impairments	UC/SLC	ISSUED
704-AU	AU	13133/99	746634	Method for Improving Motor Control in an Individual by Sensory Training	UC/SLC	ISSUED
704-HK	HK	101437.9		Method for Improving Motor Control in an Individual by Sensory Training	UC/SLC	PENDING
704-JP	JP	11-528635		Method for Improving Motor Control in an Individual by Sensory Training	UC/SLC	PENDING
704B	US	09/470,047	6,409,685	Method for Improving Motor Control in an Individual by Sensory Training	UC/SLC	ISSUED
704C1	US	09/374,227	6,267,733	Apparatus and Methods for Treating Motor Control and Somatosensory Perception Deficits	UC/SLC	ISSUED
706	US	08/970,564	6,422,869	Methods and Apparatus for Assessing and Improving Processing of Temporal Information in Human	UC/SLC	ISSUED

706-HK	HK	100536.1		Methods and Apparatus for Assessing and Improving Processing of Temporal Information in Human	UC/SLC	PENDING
706-JP	JP	11-528633		Methods and Apparatus for Assessing and Improving Processing of Temporal Information in Human	UC/SLC	PENDING
724	US	09/224,510	6,221,908	System for Stimulating Brain Plasticity	UC/SLC	ISSUED
725	US	09/134,759	6,231,344	Prophylactic Reduction and Remediation of Schizophrenic Impairments Through Interactive Behavioral Training	UC/SLC	ISSUED
725-CA	CA	2340667		Prophylactic Reduction and Remediation of Schizophrenic Impairments Through Interactive Behavioral Training	UC/SLC	PENDING
725A	US	09/153,568	6,165,126	Remediation of Depression Through Computer-Implemented Interactive Behavioral Training	UC/SLC	ISSUED
0008	US	10/000,844		Computer -Implemented Methods and Apparatus for Remediating Abnormal Behaviors	UC/SLC/UofTDallas	PENDING

Corporation Resolutions and Incumbency Certification
Authority to Procure Loans

I certify that I am the duly elected and qualified Secretary of Scientific Learning Corporation; that the following is a true and correct copy of resolutions duly adopted by the Board of Directors of the Corporation in accordance with its bylaws and applicable statutes.

Copy of Resolutions:

Be it Resolved, That:

1.             Any one (1) of the following CEO, CFO, Controller, General Counsel (insert titles only) of the Corporation are/is authorized, for, on behalf of, and in the name of the Corporation to:

(a)           Negotiate and procure loans, letters of credit and other credit or financial accommodations from Comerica Bank (“Bank”), a Michigan banking corporation, including, without limitation, pursuant to that certain Loan and Security Agreement dated as of January 15, 2004, as amended from time to time including by that certain First Amendment to Loan and Security Agreement dated as of September 29, 2004 and that certain Second Amendment to Loan and Security Agreement dated as of December __, 2005.

(b)           Discount with the Bank, commercial or other business paper belonging to the Corporation made or drawn by or upon third parties, without limit as to amount;

(c)           Purchase, sell, exchange, assign, endorse for transfer and/or deliver certificates and/or instruments representing stocks, bonds, evidences of Indebtedness or other securities owned by the Corporation, whether or not registered in the name of the Corporation;

(d)           Give security for any liabilities of the Corporation to the Bank by grant, security interest, assignment, lien, deed of trust or mortgage upon any real or personal property, tangible or intangible of the Corporation; and

(e)           Execute and deliver in form and content as may be required by the Bank any and all notes, evidences of Indebtedness, applications for letters of credit, guaranties, subordination agreements, loan and security agreements, financing statements, assignments, liens, deeds of trust, mortgages, trust receipts and other agreements, instruments or documents to carry out the purposes of these Resolutions, any or all of which may relate to all or to substantially all of the Corporation’s property and assets.

2.             Said Bank be and it is authorized and directed to pay the proceeds of any such loans or discounts as directed by the persons so authorized to sign, whether so payable to the order of any of said persons in their individual capacities or not, and whether such proceeds are deposited to the individual credit of any of said persons or not;

3.             Any and all agreements, instruments and documents previously executed and acts and things previously done to carry out the purposes of these Resolutions are ratified, confirmed and approved as the act or acts of the Corporation.

4.             These Resolutions shall continue in force, and the Bank may consider the holders of said offices and their signatures to be and continue to be as set forth in a certified copy of these Resolutions delivered to the Bank, until notice to the contrary in writing is duly served on the Bank (such notice to have no effect on any action previously taken by the Bank in reliance on these Resolutions).

5.             Any person, corporation or other legal entity dealing with the Bank may rely upon a certificate signed by an officer of the Bank to effect that these Resolutions and any agreement, instrument or document executed pursuant to them are still in full force and effect and binding upon the Corporation.

6.             The Bank may consider the holders of the offices of the Corporation and their signatures, respectively, to be and continue to be as set forth in the Certificate of the Secretary of the Corporation until notice to the contrary in writing is duly served on the Bank.

I further certify that the above Resolutions are in full force and effect as of the date of this Certificate; that these Resolutions and any borrowings or financial accommodations under these Resolutions have been properly noted in the corporate books and records, and have not been rescinded, annulled, revoked or modified; that neither the foregoing Resolutions nor any actions to be taken pursuant to them are or will be in contravention of any provision of the articles of incorporation or bylaws of the Corporation or of any agreement, indenture or other instrument to which the Corporation is a party or by which it is bound; and that neither the articles of incorporation nor bylaws of the Corporation nor any agreement, indenture or other instrument to which the Corporation is a party or by which it is bound require the vote or consent of shareholders of the Corporation to authorize any act, matter or thing described in the foregoing Resolutions.

I further certify that the following named persons have been duly elected to the offices set opposite their respective names, that they continue to hold these offices at the present time, and that the signatures which appear below are the genuine, original signatures of each respectively:

(PLEASE SUPPLY GENUINE SIGNATURES OF AUTHORIZED SIGNERS BELOW)

NAME (Type or Print)	TITLE	SIGNATURE
Robert C. Bowen ——————————————	CEO ————————	/s/ Robert C. Bowen ——————————
Jane A. Freeman ———————————	CFO ————————	/s/ Jane A. Freeman ——————————
Jon Corbet ——————————————	Controller ————————	/s/ Jon Corbett ——————————
Linda L. Carlon ———————————	General Counsel ————————	/s/ Linda L. Carloni ——————————

In Witness Whereof, I have affixed my name as Secretary and have caused the corporate seal (where available) of said Corporation to be affixed on December 2, 2005.

/s/ Linda L. Carloni                                                          

Secretary

The Above Statements are Correct. /s/ Jane A. Freeman                                                                                   

SIGNATURE OF OFFICER OR DIRECTOR OR, IF NONE. A SHAREHOLDER OTHER THAN SECRETARY WHEN SECRETARY IS AUTHORIZED TO SIGN ALONE.

Failure to complete the above when the Secretary is authorized to sign alone shall constitute a certification by the Secretary that the Secretary is the sole Shareholder, Director and Officer of the Corporation.

EX-23.1

EXHIBIT 23.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 333-87213, No. 333-43042, No. 333-91426, No. 333-109191, No. 333-126649) pertaining to the 1999 Equity Incentive Plan, 1999 Non-Employee Directors’ Stock Option Plan, 1999 Employee Stock Purchase Plan, 2002 CEO Option Plan, and Milestone Equity Incentive Plan of Scientific Learning Corporation of our report dated February 15, 2006 with respect to the financial statements and schedule of Scientific Learning Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 2005.

/s/ Ernst & Young LLP

San Francisco, California

March 8, 2006

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Robert C. Bowen, certify that:

1. I have reviewed this annual report on Form 10-K of Scientific Learning Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 10, 2006

/s/ Robert C. Bowen

Robert C. Bowen

Chairman and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Jane A. Freeman, certify that:

1. I have reviewed this annual report on Form 10-K of Scientific Learning Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 10, 2006

/s/ Jane A. Freeman

Jane A. Freeman

Senior Vice President and Chief Financial Officer

EX-32.1

EXHIBIT 32.1

CERTIFICATION

Pursuant to the requirements set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. § 1350, as adopted, the “Sarbanes-Oxley Act”), Robert C. Bowen, the Chief Executive Officer of Scientific Learning Corporation (the “Company”), hereby certifies that, to the best of his knowledge:

1. The Company’s Annual Report on Form 10-K for the period ended December 31, 2005, to which this Certification is attached as Exhibit 32.1 (the “Periodic Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: March 10, 2006

/s/ Robert C. Bowen

Robert C. Bowen

Chairman and Chief Executive Officer

This certification accompanies and is being “furnished” with this Periodic Report, shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended or otherwise subject to liability under that Section and shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Periodic Report, irrespective of any general incorporation language contained in such filing.

EX-32.2

EXHIBIT 32.2

CERTIFICATION

Pursuant to the requirements set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. § 1350, as adopted, the “Sarbanes-Oxley Act”), Jane A. Freeman, the Chief Financial Officer of Scientific Learning Corporation (the “Company”), hereby certifies that, to the best of her knowledge:

1. The Company’s Annual Report on Form 10-K for the period ended December 31, 2005, to which this Certification is attached as Exhibit 32.1 (the “Periodic Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: March 10, 2006

/s/ Jane A. Freeman

Jane A. Freeman

Senior Vice President and Chief Financial Officer

This certification accompanies and is being “furnished” with this Periodic Report, shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended or otherwise subject to liability under that Section and shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Periodic Report, irrespective of any general incorporation language contained in such filing.