INSIGHTFUL CORP - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended September 30, 2004

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___ to ___

Commission file number 0-020992

INSIGHTFUL CORPORATION
(Exact name of registrant as specified in its charter)

Delaware		04-2842217
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification no.)

1700 Westlake Avenue North, Suite 500, Seattle, Washington 98109-3044
(Address of principal executive offices) (Zip code)

(206) 283-8802
Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value
(Title of class)

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

Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, was 12,366,842 shares as of November 1, 2004.

TABLE OF CONTENTS

			Page


PART I. FINANCIAL INFORMATION

	ITEM 1.	Consolidated Financial Statements (Unaudited)

		Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003	2

		Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003	3

		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003	4

		Notes to Condensed Consolidated Financial Statements	5

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9

	ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	22

	ITEM 4.	Controls and Procedures	22

PART II. OTHER INFORMATION

	ITEM 1.	Legal Proceedings	23

	ITEM 4.	Submission of Matters to a Vote of Security Holders	23

	ITEM 5.	Other Information	23

	ITEM 6.	Exhibits	23

SIGNATURES			24

Trademarks

Insightful, Insightful Corporation, the Insightful logo, “Insightful intelligence from data,” S-PLUS, S-PLUS Analytic Server, StatServer and InFact are registered trademarks of Insightful Corporation. S, SpatialStats, FinMetrics, GARCH, SeqTrial, Anatolytics, ArrayAnalyzer, and “Human-like Intelligence,” are trademarks of Insightful Corporation. All other brand names, trademarks or service marks referred to in the report are the property of their owners.

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

INSIGHTFUL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)

	September 30, 2004				December 31, 2003

	(unaudited)

ASSETS
Current Assets:
Cash and cash equivalents		$	8,568			$	7,139
Trade accounts receivable, net			3,468				3,210
Other receivables			448				726
Prepaid expenses and other current assets			478				422

Total current assets			12,962				11,497

Property and equipment, net			540				984

Purchased technology, net			1,373				-

Goodwill			800				800

Other assets			60				175


		$	15,735			$	13,456


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities:
Current portion of long-term debt		$	129			$	129
Accounts payable			1,219				914
Accrued payroll and payroll-related items			1,350				1,372
Accrued expenses and other current liabilities			561				1,390
Deferred revenue			5,558				5,633

Total current liabilities			8,817				9,438
Long-term debt, less current portion			64				161

Commitments and contingencies

Stockholders’ equity:
Preferred stock, $0.01 par value–
Authorized–1,000,000 shares
Issued and outstanding–none			-				-
Common stock, $0.01 par value–
Authorized–20,000,000 shares
Issued and outstanding–12,319,525 and 11,474,444, shares at September 30, 2004 and December 31, 2003, respectively			123				115
Additional paid-in capital			36,177				34,319
Accumulated deficit			(29,320	)			(30,454	)
Other accumulated comprehensive loss-cumulative translation adjustment			(126	)			(123	)


Total stockholders’ equity			6,854				3,857


		$	15,735			$	13,456

The accompanying notes are an integral part of these consolidated financial statements.

INSIGHTFUL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)

	Three Months Ended September 30,								Nine Months Ended September 30,

	2004				2003				2004				2003

Revenues:
Software licenses		$	2,164			$	1,855			$	6,183			$	5,566
Software maintenance			1,626				1,627				4,879				5,010
Professional services and other			979				555				2,519				2,100

Total revenues			4,769				4,037				13,581				12,676

Cost of revenues:
Software related			390				527				1,255				1,537
Professional services and other			526				511				1,634				2,027

Total cost of revenues			916				1,038				2,889				3,564

Gross profit			3,853				2,999				10,692				9,112

Operating expenses:
Sales and marketing			1,678				1,671				4,830				5,286
Research and development			1,342				1,646				3,992				5,095
Less–Funded research			(650	)			(1,180	)			(2,439	)			(3,264	)

Research and development, net			692				466				1,553				1,831
General and administrative			961				986				3,199				2,703
Restructuring charges			-				911				-				911

Total operating expenses			3,331				4,034				9,582				10,731

Income (loss) from operations			522				(1,035	)			1,110				(1,619	)

Other income, net			90				61				55				81

Income (loss) before income taxes			612				(974	)			1,165				(1,538	)


Income tax expense			3				16				31				107

Income (loss) from continuing operations			609				(990	)			1,134				(1,645	)

Loss from discontinued operations, net of tax			-				-				-				(137	)

Net income (loss)		$	609			$	(990	)		$	1,134			$	(1,782	)

Basic and diluted net income (loss) per share – continuing operations		$	0.05			$	(0.09	)		$	0.09			$	(0.15	)

Basic and diluted net loss per share – discontinued operations		$	-			$	-			$	-			$	(0.01	)

Basic and diluted net income (loss) per share		$	0.05			$	(0.09	)		$	0.09			$	(0.16	)

Weighted average common shares outstanding			12,312				11,404				12,072				11,396

Weighted average common shares assuming dilution			12,572				11,404				12,768				11,396

The accompanying notes are an integral part of these consolidated financial statements.

INSIGHTFUL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)

	Nine Months Ended September 30,

	2004				2003

Operating activities:
Net income (loss)		$	1,134			$	(1,782	)
Less–Loss from discontinued operations			-				137

Loss from continuing operations			1,134				(1,645	)
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) operating activities:
Depreciation, amortization and other non-cash charges			1,059				1,253
Stock-based compensation			5				(105	)
Changes in current assets and liabilities:			-				-
Trade accounts receivable			(265	)			524
Other receivables			278				(25	)
Prepaid expenses and other assets			(63	)			(323	)
Accounts payable			(196	)			(85	)
Accrued payroll and payroll-related items			(24	)			(257	)
Accrued expenses and other current liabilities			(832	)			419
Deferred revenue			(82	)			(378	)

Net cash provided by (used in) operating activities			1,014				(653	)

Investing activities:
Purchases of property and equipment			(104	)			(145	)
Purchases of other non-current assets			-				(52	)
Purchase of technology			(1,265	)			-

Net cash used in investing activities			(1,369	)			(197	)

Financing activities:
Payments on debt			(97	)			(96	)
Proceeds from exercise of stock options and employee stock purchase plan			1,861				25

Net cash provided by (used in) financing activities			1,764				(71	)

Effect of exchange rate changes on cash and cash equivalents			20				17

Net cash used in continuing operations			1,429				(904	)

Net cash used in discontinued operations			–				(137	)

Net increase (decrease) in cash and cash equivalents			1,429				(1,041	)

Cash and cash equivalents, beginning of period			7,139				6,819

Cash and cash equivalents, end of period			8,568				5,778

Supplemental disclosure of cash flow information:
Cash paid for:
Interest		$	24			$	16
Income taxes (refund)			(1	)		$	128
Supplemental disclosure of non-cash investing information – portion of purchased technology financed through accounts payable		$	500

The accompanying notes are an integral part of these consolidated financial statements

INSIGHTFUL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2004

(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

a) Description of Business

Insightful Corporation and its wholly owned subsidiaries (“Insightful” or “the Company”) provide enterprises with scalable data analysis solutions designed to drive better decisions faster by revealing patterns, trends and relationships in data. Insightful is a supplier of software and services for the statistical data mining, business analytics, knowledge management, and information retrieval industry segments enabling customers to gain intelligence from numerical data and text.

Insightful’s products include InFact^®, Insightful Miner, S-PLUS^® and S-PLUS Server. Insightful’s consulting services and training provide specialized expertise and proven processes for the design, development and deployment of analytical solutions.

Insightful has been delivering data analysis solutions for 18 years to companies in financial services, pharmaceuticals, biotechnology, telecommunications and manufacturing, as well as government and research institutions.

Headquartered in Seattle, Washington, Insightful has North American offices in New York City and North Carolina. Insightful’s international offices are located in France, Switzerland, and the United Kingdom, with distributors around the world.

(b) Unaudited Interim Financial Information

The accompanying unaudited condensed consolidated financial statements have been prepared by Insightful pursuant to accounting principles generally accepted in the United States and the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The balance sheet at December 31, 2003 has been derived from audited financial statements at that date, but does not include all disclosures required by generally accepted accounting principles for complete financial statements. These condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2003 included in Insightful’s Annual Report on Form 10-K. The accompanying consolidated financial statements reflect all adjustments (consisting solely of normal, recurring adjustments), which, in the opinion of management, are necessary for a fair presentation of results for the interim periods presented. The results of operations for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results to be expected for the entire fiscal year or future years.

(2) SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Insightful and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

(b) Revenue Recognition

Insightful offers a variety of scalable data analysis software solutions, maintenance contracts, training and consulting services to its customers. Insightful records revenue in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Modification of 97-2, Software Revenue Recognition, with Respect to Certain Transactions and related interpretations including Technical Practice Aids. License revenue consists principally of software license fees earned from sales of perpetual or fixed term software licenses. Perpetual software license fees are generally recognized upon delivery of the software after receipt of a definitive purchase order, if collection of the resulting receivable is probable, the fee is fixed or determinable, and vendor-specific objective evidence (“VSOE”) of fair value exists for all undelivered elements if sold in a bundled arrangement.

Revenue from fixed-term licenses is recognized on a straight-line basis over the license term if all other aspects of SOP 97-2 are satisfied. Revenues under arrangements that include several different software products and services sold together are allocated based on the residual method in accordance with SOP No. 98-9. Under the residual method, the fair value of the undelivered non-essential elements is deferred and subsequently recognized when earned. Insightful has established VSOE of fair value for professional services and training services. In addition, the Company has established VSOE for maintenance related to most of its products. For software products sold with maintenance where VSOE for the maintenance element has not been established, all revenue under the arrangement is recognized over the maintenance term provided all other revenue recognition criteria have been met. VSOE is based on the price charged when an element is sold separately or, in case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. Standard terms for license agreements in North America typically call for payment within 30 to 45 days, while standard terms in other areas of the world may be longer. Probability of collection is based upon the assessment of the customer’s financial condition through review of their current financial statements or credit reports. For existing customers, prior payment history is used to evaluate probability of collection. Insightful has an unconditional 30-day return policy and provides for estimated returns at the time of sale based on historical experience.

Maintenance revenue is recognized ratably over the term of the related maintenance contracts, which generally span one year or less. The initial one-year maintenance contract is bundled into the license fees on most of the Company’s products. Maintenance services, which include unspecified product upgrades on a when-and-if available basis, are generally priced based on a percentage of the current list price of the licensed software products. Maintenance renewals are optional.

Consulting revenues typically include deployment assistance, project management, integration with existing customer applications and related services performed on a time-and-materials basis under separate service arrangements. Training consists of fee based courses offered on a per attendee or a per group rate. Revenues from consulting and training services are generally recognized as services are performed. Standard terms for renewal of maintenance contracts, consulting services and training call for payment within 30 to 45 days.

Fees from licenses sold together with consulting are generally recognized upon shipment of the software, provided that the above residual method criteria are met, payment of the license fees are not dependent upon the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees is dependent upon the performance of the services, both the software license and consulting fees are recognized under the percentage of completion method of contract accounting. All sales made through indirect channels including value added resellers, or VARs, and distributors are accounted for using the sell-through method.

If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If an acceptance period is required, revenues are recognized upon the earlier of customer acceptance or the expiration of the acceptance period.

Cash payments received in advance of revenue recognition are recorded as deferred revenue on the accompanying consolidated balance sheets.

(c) Stock-Based Compensation

The Company accounts for its employee stock-based compensation plans using the intrinsic value method, as prescribed by APB No. 25 “Accounting for Stock Issued to Employees”. Accordingly, the Company records deferred compensation costs related to its employee stock options when the market price of the underlying stock on the date of grant exceeds the exercise price of the stock option on the date of grant. Deferred compensation is expensed on a straight-line basis over the vesting period of the related stock option, which is generally five years. The Company did not grant any stock options at exercise prices below the fair market value of the Company’s common stock on the date of grant during any period presented.

An alternative to the intrinsic value method of accounting for stock-based compensation is the fair value approach prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure” (collectively referred to as “SFAS 123”). If the Company followed the fair value approach, the Company would record deferred compensation based on the fair value of the stock option at the date of grant. The fair value of the stock option is required to be computed using an option-pricing model, such as the Black-Scholes option valuation model, at the date of the stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the stock option.

As required by SFAS 123, summarized below are the pro forma effects on net income and net income per share, as if the Company had elected to use the fair value approach prescribed by SFAS 123 to account for its employee stock-based compensation plans (in thousands, except per share data):

	Three Months Ended September 30,								Nine Months Ended September 30,

	2004				2003				2004				2003

Net income (loss) as reported		$	609			$	(990	)		$	1,134			$	(1,782	)
Employee stock-based compensation, as reported			—				19				—				(105	)
Employee stock-based compensation determined under the fair value method			(63	)			(337	)			(889	)			(953	)

Pro forma net income (loss)		$	546			$	(1,308	)		$	245			$	(2,840	)

Basic and diluted net income (loss) per share as reported		$	0.05			$	(0.09	)		$	0.09			$	(0.16	)
Pro forma basic and diluted net income (loss) loss per share		$	0.04			$	(0.11	)		$	0.02			$	(0.25	)

(d) Reclassification of Amounts

Certain prior year amounts have been reclassified to conform to the current year presentation. Specifically, shipping fee revenue of approximately $13,000 and $42,000 for the three and nine months ended September 30, 2003, respectively, which was offset against software-related costs in the statements of operations in the second quarter 2003 Form 10-Q, was reclassified to software license revenues in the accompanying consolidated statements of operations.

(3) PURCHASED TECHNOLOGY

In January 2004, the Company acquired title to the software code underlying the “S” programming language from Lucent Technologies Inc. for $2.0 million. The $2.0 million purchase price included settlement in full for all royalties owed by the Company to Lucent at the date of the acquisition in the amount of $235,000. As a result of this transaction, $1,765,000 was capitalized as purchased technology. This amount is being amortized to cost of revenues - software related over a 3-year estimated life. During the three and nine months ended September 30, 2004 the Company recognized $147,000 and $442,000, respectively, in amortization expense related to this technology. Under the agreement, $1.5 million of the purchase price was paid in the first quarter of 2004 with the remaining $0.5 million to be paid in the first quarter of 2005.

Prior to this agreement, the Company was a worldwide licensee of the “S” programming language in exchange for payment of royalties, with a minimum exclusivity fee of $450,000 per year and variable royalties of 3% to 6% of revenues. “S” programming language related royalty costs were $13,000 for the three and nine months ended September 30, 2004 and were $204,000 and $682,000 for the three and nine months ended September 30, 2003, respectively.

(4) FINANCING ARRANGEMENTS

In March 2004, the Company renewed a working capital revolving line of credit and security agreement with Silicon Valley Bank, or SVB, and modified the terms to provide for up to $3.0 million in borrowing availability through December 26, 2004. This facility is secured by the Company’s accounts receivable and allows it to borrow up to the lesser of (a) 75% of its eligible accounts receivable or (b) $3.0 million and bears interest at the prime rate, which was 4.75% as of September 30, 2004, plus 1%. At September 30, 2004, no amounts had been borrowed and $1,727,000 was available for future borrowings under the line of credit facility.

In March 2004, the Company also renewed and modified the terms of a term loan and security agreement with SVB. This facility allows it to take advances on the cost of eligible equipment and software less than 90 days old and is secured by the underlying assets. The Company borrowed $450,000 under this facility in 2002 and the remaining outstanding balance was $193,000 at September 30, 2004. Through December 26, 2004, the Company may draw up to an additional $500,000 under this agreement, no more than $250,000 of which may be for software. These term loan advances bear interest at the prime rate plus 1%. Advances are repaid over a 36 or 24-month period.

These credit facilities contain covenants that limit the Company’s net losses and restrict the amount of capital expenditures not financed through the equipment term loan. In addition, the Company is prohibited under these facilities from paying dividends. The Company was in compliance with these covenants as of September 30, 2004.

Future maturities of debt as of September 30, 2004 are (in thousands):

	Before December 31,			Year Ending December 31,

	2004			2005			2006			2007		2008		Thereafter		Total

Equipment term loan		$	32		$	129		$	32		—		—		—		$	193

(5) NET INCOME (LOSS) PER SHARE

The following is a reconciliation of the number of shares used in the basic and diluted net income (loss) per share computations for the periods presented (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,

	2004		2003		2004		2003

Shares used in basic net income (loss) per share computation		12,312		11,404		12,072		11,396
Effect of dilutive potential common shares resulting from stock options		260		—		696		—

Shares used in diluted net income (loss) per share computation		12,572		11,404		12,768		11,396

The dilutive impact of the Company’s stock options is calculated using the treasury stock method, based on the average share price of the Company’s common stock. Under the treasury stock method, the proceeds that would be hypothetically received from the exercise of all stock options with exercise prices below the average share price of the Company’s common stock are assumed to be used to repurchase shares of the Company’s common stock.

The Company excludes all potentially dilutive securities from its diluted net income per share computation when their effect would be anti-dilutive. The following common stock equivalents were excluded from the earnings per share computation, as their inclusion would have been anti-dilutive (in thousands):

Three Months Ended
September 30,

Nine Months Ended
September 30,

2004

2003

2004

2003

Weighted-average stock options excluded from the computation of
diluted net income (loss)

1,431

2,983

554

3,025

(6) OTHER COMPREHENSIVE INCOME (LOSS)

SFAS No. 130, Reporting Comprehensive Income, establishes standards for reporting and display of comprehensive income and its components in the financial statements. The only item of other comprehensive income (loss) is foreign currency translation adjustments. Total comprehensive income (loss) is as follows:

	Three Months Ended September 30,								Nine Months Ended September 30,

	2004				2003				2004				2003

Net income (loss)		$	609			$	(990	)		$	1,134			$	(1,782	)
Change in cumulative translation adjustment			(44	)			77				(3	)			18

Comprehensive income (loss)		$	565			$	(913	)		$	1,131			$	(1,764	)

(7) SEGMENT REPORTING

SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” establishes standards for reporting information about operating segments in annual financial statements. It also establishes standards for related disclosures about products, services, geographical areas and major customers. Continuing business segment information includes the segments of North American Data Analysis, International Data Analysis and North American Text Analysis. The Company measures segment performance based on their revenues and operating income and loss. Assets are not allocated to segments for internal reporting presentations. Corporate overhead costs, which are included in the North American Data Analysis segment, are not allocated to the International Data Analysis and North American Text Analysis segments. Intercompany transactions have been eliminated from the segment information. Non-operating income and expenses are not tracked by segment.

North American Data Analysis	Three Months Ended September 30,								Nine Months Ended September 30,

	2004				2003				2004				2003

Revenues		$	2,947			$	2,722			$	8,499			$	8,390
Loss from operations		$	(57	)		$	(922	)		$	(441	)		$	(1,520	)

International Data Analysis	Three Months Ended September 30,								Nine Months Ended September 30,

	2004				2003				2004				2003

Revenues		$	1,542			$	1,177			$	4,490			$	3,763
Income (loss) from operations		$	628			$	(46	)		$	1,619			$	277

North American Text Analysis	Three Months Ended September 30,								Nine Months Ended September 30,

	2004				2003				2004				2003

Revenues		$	280			$	138			$	592			$	523
Loss from operations		$	(49	)		$	(67	)		$	(68	)		$	(376	)

(8) BUSINESS RESTRUCTURING

During the third quarter of 2003, the Company reduced its headcount by 18%, or 23 employees. The reduction included employees from all functional areas of the Company, 35% of which were in Europe. In addition, as part of this restructuring, the Company combined its German operations with its Swiss subsidiary headquartered in Basel, Switzerland. On September 30, 2003, Shawn Javid, President and CEO, resigned from the company. The restructuring charges, including charges associated with the resignation of Shawn Javid, totaled $911,000 and consisted primarily of employee severance and termination payments and lease termination costs, as well as a $176,000 non-cash compensation charge related to a modification of stock options upon termination of Mr. Javid.

During the nine months ended September 30, 2004, the Company paid $187,000 in restructuring costs. As of September 30, 2004, $134,000 in termination benefits remained to be paid. All termination benefits will be paid by March 31, 2005. No additional expenses are expected to be incurred in connection with this restructuring.

(9) COMMITMENTS AND CONTINGENCIES

In certain of its licensing agreements, the Company provides intellectual property infringement indemnifications. These indemnifications are excluded from the initial recognition and measurement requirements of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees. Including Indirect Guarantees of Indebtedness of Others. The Company’s policy is to record any obligation under such indemnification when a required payment under such indemnification is probable and the amount of the future loss is estimable. At September 30, 2004 and 2003 there were no such indemnifications for which a required payment was deemed to be probable or estimable; therefore, no accrual has been made for potential losses associated with these indemnifications.

In December 2002, a former Insightful employee filed a complaint against the Company in the Superior Court for King County, Washington. The former employee alleged that his employment was wrongfully terminated, and he sought an unspecified amount of damages. Specifically, he alleged that the Company improperly recognized services revenues in the fourth quarter of 2001 and that the Company terminated him in violation of public policy. On December 5, 2003, a judge for the Superior Court for King County granted summary judgment in the Company’s favor and dismissed the case. The plaintiff has appealed the decision, and if his appeal is successful the Company will likely resume litigation in the Superior Court for King County. The Company continues to believe his lawsuit is without merit and it denies his claims. An evaluation of the likelihood of an adverse outcome cannot be expressed with sufficient certainty at this time. An unfavorable outcome could have a materially adverse effect on the Company’s financial position, results of operations, and cash flows.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Our disclosure and analysis in this report contain forward-looking statements, which provide our current expectations or forecasts of future events. Forward-looking statements in this report include, without limitation:

	•	information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth;

	•	statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;

	•	statements about expected future trends for sales of our products and services;

	•	Statements about the long-term potential of the data analysis market;

	•	statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments and available bank borrowings to meet these requirements;

	•	information about the anticipated release dates of new products;

	•	other statements about our plans, objectives, expectations and intentions; and

	•	other statements that are not historical facts.

Words such as “believes,” “anticipates” and “intends” may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the factors described in the section entitled Important Factors That May Affect Our Business, Our Operating Results and Our Stock Price in this report. Other factors besides those described in this report could also affect actual results. You should carefully consider the factors described in the section entitled Important Factors That May Affect Our Business, Our Operating Results and Our Stock Price in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect the occurrence of unanticipated events.

Description of the Company

We provide enterprises with scalable data analysis solutions designed to facilitate decision-making by revealing patterns, trends and relationships. We are a leading supplier of software and services for the statistical analysis, data mining and knowledge access industry segments enabling customers to gain intelligence from numerical data and text.

Our products include S-PLUS^®, S-PLUS Server, Insightful Miner and InFact^®. Our consulting services provide specialized expertise and processes for the design, development and deployment of analytical solutions.

We have been delivering data analysis solutions for 18 years to companies in financial services, pharmaceuticals, biotechnology, telecommunications and manufacturing as well as government and research institutions.

We originally incorporated in Massachusetts in 1984 and reincorporated in Delaware in 2001. Our headquarters and principal executive offices are located at 1700 Westlake Ave. N, Suite 500, Seattle, Washington 98109, and our telephone number is (206) 283-8802. Our Internet address is http://www.insightful.com. We also have North American offices in New York and North Carolina. Our international subsidiaries are located in France, Switzerland, and the United Kingdom.

Products

Data Analysis Products

S-PLUS^®

S-PLUS is our flagship product for statistical data analysis. The software offers technical professionals a flexible, extensible and productive platform for data analysis and visualization. S-PLUS is based on our award-winning object-oriented “S” programming language, to which we acquired the rights from Lucent Technologies Inc. in January 2004. Prior to that, we licensed the rights on an exclusive worldwide basis. S-PLUS offers a wide range of analytic methods for extracting intelligence from large data sets, and allows its users to create customized analytical applications that operate in the Windows and UNIX environments.

Insightful Miner

Insightful Miner is a highly scalable data analysis workbench for predictive modeling, data mining and statistical data analysis. Insightful Miner provides data miners, business analysts and data analysis professionals with a full suite of scalable components for data access, management and modeling, and its unique pipeline architecture allows the user to process very large data sets. Insightful Miner is an open and extensible tool that offers full integration with the S-PLUS programming language. Insightful Miner offers deployment capabilities via batch mode, predictive model markup language (PMML), or generated C code. Insightful Miner has a low cost of ownership compared to its competitors, with a desktop entry-level version and multiple server versions offered under perpetual licenses rather than annual rental agreements.

Verticalized Toolkits

To complement S-PLUS and Insightful Miner, we offer toolkits for the financial services and pharmaceutical markets to allow users to perform specialized data analysis.

Server Products

Insightful’s S-PLUS Server products enable our customers to deploy statistical data analysis throughout an organization, leveraging existing Web-based or client/server technologies using server computers running Windows^® and UNIX^® operating systems. Our server products are data warehouse-independent and integrate seamlessly with standard database and file formats. With our server products, a wide range of statistical models and data visualization capabilities are built and stored in a central server for access by non-technical users, who can apply these analytical techniques using a simple and familiar Web browser interface, or dedicated graphical user interfaces written using Java technology. Our server products enable end-users to analyze and understand technical or business information without requiring expertise in statistics or statistical tools.

Text Analysis Products

InFact^®

We launched our text analysis product, InFact, in April 2002 to provide text analysis for knowledge workers. InFact combines statistical text mining methods with linguistic techniques that apply natural language processing, such as full sentence deep syntactic parsing, to text search and analysis. Researchers are able to utilize InFact’s natural language question and answer and tabular exploratory search interfaces to efficiently uncover information for which they are searching. InFact thus is designed to enable researchers to experience higher levels of productivity, and to improve the quality of their research. InFact has been initially targeted at the defense/intelligence and pharmaceutical markets.

Maintenance and Services

We deliver support for our data analysis products through our maintenance, consulting, and training services.

We offer unspecified product updates and product upgrades and customer support services under an annual maintenance agreement. Our consulting organization provides fee-based services, including deployment assistance, project management, integration with existing customer applications and related services to our customers. We also offer a series of fee-based training courses to our customers. Courses can be taken at Insightful offices, at the customer’s site, or at other prearranged sites for larger customer groups.

Critical Accounting Policies and Estimates

We have based our discussion and analysis of our financial condition and results of operations upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, bad debts, intangible assets, restructuring, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

Our revenue recognition policy is significant because our revenues are a key component of our results of operations. We follow very specific and detailed guidelines, discussed in Note 2 of the condensed consolidated financial statements, in measuring revenues.

We derive our revenues primarily from three sources: license revenues, which consist of perpetual and fixed term software license fees, maintenance revenues, consisting of fees for maintenance and support, and professional services revenues, which are comprised of fees for consulting and training. The revenue recognition rules for software companies are complex and require our management to exercise judgment and make a number of estimates. For example, many of our contracts contain multiple element arrangements, which require us to make assumptions and judgments in order to allocate the total price among the various elements we must deliver, to determine whether vendor specific objective evidence of fair value exists for each element, to determine if undelivered elements are deemed essential, and to determine whether and when each element has been delivered. We also evaluate whether there is any material risk of customer non-payment or product returns.

If we were to change any of these assumptions or judgments, which are made based upon all of the information available to us at the time, it could cause a material increase or decrease in the amount of revenue that we report in a particular period. Deferred revenue is recognized over time as the applicable revenue recognition criteria are satisfied.

Sales Returns

We provide an estimated reserve for return rights at the time of sale. We offer our customers a 30-day return policy on all of our products. Refunds are provided to customers upon return to us of the complete product package, including all original materials, CD-ROM or other media. Our provision for sales returns is estimated based on historical returns experience and our judgment of the likelihood of future returns.

Bad Debts

A considerable amount of judgment is required when we assess the ultimate realization of receivables including assessing the aging of the amounts and reviewing the current credit-worthiness of our customers. Customer credit worthiness is subject to many business and finance risks facing each customer and is subject to sudden changes.

Impairment of Goodwill and Other Long Lived Assets

We evaluate goodwill arising from acquired businesses for potential impairment on an annual basis, during the fourth quarter. This evaluation requires significant judgment and estimation. In addition, throughout the year we consider whether there are impairment indicators that would require an immediate evaluation of impairment. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance of our acquired businesses. Future events could cause us to conclude that impairment indicators exist and that goodwill associated with our acquired business is impaired.

Impairment losses, if any, will be charged to earnings in the period in which they are identified.

Contingencies

We are engaged in legal actions arising in the ordinary course of business. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of possible losses. A determination of the amount of reserves required, if any, for these contingencies are made after careful analysis of each individual matter. The required reserves, if any, may change in the future due to new developments in each matter or changes in approach, such as a change in settlement strategy for a particular matter.

Results of Operations for the Three and Nine Months Ended September 30, 2004 and 2003

Revenues by Type

	Three Months Ended September 30,								Percent Increase			Nine Months Ended September 30,								Percent Increase (Decrease)

	2004				2003							2004				2003

Revenues (in thousands):
Software licenses		$	2,164			$	1,855			17	%		$	6,183			$	5,566			11	%
Software maintenance			1,626				1,627			—				4,879				5,010			(3	) %
Professional services and other			979				555			76	%			2,519				2,100			20	%

Total		$	4,769			$	4,037			18	%			13,581				12,676			7	%


Revenues by type (as% of total revenues):
Software licenses			45	%			46	%						46	%			44	%
Software maintenance			34	%			40	%						36	%			40	%
Professional services and other			21	%			14	%						18	%			16	%

Total			100	%			100	%						100	%			100	%

Software license revenues, consisting of software licenses and subscriptions, increased for the three months ended September 30, 2004, as compared to the same period of 2003, due primarily to the increase in sales of S-Plus products, primarily as a result of successful efforts in closing transactions in our pipeline. The increase in software licenses revenue is also due to the increased sales of server products, toolkits and InFact products, including related InFact subscriptions, offset by a decline in software license revenues from sales of Insightful Miner.

Software license revenues increased for the nine months ended September 30, 2004, as compared to the same period of 2003, primarily due to the increase in revenues from S-PLUS licenses and, to a lesser extent, due to the increase in revenues from Insightful Miner in the first and second quarter of 2004, as compared to the corresponding quarters of 2003.

Software maintenance revenues remained comparable for both three months periods ended September 30, 2003 and September 30, 2004 and decreased for the nine months ended September 30, 2004, as compared to same period of 2003. This decrease for the nine months ended September 30, 2004, as compared to the same period of 2003, is attributable to a decrease in maintenance renewals in the second and third quarters of 2003.

The increase in professional services and other revenues for the three and nine months ended September 30, 2004, as compared to the corresponding periods of 2003, relates to better utilization of our professional staff resulting from our increased focus on training and consulting, as we updated and broadened the range of training courses and materials and better aligned our consulting services with our core software license products. The increase in consulting revenue is also partially attributable to additional revenues of $109,000 generated from consulting services related to our InFact segment resulting from the redeployment of team members previously utilized primarily for government grant-funded research. The reimbursements from these research programs are recorded as a reduction of research and development expenses rather than revenue.

Revenues by Segment and Geography

We operate in three segments: North American Data Analysis, International Data Analysis, and North American Text Analysis and we have international operations primarily in Europe and Asia. Revenues by segment and geography are as follows:

	Three Months Ended September 30,								Percent Increase			Nine Months Ended September 30,								Percent Increase

	2004				2003							2004				2003

Revenues (in thousands):
North American Data Analysis		$	2,947			$	2,722			8	%		$	8,499			$	8,390			1	%
International Data Analysis			1,542				1,177			31	%			4,490				3,763			19	%
North American Text Analysis			280				138			103	%			592				523			13	%

Total		$	4,769			$	4,037			18	%			13,581				12,676			7	%


Revenues (as% of total revenues):
North American Data Analysis			62	%			68	%						63	%			66	%
International Data Analysis			32	%			29	%						33	%			30	%
North American Text Analysis			6	%			3	%						4	%			4	%

Total			100	%			100	%						100	%			100	%

The increase in North American data analysis revenues for the three months ended September 30, 2004, as compared to same period of 2003, is due primarily to the increase in consulting revenues as a result of our increased emphasis on training and consulting and as well improved alignment of those services with sales of our core license products.

The increase in North American data analysis revenues for the nine months ended September 30, 2004, as compared to the same period of 2003, was primarily achieved in the first quarter of 2004 due to an increase in revenues for S-Plus and Insightful Miner when compared to the first quarter of 2003.

The increase in international data analysis revenues for the three and nine months ended September 30, 2004, as compared to the corresponding periods of 2003, is primarily attributable to increased revenues from professional services as well as increased software license sales. The increase in international revenues is related to the streamlining our European organization in mid-2003, resulting in the creation of direct sales organizations that focus on building relationship with large target accounts. This initiative allowed us to expand our customer base to drive more deployment and enterprise deals, incorporating both license sales and services.

The increase in North American text analysis revenues in the three and nine months ended September 30, 2004, as compared to the corresponding periods of 2003, relates to additional consulting revenue generated by InFact group in the third quarter of 2004 resulting from the redeployment of team members previously utilized primarily for government grant-funded research. The reimbursements from these research programs are recorded as a reduction of research and development expenses rather than revenue. The increase in North American text analysis revenues for the three months ended September 30, 2004, as compared to the corresponding period of 2003 also relates, in part, to an increase in license revenues.

Cost of Revenues

	Three Months Ended September 30,								Percent Increase (Decrease)			Nine Months Ended September 30,								Percent Decrease

	2004				2003							2004				2003

Cost of revenues (in thousands):
Software related		$	390			$	527			(26	) %		$	1,255			$	1,537			(18	) %
Professional services and other			526				511			3	%			1,634				2,027			(19	) %

Total		$	916			$	1,038			(12	) %			2,889				3,564			(19	) %


Cost of revenues (as% of total revenues):
Software related			8	%			13	%						9	%			12	%
Professional services and other			11	%			13	%						11	%			15	%

Total			19	%			26	%						20	%			27	%

Cost of software-related revenue, which consists of royalties for third-party software, product media, product duplication, manuals and maintenance and technical support costs, decreased for the three and nine months ended September 30, 2004, as compared to the corresponding periods of 2003 due primarily to a reduction in royalty costs resulting from the January 2004 acquisition of the copyrights to the software code underlying the “S” Programming language. Our “S” programming related royalty costs in the three and nine months ended September 30, 2003 were $204,000 and $682,000, respectively. Amortization of the “S” Programming acquisition cost was $147,000 and $442,000 during the three and nine months ended September 30, 2004, respectively. The decline in costs of software related revenue is also due to costs savings on materials and shipping costs as a result of purchases of multiple licenses by the same customers.

Cost of professional services and other consists primarily of salaries and other labor related costs of employees who provide consulting services and training. Cost of professional services increased in absolute dollars for the three months ended September 30, 2004, as compared to the same period of 2003, due to the additional $56,000 incurred by the InFact personnel resulting from the redeployment of team members previously utilized primarily for government grant-funded research. The reimbursements from these research programs are recorded as a reduction of research and development expenses rather than revenue.

The costs of professional services, as a percentage of revenues, decreased in the three months ended September 30, 2004, as compared to the same period of 2003, due to higher utilization rates and billable productivity of our consulting professionals.

The decline in cost of services for the nine months period ended September 30, 2004, as compared to the same period of 2003, is primarily due to cost saving measures implemented in July 2003 as part of a corporate restructuring.

Operating Expenses

Sales and Marketing

	Three Months Ended September 30,								Percent Increase		Nine Months Ended September 30,								Percent Decrease

	2004				2003						2004				2003

Sales and marketing expenses (in thousands)		$	1,678			$	1,671			—		$	4,830			$	5,286			(9	) %
Sales and marketing expenses (as percentage of revenues)			35	%			41	%					36	%			39	%

Sales and marketing expenses consist primarily of salaries, travel, facilities costs for sales and marketing personnel, promotional activities, and costs of advertising and trade shows. The slight increase in sales and marketing expenses for the three months ended September 30, 2004, as compared to the same period of 2004, is related to the increase in revenue-related compensation, partially offset by the reductions in variable costs for marketing-related activities.

The decrease in sales and marketing expenses for the nine months ended September 30, 2004, as compared to the same period of 2003, primarily relates to a reduction of headcount in our Swiss office, the closing of our German office as part of our business restructuring that began in July 2003 and reduced usage of outside consultants.

We expect sales and marketing expenses to increase in future periods as we recruit and hire additional personnel, including executives, and expand our marketing programs.

Research and Development, Net

	Three Months Ended September 30,								Percent Increase (Decrease)			Nine Months Ended September 30,								Percent Decrease

	2004				2003							2004				2003

Research and development (in thousands):
Research and development		$	1,342			$	1,646			(18)%			$	3,992			$	5,095			(22)%
Less – Funded research			(650	)			(1,180	)		(45)%				(2,439	)			(3,264	)		(25)%

Research and development, net		$	692			$	466			48	%		$	1,553			$	1,831			(15)%


Research and development (as percentage of revenues):
Research and development			28%				41%							29%				40%
Less – Funded research			(13)%				(29)%							(18)%				(26)%

Research and development, net			15%				12%							11%				14%

Net research and development expenses consist primarily of salaries and related benefits, equipment for software developers, facility costs, and payments to outside contractors, less funded research. The increase both in dollars and as a percentage of revenues in the net research and development costs for the three months ended September 30, 2004, as compared to the same period of 2003, reflects primarily the decline in reimbursements from government research grants, as we are refocusing our research and development efforts towards further development of technology more closely aligned with our commercial product lines. The decline in funded research also reflects the use of our research and development staff in support for our revenues from professional consulting services. In the third quarter of 2004, $109,000 of additional consulting revenue was generated by our professional personnel redeployed from the research and development departments.

The decrease in research and development expenses for the nine months ended September 30, 2004, as compared to the same period of 2003, relates primarily to the business restructuring begun in July 2003. We expect our gross and net research and development expenses to increase for the remainder of 2004 as we add to our development staffing and continue to narrow our funded research focus.

General and Administrative

	Three Months Ended September 30,								Percent Decrease			Nine Months Ended September 30,								Percent Increase

	2004				2003							2004				2003

General and administrative (in thousands)		$	961			$	986			(3	) %		$	3,199			$	2,703			18	%
General and administrative (as percentage of revenues)			20	%			24	%						24	%			20	%

General and administrative expenses consist primarily of salaries and other operating costs associated with finance, accounting, legal, corporate governance, investor relations, administration and facilities. The decline in general and administrative expenses for the three months ended September 30, 2004, as compared to the same period of 2003, is primarily related to the reduction in amortization of other intangible assets, partially offset by higher compensation costs. The increase in general and administrative expenses for the nine months ended September 30, 2004, as compared to the same period of 2003, is primarily attributable to the additional costs incurred in the second quarter of 2004 for our independent investigation of issues related to our 2003 audit, as well ad due to additional legal costs incurred in the first quarter of 2004 in resolving a dispute with Lucent Technology.

We anticipate that general and administrative expenses will increase in the future as we incur additional costs in connection with the enhanced regulatory and corporate governance requirements of the Sarbanes-Oxley Act of 2002

Restructuring charges

In the third quarter of 2003, we recorded a restructuring charge of $911,000, as we implemented a restructuring plan that included a workforce reduction of 23 employees, or 18% of our employee base at that time, from all functional areas. In addition, as part of this restructuring, we combined our German operations with our Swiss subsidiary headquartered in Basel, Switzerland. The restructuring charges, including charges associated with the resignation of Shawn Javid, our former President and CEO, consisted primarily of employee severance and termination payments, lease termination costs and non-cash stock-based compensation costs related to the modification of stock options in connection with these employee terminations.

Other Income, Net

Total other income, net increased from $61,000 in the three months ended September 30, 2003 to $90,000 in the three months ended September 30, 2004. Total other income, net declined from $81,000 in the nine months ended September 30, 2003 to $55,000 in the nine months ended September 30, 2004. The fluctuations in total other income primarily reflect the results of foreign currency transactions activity as well as fluctuations in invested cash balances and the related rates of return on those investments.

Income Tax Expense

The decrease in the tax expense from $16,000 and $107,000 for the respective three and nine months ended September 30, 2003 to $3,000 and $31,000 for the respective three and nine months ended September 30, 2004 relates to a decrease in taxes owed for our international operations.

Loss from Discontinued Operations, net of tax

Discontinued operations consisted of our sale of the operations of our Engineering and Education Products Division (EEPD) in January 2001. The loss from discontinued operations, net of tax of $137,000 for the nine months ended September 30, 2003 resulted from the recording of additional accrued expenses in the second quarter of 2003 for third party contractual commitments based on an analysis of the liabilities related to EEPD.

Liquidity and Capital Resources

Cash and cash equivalents increased from $7.1 million at December 31, 2003 to $8.6 million at September 30, 2004. Our working capital increased from $2.1 million at December 31, 2003 to $4.1 million at September 30, 2004.

We generated $1.0 million from operating activities for the nine months ended September 30, 2004 compared to the use of $0.7 million in operating activities for the nine months ended September 30, 2003. The increase in operating cash inflows primarily relates to an increase in profitability, partially offset by the increases in net working capital components, other than cash.

The difference between our net income (loss) from continuing operations and our operating cash inflow (outflow) is attributable to non-cash expenses included in net income (loss), and changes in operating assets and liabilities, as presented below (in thousands):

	Nine Months Ended September 30,

	2004				2003

Net income (loss) from continuing operations		$	1,134			$	(1,645	)
Add: non-cash expenses			1,064				1,148
Deduct: changes in operating assets and liabilities			(1,184	)			(156	)

Net cash provided by (used in) operating activities			1,014				(653	)

Non-cash expenses are associated with the amortization of intangible assets, including purchased technology, depreciation and amortization of property and equipment, and stock-based compensation charges. Changes in operating assets and liabilities reflect changes in working capital components of the balance sheet apart from cash and short-term investments.

Investing activities resulted in net cash outflows of $1.4 million for the nine months ended September 30, 2004 compared to $0.2 million for the nine months ended September 30, 2003. The increase in cash outflows from investing activities primarily relates to the purchase of the “S” programming language from Lucent Technologies.

Financing activities resulted in net cash inflows of $1.8 million for the nine months ended September 30, 2004 compared to net cash outflows of $0.1 million for the nine months ended September 30, 2003. The increase in cash inflows from financing activities relates to our receipt proceeds from the exercise of employee stock options and contributions to our employee stock purchase plan.

In March 2004, the Company renewed a working capital revolving line of credit and security agreement with Silicon Valley Bank, or SVB, and modified the terms to provide for up to $3.0 million in borrowing availability through December 26, 2004. This facility is secured by our accounts receivable and allows us to borrow up to the lesser of (a) 75% of our eligible accounts receivable or (b) $3.0 million and bears interest at the prime rate, which was 4.75% as of September 30, 2004, plus 1%. At September 30, 2004, no amounts had been borrowed and $1.7 million was available for future borrowings under the line of credit facility.

In March 2004, we also renewed and modified the terms of a term loan and security agreement with SVB. This facility allows us to take advances on the cost of eligible equipment and software less than 90 days old and is secured by the underlying assets. We had borrowed $450,000 under this facility in 2002 and the remaining outstanding balance was $193,000 at September 30, 2004. Through December 26, 2004, we may draw up to an additional $500,000 under this agreement, no more than $250,000 of which may be for software. These term loan advances bear interest at the prime rate plus 1%. Advances are repaid over a 36 or 24-month period.

These credit facilities contain covenants that limit our net losses and restrict the amount of capital expenditures not financed through the equipment term loan. In addition, we are prohibited under these facilities from paying dividends. We were in compliance with these covenants as of September 30, 2004.

As of September 30, 2004, our contractual commitments associated with our operating leases, primarily for our office space in Seattle, Washington, as well as other domestic and international locations, and equipment financing are as follows (in thousands):

	Before December 31,			Year Ending December 31,

	2004			2005		2006		2007		2008		Thereafter			Total

Equipment term loan		$	32	$	129	$	32	$	—	$	—		$	—	$	193
Operating lease obligations			165		605		581		451		46			60		1,908

Total		$	197	$	734	$	613	$	451	$	46		$	60	$	2,101

We believe that our existing cash and cash equivalents and available bank borrowings will be sufficient to meet our capital requirements for at least the next 12 months. However, if during that time, we choose to increase our investment in current or new product and marketing initiatives, market conditions worsen, or if other unforeseen events should occur, we could deem it necessary to seek additional funds through public or private equity financing or from other sources in order to fund our operations and pursue our growth strategy. Any financing we obtain may contain covenants that restrict our freedom to operate our business or may require us to issue securities that have rights, preferences or privileges senior to our common stock and may dilute stockholder ownership interest in Insightful.

Important Factors That May Affect Our Business, Our Operating Results and Our Stock Price

In addition to the other information contained in this quarterly report, you should carefully read and consider the following risk factors. If any of these risks actually occur, our business, financial condition or operating results could be adversely affected and the trading price of our common stock could decline.

Our operating results fluctuate and could fall below expectations of securities analysts and investors, resulting in a decrease in our stock price.

Our operating results have varied widely in the past, and we expect that they could continue to fluctuate in the future. Our stock price could decrease if our operating results for a particular quarter or year fall below the expectations of securities analysts and investors. Some of the factors that could affect the amount and timing of our revenues and related expenses and cause our operating results to fluctuate include:

	•	our primary reliance on one product family;

	•	our ability to penetrate new markets;

	•	market acceptance of our products;

	•	our ability to compete in the highly competitive statistics, data mining and knowledge access markets;

	•	our ability to obtain government contracts and research grants;

	•	our ability to expand our sales and support infrastructure;

	•	our ability to maintain our relationships with key partners;

	•	our ability to successfully expand our international operations;

	•	our ability to maintain third-party licenses;

	•	general economic conditions, which may affect our customers’ purchasing decisions;

	•	our ability to attract and retain key employees or management team members;

	•	integration of our new key management team members;

	•	our ability to develop, introduce and market new products on a timely basis;

	•	our ability to protect our intellectual property rights;

	•	unanticipated legal costs; and

	•	uncertain costs associated with being a public company, such as the cost of being compliant with the provisions of The Sarbanes-Oxley Act of 2002, or SOX.

Because we cannot predict our revenues and expenses with certainty, our expectations of future profits or losses may differ from actual results. It is particularly difficult to predict the timing or amount of our license revenues because:

	•	our sales cycles are lengthy and variable, typically ranging between two and eight months from our initial contact with a potential customer;

	•	a substantial portion of our sales are completed at the end of the quarter and, as a result, a substantial portion of our license revenues are recognized in the last days of a quarter;

	•	the amount of unfulfilled orders for our products is typically small; and

	•	delay of new product releases can result in a customer’s decision to delay execution of a contract or, for contracts that include the new release as an element of the contract, will result in deferral of revenue recognition until such release.

Even though our revenues are difficult to predict with certainty, we base our decisions regarding many of our operating expenses on anticipated revenue trends. Many of our expenses are relatively fixed, and we cannot quickly reduce spending if our revenues are lower than expected. As a result, revenue shortfalls could result in significantly lower income or greater loss than anticipated for any given period, which could result in a decrease in our stock price.

If potential customers do not continue to purchase the S-PLUS product family, our revenues and operating results will be adversely affected.

License revenues from the S-PLUS product and add-on modules account for a significant portion of our license revenues. Our newest products, In Fact and Insightful Miner, have not contributed consistent revenues to date. We expect license revenues from the S-PLUS product family to continue to account for a substantial majority of our revenues in the near future. As a result, factors adversely affecting the pricing of or demand for the S-PLUS product family, such as competition or technological change, could dramatically affect our operating results. If we are unable to successfully deploy current versions of the S-PLUS product family and to develop, introduce and establish customer acceptance of new and enhanced versions of the S-PLUS product family, our revenues and operating results will be adversely affected.

If we are unable to penetrate new end-user markets with our current and future products, the growth of our business will be limited.

We focus our statistics business on two vertical markets: financial services and pharmaceuticals. In order to grow our business, we will need to expand into new end-user markets within these two vertical markets for our statistics software, and we must simultaneously develop and sell new products that address these and other markets. We will need to simultaneously invest in the scalability and deployability of our statistics product offerings and in the further development and enhancement of our data mining and knowledge access products. These simultaneous investments may strain our financial resources and diffuse management’s time and attention. If any of these initiatives fails, our business will not grow and could fail.

Many potential customers are not yet aware of the benefits of knowledge access solutions utilizing relationship search capabilities, and our products may not achieve market acceptance.

One of our newest products, InFact, targets the knowledge access market. This product has not contributed substantial revenues to date. The market for knowledge access solutions is still emerging and any growth in demand for and acceptance of these solutions remains uncertain. Even if this market grows, businesses may purchase our competitors’ solutions or develop their own. If InFact does not achieve market acceptance, our business may not grow.

If we are unable to compete successfully in the statistics, data mining and knowledge access markets, our business will fail.

Our S-PLUS product suite targets the statistics and data analysis market. This market is highly competitive, fragmented and mature. We face competition in the statistics and data analysis market primarily from large enterprise software vendors and our potential customers’ information technology departments. These departments may seek to develop data analysis solutions that utilize R, an open-source software package that performs operations similar to the “S” language that forms the core of our S-PLUS product. The dominant competitor in our industry is SAS Institute. Other companies with which we compete include, but are not limited to, SPSS, Inc., StatSoft Inc., Mathworks and Minitab, Inc. In addition to competition from other statistical software companies, we face competition from providers of software for specific statistical applications. In the data mining and knowledge access market, we face competition from many companies, including SAS Institute, SPSS, IBM, NCR, Autonomy, Verity, Inxight, ClearForest and Iphrase, many of which are much larger than we are.

In addition, as we develop other new products, or attempt to expand our sales into new vertical and end-user markets, we may begin competing with companies with whom we have not previously competed. It is also possible that new competitors will enter the market. An increase in competitive pressures in our market or our failure to compete effectively may result in pricing reductions, reduced gross margins and loss of market share. Many of our competitors have longer operating histories, greater name recognition, greater market share, larger customer bases and significantly greater financial, technical, marketing and other resources than we do. We could also experience competition from companies in other sectors of the broader market for business intelligence software, like providers of on-line analytical processing, or OLAP, business intelligence and analytical application software, as well as from companies in other sectors.

Our business is sensitive to the risks associated with government funding decisions.

We regularly apply for and are granted research contracts from a variety of government agencies and funding programs. Over the last three fiscal years, these contracts have generated from $4.3 to $4.8 million annually in offsets to our research and development expenses. During the nine months ended September 30, 2004, research contracts have generated $2.4 million. We may not receive new funded research contracts or any renewals of government-funded projects currently in process, and we may decide to cancel or reassign certain ongoing projects that are not aligned with our core business needs. The personnel and other costs associated with these programs are relatively fixed in the short run, and a sudden cancellation or non-renewal of a major funding program or multiple smaller programs would be harmful to our operating results. A substantial portion of the research grant money we receive is granted to us based on our status as a small business, the definition of which varies depending on the individual contract terms. If the number of our employees or the amount of our revenues ever grows beyond the limits prescribed in any of these contracts, we will no longer be eligible for such research contracts and we will have to incur certain research and development expenses without the benefit of offsets.

We are working to align our research and development efforts to ensure that we only pursue projects that directly support our business strategy. Through this alignment, we expect to apply for and receive fewer government research contracts, which will likely reduce the offsets to our research and development expenses and thereby harm our operating results.

Furthermore, a significant portion of our license revenues come from United States government entities, as well as institutions, healthcare organizations and private businesses that contract with or are funded by government entities. Government appropriations processes are often slow and unpredictable and may be affected by factors outside of our control. Reductions in government expenditures and termination or renegotiation of government-funded programs or contracts could adversely affect our revenue and operating results.

We may be unable to expand our sales organization, which could harm our ability to expand our business.

To date, we have sold our desktop products primarily through our telesales department while we have relied on our field sales force to sell our server-based solutions and generate orders for multiple desktop licenses. We believe our future revenue growth will depend in large part on recruiting, training and retaining both telesales and direct sales personnel. Competition for such personnel in the software industry is intense. Our growth will further depend on expanding our indirect distribution channels. These indirect channels include value added resellers, or VARs, distributors, original equipment manufacturer, or OEM, partners, system integrators and consultants. If we experience difficulty in recruiting and retaining qualified telesales and direct sales personnel and in establishing third-party relationships with VARs, distributors, OEM partners and systems integrators and consultants, our sales could be reduced or our sales growth limited. Even if we successfully expand our sales force and other distribution channels, the expansion may not result in expected revenue growth.

If we are unable to develop and maintain effective long-term relationships with our key partners, or if our key partners fail to perform, our ability to sell our solution will be limited.

We rely on our existing relationships with a number of key partners, including system integrators, VARs, distributors and third-party technology vendors that are important to worldwide sales and marketing of our solutions. In addition, to be successful and to more effectively sell our products to larger customers, we must develop successful new relationships with other key partners. These key partners often provide enterprise software, consulting, implementation and customer support services, and endorse our solution during the competitive evaluation stage of the sales cycle. Although we seek to maintain relationships with our key partners, and to develop relationships with new partners, many of these existing and potential key partners have similar, and often more established, relationships with our competitors. These existing and potential partners, many of which have significantly greater resources than we have, may in the future market software products that compete with our solution or reduce or discontinue their relationships with us or their support of our solution.

Our sales cycle is variable, and sales delays could cause our operating results to fluctuate, which could cause a decline in our stock price.

An enterprise’s decision to purchase statistics, data mining and knowledge access software and services is discretionary, involves a significant commitment of its resources and is influenced by its budget cycles. Our sales cycles are long and variable, typically ranging between two and eight months from our initial contact with a potential customer to the issuance of a purchase order or signing of a license or services agreement, although the amount of time varies substantially from customer to customer and occasionally sales require substantially more time. When economic conditions weaken, sales cycles for software products and related services tend to lengthen, and as a result, we experienced longer sales cycles in 2002, 2003 and the first nine months of 2004 and we expect to continue to experience longer sales cycles at least through the remainder of 2004. Sales delays could cause our operating results to fall below the expectations of securities analysts or investors, which could result in a decrease in our stock price.

We have incurred losses in recent periods, and may continue to do so, which could cause a decrease in our stock price.

Until the fourth quarter of 2003, we had posted net losses for each fiscal quarter since the fourth quarter of 2001. As of September 30, 2004, we had an accumulated deficit of over $29 million. We achieved only slight profits in recent quarters, and a small shortfall in revenue or unexpected increase in expenses, could again cause us to suffer a quarterly net loss. For example, because we self-insure a portion of our employee medical benefits, we may experience significant increases in these expenses if the number or amount of claims for which we are responsible increases substantially. As a result, we may experience losses and negative cash flows in the near term, even if sales of our products and services continue to grow.

We believe that we may need to significantly increase our product development and professional services personnel costs to expand our market position and further increase acceptance of our products . We may not be able to increase our revenues sufficiently to keep pace with these growing expenditures, if at all, and as a result may be unable to achieve or maintain profitability in the future. In addition, if we are unable to grow our revenues, we may be forced to discontinue certain research and/or development projects, which could limit our future product development opportunities.

If we fail to maintain effective internal financial and managerial systems, controls and procedures, our results of operations may be adversely affected.

We face the risk that our systems, procedures and controls might not be adequate to support our operations, maintain accountability for our assets or ensure proper identification of, and proper accounting treatment for, our activities. Our failure to maintain and implement such adequate systems, procedures and controls could adversely impact our business, financial condition and results of operations. In the completion of our year–end audit, our former independent auditors advised us that they observed significant deficiencies in the design or operation of our internal controls that, in their judgment, could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the consolidated financial statements. Specifically, our former auditors communicated to us the following reportable conditions:

	•	that our close process, both domestically and internationally was not performed on a timely basis resulting in a large number of adjustments generated by both us and the our former independent auditors;

	•	there was a lack of adequate detailed review resulting in errors requiring adjusting entries during audit fieldwork;

	•	our accounting department was understaffed.

	•	we had a lack of segregation of duties surrounding the purchasing, receiving and authorization functions.

As a result of these deficiencies our former independent auditors made the following recommendations:

	•	that we review all significant processes involved in the financial reporting and operating activities of the company for potential segregation-of-duties issues; review and test our expense and purchasing approval functions; and, as necessary, revise our processes and procedures around internal investigations.

	•	that we perform a detailed critique of our financial statement close process, domestically as well as internationally including implementing and documenting recurring close procedures and assessing our staffing levels.

We have implemented efforts to address these internal control deficiencies, but they might not prove adequate. We continue to evaluate our operational, financial and accounting systems and our managerial controls and procedures to determine what additional changes, if any, might help us to manage our current operations better. We expect to incur significant expenditures to enhance our information technology resources and to hire additional administrative personnel to improve our financial and managerial systems. Even with these additional expenditures, we might not be able to sufficiently enhance our systems, procedures and controls.

We may have difficulty implementing in a timely manner the internal controls necessary to allow our management to report on the effectiveness of our internal controls, and these reports may not reveal all material weaknesses or significant deficiencies with our internal controls.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we will be required to furnish an internal controls report of management’s assessment of the design and effectiveness of our internal controls as part of our Annual Report on Form 10-K beginning with the fiscal year ended December 31, 2005. Our auditors will then be required to attest to, and report on, management’s assessment. In order to issue our report, our management must document both the design for our internal controls and the testing processes that support management’s evaluation and conclusion. This process will likely require us to hire additional personnel and outside advisory services which would result in additional accounting and legal expenses. In addition, the evaluation and attestation processes required by Section 404 are new and neither companies nor auditing firms have significant experience in complying with these requirements. Accordingly, we may encounter problems or delays in completing the review and evaluation, the implementation of improvements and the receipt of an attestation by our independent auditors.

Our management has started the necessary processes and procedures for issuing its report on our internal controls. We may not be able to complete the work necessary for our management to issue its management report in a timely manner and our management may be unable to report that our internal controls are effective. Our testing may not reveal all material weaknesses or significant deficiencies in our internal controls. Material weaknesses or significant deficiencies in our internal controls could have a material adverse effect on our results of operations.

Additionally, upon the completion of our testing and documentation, certain deficiencies may be discovered that will require remediation. This remediation may require implementing additional controls, the costs of which could have a material adverse effect on our results of operations. If we are unable to implement the requirements of Section 404 in a timely manner or with adequate compliance, in addition to receiving an adverse opinion from our auditors, we might be subject to sanctions or investigation by regulatory authorities. Any such action could adversely affect our business and financial results.

If we do not expand our international operations and successfully overcome the risks inherent in international business activities, the growth of our business will be limited.

To be successful, we must continue to expand our international operations and enter new international markets. This expansion may be delayed as a result of operating expense reduction measures and general economic conditions. If we do expand internationally, it will require significant management attention and financial resources to successfully translate and localize our software products to various languages and to develop direct and indirect international sales and support channels. Even if we successfully translate our software and develop new channels, we may not be able to maintain or increase international market demand for our solutions. We, or our VARs or distributors, may be unable to sustain or increase international revenues from licenses or from consulting and customer support. In addition, our international sales are subject to the risks inherent in international business activities, including:

	•	costs of customizing products for foreign countries;

	•	export and import restrictions, tariffs and other trade barriers;

	•	the need to comply with multiple, conflicting and changing laws and regulations;

	•	separate management information systems and control procedures;

	•	reduced protection of intellectual property rights and increased liability exposure; and

	•	regional economic, cultural and political conditions, including the direct and indirect effects of terrorist activity and armed conflict in countries in which we do business.

Our foreign subsidiaries operate primarily in local currencies, and their results are translated into U.S. dollars. We do not currently engage in currency hedging activities, but we may do so in the future. Changes in the value of the U.S. dollar relative to foreign currencies increased both our European revenues and expenses in 2003 and the first nine months of 2004. Our operating results could be materially harmed if we enter into license or service agreements providing for significant amounts of foreign currencies with extended payment terms or extended implementation timeframes if the values of those currencies fall in relation to the U.S. dollar over the payment period of the agreement.

Delivery of our solution may be delayed if we cannot continue to license third-party technology that is important to the functionality of our solution.

We incorporate into our products software that is licensed to us by third-party software developers. The third-party software currently offered in conjunction with our solution may become obsolete or incompatible with future versions of our products. Further, numerous individual and institutional licensors have contributed software code to S-PLUS in exchange for little or no consideration, and some of these third parties may choose to revise or revoke their licensing terms with us. A significant interruption in the supply of this technology could delay our sales until we can find, license and integrate equivalent technology. This could take a significant amount of time, perhaps several months, which would cause our operating results to fall below the expectations of securities analysts or investors and result in a decrease in our stock price.

We may be unable to obtain funding that may be necessary to support the expansion of our business.

Our future revenues may be insufficient to support the expenses of our operations and the expansion of our business. We may therefore need additional equity or debt capital to finance our operations. If we are unable to generate sufficient cash flow from operations or to obtain funds through additional financing, we may have to reduce some or all of our development and sales and marketing efforts and limit the expansion of our business or cease operations.

We believe that our existing cash and cash equivalents and available bank borrowings will be sufficient to meet the capital requirements of our core business for at least the next twelve months. However, if during that time the market for our products worsens, or if other unforeseen events should occur, we may need additional funds through public or private equity financing or from other sources in order to fund our operations and pursue our growth strategy. If our newer products require substantial investment in order to make them commercially viable, we may need to seek additional funding or we may be forced to discontinue further investment in them. We have no commitment for additional financing, and, if funding does become necessary, we may experience difficulty in obtaining it on favorable terms, if at all.

Our credit line and equipment term loan with Silicon Valley Bank contain covenants that require us to maintain a certain level of net income. Any additional financing we obtain may contain covenants that restrict our freedom to operate our business or may require us to issue securities that have rights, preferences or privileges senior to our common stock and may dilute your ownership interest in us.

Global economic conditions could adversely affect our revenue growth and ability to forecast revenue.

Our revenue growth and potential for profitability depend on the overall demand for statistics and data analysis, data mining and knowledge access software and services. Because our sales are primarily to corporate customers, our business also depends on general economic and business conditions. Continued soft demand for computer software caused by a weakened economy, both domestic and international, may affect our sales and may continue to result in decreased revenues. As a result of inconsistent and weakened economic conditions, we may experience difficulties in collecting outstanding receivables from our customers.

Privacy and security concerns may limit the effectiveness of and reduce the demand for our solution.

The effectiveness of our solution relies on the storage and use of data collected from various sources, including personal information. The collection and use of such data by our customers for customer profiling may raise privacy and security concerns, especially in pharmaceutical markets where companies are subject to the strict privacy requirement of the Health Insurance Portability and Privacy Act of 1996. Our customers generally have implemented security measures to protect customer data from disclosure or interception by third parties. However, the security measures may not be effective against all potential security threats. If a well-publicized breach of customer data security were to occur, our products and solutions may be perceived as less desirable, which could limit our revenue growth.

In addition, due to privacy concerns, some Internet commentators, consumer advocates and governmental or legislative bodies have suggested legislation to limit the use of customer profiling technologies. The European Union and some European countries have already adopted some restrictions on the use of customer profiling data. If major countries or regions adopt legislation or other restrictions on the use of customer profiling data, our solution would be less useful to customers, and our sales could decrease.

If we do not attract and retain key employees or management team, our ability to execute our business strategy will be limited.

Our future performance will depend largely on the efforts and abilities of our key technical, sales, customer support and managerial personnel and on our ability to attract and retain them. In addition, our ability to execute our business strategy will depend on our ability to recruit additional experienced senior managers and to retain our existing executive officers. Departures of key executives could adversely impact our reputation. We may be unable to attract and retain such personnel in the future. In addition, due to competition for qualified employees, we may be required to increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses. We are also currently in the process of recruiting a replacement for our recently departed Senior Vice President of Marketing.

In addition, our ability to attract and retain employees may be adversely affected by the market price of our common stock, which has declined in 2004. Consequently, potential employees may perceive our equity incentives such as stock options as less attractive, and current employees whose options are no longer priced below market value may choose not to remain employed by us. Because our key employees are not obligated to continue their employment with us, they could leave at any time.

Integration of our new directives and key employees could disrupt our business and the execution of our strategy.

Substantially all of our executive leadership team has been replaced in the last twelve months. Since January 2004, we hired a new Chief Executive Officer, Chief Financial Officer and Vice President of Research and Development. We also currently in the process of replacing our recently departed Senior Vice President of Marketing and Vice President of North American Sales. Additionally, we have appointed two new members to our board of directors and audit committee. In addition, we have experienced turnover of other key finance and administration personnel in recent months. The restructuring of our senior management and finance leadership and the integration of these key employees and directors may result in some disruption in our business.

Rapid changes in technology could render our products obsolete or unmarketable, and we may be unable to introduce new products and services successfully and in a timely manner.

The business software market is characterized by rapid change due to changing customer needs, rapid technological developments and advances introduced by competitors. Existing products can become obsolete and unmarketable when products using new technologies are introduced and new industry standards emerge. New technologies, including the rapid growth of the Internet and commercial acceptance of open source software, such as R, could change the way software is sold or delivered. We may also need to modify our products when third parties change software that we integrate into our products. As a result, the life cycles of our products are difficult to estimate.

To be successful, we must continue to enhance our current product line and develop new products that successfully respond to changing customer needs, technological developments and competitive product offerings. We may not be able to successfully develop or license the applications necessary to respond to these changes, or to integrate new applications with our existing products. Past or future reductions in our research and development personnel may harm our ability to innovate and compete. We may not be able to introduce enhancements or new products successfully or in a timely manner in the future. If we delay release of our products and product enhancements, or if they fail to achieve market acceptance when released, it could harm our reputation and our ability to attract and retain customers, and our revenues may decline. In addition, customers may defer or forego purchases of our products if competitors, our major hardware, systems or software vendors or we introduce or announce new products or product enhancements. Finally, delays in any new research or development efforts could cause delays in our general product development schedule, including causing delays in the release of new product versions, which could materially harm our maintenance revenues.

We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively.

Our success depends in part on our ability to protect our proprietary rights, including our “S” programming language purchased from Lucent Technologies in January 2004. To protect our proprietary rights, we rely primarily on a combination of patent, copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties and protective contractual provisions such as those contained in license agreements with consultants, vendors and customers, although we have not signed these agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. Generally, our products are not physically copy-protected. In order to retain exclusive ownership rights to all software developed by us, we license all software and provide it in executable code only, with contractual restrictions on copying, disclosure and transferability. As is customary in the industry, we generally license our products to end-users by use of a ‘shrink-wrap’ license. Certain specialized products may utilize a written, signed license agreement with the customer. The source code for most of our products is protected as a trade secret and as unpublished copyrighted work. Other parties may breach confidentiality agreements and other protective contracts we have entered into, and we may not become aware of, or have adequate remedies in the event of, a breach. We face additional risk when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. While we are unable to determine the extent to which piracy of our software products exists, we expect piracy to be a continuing concern, particularly in international markets and as a result of the growing use of the Internet. In any event, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

Intellectual property claims and litigation could subject us to significant liability for damages and result in invalidation of our proprietary rights.

In the future, we may have to resort to litigation to protect our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation, regardless of its success, would probably be costly and require significant time and attention of our key management and technical personnel. Although we have not been sued for intellectual property infringement, we may face infringement claims from third parties in the future. The software industry has seen frequent litigation over intellectual property rights, and we expect that participants in the industry will be increasingly subject to infringement claims as the number of products, services and competitors grows and the functionality of products and services overlap. Infringement litigation could also force us to:

	•	stop or delay selling, incorporating or using products that incorporate the challenged intellectual property;

	•	pay damages;

	•	enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or

	•	redesign products or services that incorporate infringing technology, which we might not be able to do at an acceptable price, in a timely fashion or at all.

Our products may suffer from defects or errors, which could result in loss of revenues, delayed or limited market acceptance of our products, increased costs and reputational damage.

Software products as complex as ours frequently contain errors or defects, especially when first introduced or when new versions are released. Our customers are particularly sensitive to such defects and errors because of the importance of accuracy in software used in analyzing data. We have had to delay commercial release of past versions of our products until software problems were corrected, and in some cases have provided product updates to correct errors in released products. Our new products or releases may not be free from errors after commercial shipments have begun. Any errors that are discovered after commercial release could result in loss of revenues or delay in market acceptance, diversion of development resources, damage to our reputation, increased service and warranty costs or claims against us.

In addition, the operation of our products could be compromised as a result of errors in the third-party software we incorporate into our software. It may be difficult for us to correct errors in third-party software because that software is not in our control.

Our stock price may be volatile.

The price of our common stock has been volatile over the past 12 months. Our common stock reached a high of $4.97 per share on May 5, 2004 and traded as low as $1.13 per share on September 1, 2004. As a result of fluctuations in the price of our common stock, you may be unable to sell your shares at or above the price you paid for them. The trading price of our common stock could be subject to fluctuations for a number of reasons, including

	•	future announcements concerning us or our competitors;

	•	actual or anticipated quarterly variations in operating results;

	•	changes in analysts’ earnings projections or recommendations;

	•	announcements of technological innovations;

	•	the introduction of new products;

	•	changes in product pricing policies by us or our competitors;

	•	loss of key personnel;

	•	deficiencies in our internal controls;

	•	proprietary rights litigation or other litigation; or

	•	changes in accounting standards that adversely affect our revenues and earnings.

In addition, stock prices for many technology companies fluctuate widely for reasons that may be unrelated to operating results of these companies. These fluctuations, as well as general economic, market and political conditions, such as national or international currency and stock market volatility, recessions or military conflicts, may materially and adversely affect the market price of our common stock, regardless of our operating performance and may expose us to class action securities litigation which, even if unsuccessful, would be costly to defend and distracting to management. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against these companies. Litigation brought against us could result in substantial costs and a diversion of management’s attention and resources, which could have a material adverse effect on our business, financial condition and operating results.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We develop products in the United States and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We operate in the United Kingdom, France and Switzerland and incur expenses and generate billings denominated in those local currencies. Interest income and expense are sensitive to changes in the general level of U.S. interest rates, particularly since our investments are in short-term instruments. Based on the short-term nature and current levels of our investments and debt, however, we do not believe that there is any material market risk or exposure.

Our general investing policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting credit and market risk. We currently invest in highly liquid money market accounts. All highly liquid investments with original maturities of three months or less are considered to be cash equivalents.

ITEM 4.

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, or the Exchange Act. These rules refer to the controls and other procedures of a company that are designed to ensure that the information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our Exchange Act reports is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our chief executive officer and our chief financial officer have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report, and they have concluded that, as of that date, our disclosure controls and procedures were effective.

Internal Controls over Financial Reporting

During our audit for the year ended December 31, 2003, our former independent auditors advised us that they observed significant deficiencies in the design or operation of our internal controls that, in their judgment, could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the consolidated financial statements. Specifically, our former auditors communicated to us the following reportable conditions:

	•	that our close process, both domestically and internationally was not performed on a timely basis resulting in a large number of adjustments generated by both us and the our former independent auditors;
	•	there was a lack of adequate detailed review resulting in errors requiring adjusting entries during audit fieldwork;
	•	our accounting department was understaffed; and
	•	we had a lack of segregation of duties surrounding the purchasing, receiving and authorization functions.

Since that time, we have performed a critique of our close process and redefined close procedures and documented a close calendar. The close procedures include detailed and documented reviews. In addition, we assessed our staffing levels worldwide and have hired new accounting personnel both domestically and internationally. We hired a new Chief Financial Officer and appointed a new Audit Committee Chairman, both with strong backgrounds in accounting and public company financial reporting. Finally, we segregated the duties surrounding the purchasing, receiving and authorization functions.

Limitations of Disclosure Controls and Procedures and Internal Control over Financial Reporting

Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls or internal control over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in internal controls

Except as described above, there have been no changes in our internal control over financial reporting that occurred during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.	OTHER INFORMATION

ITEM 1.	Legal Proceedings

In December 2002, a former Insightful employee filed a complaint against us in the Superior Court for King County, Washington. The former employee alleged that his employment was wrongfully terminated, and he sought an unspecified amount of damages. Specifically, he alleged that we improperly recognized services revenues in the fourth quarter of 2001 and that we terminated him in violation of public policy. On December 5, 2003, a judge for the Superior Court for King County granted summary judgment in our favor and dismissed the case. The plaintiff has appealed the decision, and if his appeal is successful we will likely resume litigation in the Superior Court for King County. We continue to believe his lawsuit is without merit and we deny his claims. An evaluation of the likelihood of an adverse outcome cannot be expressed with sufficient certainty at this time. An unfavorable outcome could have a materially adverse effect on our financial position, results of operations, and cash flows.

ITEM 4.

Submission of Matters to a Vote of Security Holders

None.

ITEM 5.

Other Information

On July 27, 2004, we entered into an employment agreement regarding termination (the “Severance Agreement”) with Richard P. Barber, our Chief Financial Officer. The Severance Agreement, which is effective as of July 26, 2004, provides that, in the event Mr. Barber is terminated without cause, we will pay Mr. Barber severance equal to six months’ salary based on the rate in effect as of the date of termination, unless Mr. Barber is terminated before July 26, 2005, in which event we will pay Mr. Barber severance equal to 12 months’ salary based on the rate in effect as of the date of termination. In addition, the Severance Agreement provides that, upon a change in control, we will accelerate the vesting of 50% of Mr. Barber’s unvested and unexpired stock options. The Severance Agreement also provides for severance pay and acceleration of stock options in the event Mr. Barber is terminated without cause 3 months prior to, or within the six months following, a change in control. In such event, we will pay severance equal to six months of salary based on the rate in effect as of the date of termination, we will accelerate the vesting of all of Mr. Barber’s unvested and unexpired stock options, and we will allow Mr. Barber 90 days from the date of termination to exercise any unexpired stock options that were vested and exercisable as of the date of termination. The Severance Agreement also makes reference to a July 22, 2004, letter from Jeffrey E. Coombs, CEO of the company, to Mr. Barber (the “Offer Letter”), which provides for base annual compensation of $200,000 plus additional annual cash incentives of up to $40,000.

A complete copy of the Severance Agreement is filed with this Quarterly Report as Exhibit 10.1. The execution of the Severance Agreement was not disclosed in a report on Form 8-K during the period covered by this Form 10-Q, as the reported event preceded the August 23, 2004 effective date of new 8-K rules implementing Section 409 of the Sarbanes-Oxley Act of 2002.

ITEM 6.

Exhibits

(a) See Index to Exhibits.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

November 15, 2004

	INSIGHTFUL CORPORATION


	By:	/s/ Jeffrey E. Coombs

		Jeffrey E. Coombs President and Chief Executive Officer (Principal Executive Officer)

November 15, 2004

	INSIGHTFUL CORPORATION


	By:	/s/ Richard P. Barber

		Richard P. Barber Chief Financial Officer (Principal Financial and Accounting Officer)

EXHIBIT INDEX

Exhibit Number			Description

3.1			Amended and Restated Certificate of Incorporation of the Registrant (Exhibit 3.1) (A)

3.2			Amended and Restated Bylaws of the Registrant (Exhibit 3.2) (A)

3.3			Employment Agreement Regarding Termination between Insightful Corporation and Richard P. Barber

31.1			Certification of Chief Executive Officer of Insightful Corporation as Required by Section 302 of Sarbanes-Oxley Act of 2002

31.2			Certification of Chief Financial Officer of Insightful Corporation as Required by Section 302 of Sarbanes-Oxley Act of 2002

32.1			Certification of Financial Statements by Chief Executive Officer Insightful Corporation as Required by Section 906 of Sarbanes-Oxley Act of 2002

32.2			Certification of Financial Statements by Chief Financial Officer of Insightful Corporation as Required by Section 906 of Sarbanes-Oxley Act of 2002

(A)

Incorporated by reference to the designated exhibit included in the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001 (SEC File No. 0-20992), filed on November 14, 2001.