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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

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

For the Quarterly Period ended March 31, 2004

OR

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

For the transition period from ___ to ___

Commission file number 0-020992

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

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 þ  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 þ

     The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, was 12,336,830 shares as of April 28, 2004.

TABLE OF CONTENTS

   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.

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TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

INSIGHTFUL CORPORATION AND SUBSIDIARIES

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

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

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INSIGHTFUL CORPORATION AND SUBSIDIARIES

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

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

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INSIGHTFUL CORPORATION AND SUBSIDIARIES

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

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

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INSIGHTFUL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2004

(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

   a) Description of Business

     Insightful Corporation and its wholly owned subsidiaries provide enterprises with scalable data analysis solutions designed to drive better decisions faster by revealing patterns, trends and relationships. 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®, StatServer®, and S-PLUS Analytic Server®. Insightful’s consulting services provide specialized expertise and proven processes for the design, development and deployment of analytical solutions.

     Insightful has been delivering data analysis solutions for seventeen 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 month period ended March 31, 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.

     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,

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we have established VSOE for maintenance related to most of our 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 typically call for payment within 30 to 45 days. 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 also used to evaluate probability of collection. Insightful provides for estimated returns at the time of sale under an unconditional 30-day return policy based on historical experience.

     Maintenance revenue is recognized ratably over the term of the related contracts, which generally span one year or less. The initial one-year maintenance contract is bundled into the license fees on most of our 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. 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 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.

     Amounts received in advance for maintenance agreements are recorded as deferred revenue on the accompanying consolidated balance sheets.  

   (c) 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, which was offset against software-related costs in the statements of operations in the first 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” language from Lucent Technologies Inc. for $2.0 million. The Company recorded the amount payable to Lucent, less the amounts owed for accrued but unpaid royalties no longer payable, as purchased technology and is amortizing it over a 3-year estimated life. 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.

(4) FINANCING ARRANGEMENTS

In March 2004, we 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. 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 4.0% as of March 31, 2004, plus 1%. At March 31, 2004, no amounts had been borrowed and $1,566,000 was available for future borrowings under the line of credit facility through December 26, 2004.

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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. 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. We previously borrowed $450,000 under this facility in 2002 and the remaining outstanding balance was $258,000 at March 31, 2004. These term loan advances bear interest at the prime rate, which was 4.0% as of March 31, 2004, plus 1%. Advances are repaid over a 36 or 24-month period. At March 31, 2004, $500,000 was available under this facility for future equipment borrowings through December 26, 2004.

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 from paying dividends. We were in compliance with these covenants as of March 31, 2004 .

Future maturities of debt as of March 31, 2004 are: 

(5) NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share is calculated using the weighted-average number of shares of common stock outstanding. Stock issued and subject to restrictions is excluded from the calculation. Diluted net income (loss) per share reflects the dilutive effect of common stock equivalents (including stock options and warrants), unless their effect on earnings per share from continuing operations is anti-dilutive.  

The following securities were not included in computing diluted earnings per share because their effect would be anti-dilutive:

(6) OTHER COMPREHENSIVE 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 loss, which the Company currently reports, is foreign currency translation adjustments. Total comprehensive loss is as follows:

(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. In the third quarter of 2003, management defined the Company’s segments to correspond with the way the Company

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is now organized and managed. Accordingly, continuing business segment information includes the segments of Domestic Data Analysis, International Data Analysis and Text Analysis. Segment information for the three months ended March 31, 2003 and 2004 has been presented in accordance with the current segment definitions. The Company measures segment performance based on their income or loss from operations. Assets are not allocated to segments for internal reporting presentations.

     Non-operating income and expenses are not tracked by segment.

(8) STOCK-BASED COMPENSATION

      A reconciliation of net income (loss) as reported to pro-forma net loss that includes stock-based employee compensation cost as if the fair value method had been applied to all option awards is as follows:

(9) BUSINESS RESTRUCTURING

During the second and 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 was in Europe. In addition, as part of this restructuring, the Company combined its German operations with its Swiss subsidiary headquartered in Basel, Switzerland. The Company evaluated the goodwill acquired in the acquisition of its German business for impairment and determined no impairment occurred in the third quarter. 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. As of March 31, 2004, $290,000 in termination benefits remained to be paid, a decrease of $55,000 from the balance at December 31, 2003. All termination benefits will be paid by March 31, 2005. No additional amounts are expected to be incurred.

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(10) COMMITMENTS AND CONTINGENCIES 

In certain of our licensing agreements we provide 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 March 31, 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, Wajih Alaiyan, a former Insightful employee, filed a complaint against the Company in the Superior Court for King County, Washington. Mr. Alaiyan alleges that his employment was wrongfully terminated, and he seeks an unspecified amount of damages. On December 5, 2003, a judge for the Superior Court for King County, Washington granted summary judgement in our favor and dismissed. Mr. Alaiyan has appealed the decision. 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 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 sales trends for our products;
  
  
• 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.

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Description of the Company

     We provide enterprises with scalable data analysis solutions designed that 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®, StatServer®, S-PLUS Analytic Server®, Insightful Miner and InFact®. Our consulting services provide specialized expertise and proven processes for the design, development and deployment of analytical solutions.

     We have been delivering data analysis solutions for 17 years to companies in financial services, pharmaceuticals, biotechnology, telecommunications and manufacturing as well as government and research institutions.

     Headquartered in Seattle, Washington, we also have North American offices in New York and North Carolina. Our international offices are located in France, Switzerland, and the United Kingdom, with distributors around the world.

     We originally incorporated in Massachusetts in 1984 and reincorporated in Delaware in 2001. Our 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.

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, which we licensed on an exclusive worldwide basis from Lucent Technologies Inc. until we acquired the rights to “S” in January 2004. 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. The intuitive drag-and-drop interface makes it easy to create self-documenting visual workmaps. 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

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efficiently uncover information they are searching for. InFact thus enables 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.

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 and training 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 these condensed 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 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, it could cause a material increase or decrease in the amount of revenue that we report in a particular period. Revenue that we cannot recognize in a particular period is reflected on our balance sheet as deferred revenue and recognized over time as the applicable revenue recognition criteria are satisfied. These estimates are made based upon all of the information available to us at the time. Material differences may result in the amount and timing of our revenue for any given period if different judgments are made or different estimates are used.

 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 future return risk.

   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 each customer. Customer credit worthiness is subject to many business and finance risks facing each customer and is subject to sudden changes.

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   Impairment of Goodwill and Other Long Lived Assets

     At least annually we evaluate goodwill arising from acquired businesses for potential impairment indicators. 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 will be charged to earnings in the period in which they are identified. We will continue to evaluate goodwill for impairment and, should an impairment be indicated, the corresponding charge will be taken in that period. Separable intangible assets that do not have indefinite lives are amortized over their useful lives.

   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 Months Ended March 31, 2004 and 2003

Revenues

     Total revenues, which consist of software licenses, maintenance and service revenue, were $4,335,000 for the three months ended March 31, 2004 and $4,309,000 for the three months ended March 31, 2003.  

     Software license revenues, consisting of software licenses and subscriptions, accounted for 50% of total revenues for the three months ended March 31, 2004 and 42% of total revenues for the three months ended March 31, 2003. Software license revenues increased 20% from 1,804,000 for the three months ended March 31, 2003 to 2,168,000 for the three months ended March 31, 2004. This increase was primarily due to an increase in revenues for S-Plus and Insightful Miner both in Europe and in the U.S. We expect software license revenues to decrease slightly in the second quarter but to trend upward for the remainder of the year.

     Software maintenance revenues accounted for 38% of total revenues for the three months ended March 31, 2004 and 39% of total revenues for the three months ended March 31, 2003. Software maintenance revenue decreased 2% from $1,663,000 for the three months ended March 31, 2003 to $1,632,000 for the three months ended March 31, 2004. This decrease was primarily attributable to a decrease in maintenance renewals in 2003. We expect maintenance revenues to increase for the remainder of 2004.

     Professional services revenues generated from consulting and training activities accounted for 12% of total revenues for the three months ended March 31, 2004 and 19% of total revenues for the three months ended March 31, 2003. Professional services revenues decreased 36% from $842,000 for the three months ended March 31, 2003 to $535,000 for the three months ended March 31, 2004. This decrease was primarily due to a decrease in North American consulting revenues resulting from a smaller pipeline of projects than in the prior year period. We expect professional service revenues to increase in the second quarter based on an increase in consulting projects.

     Revenues from international operations, which include Europe and Asia Pacific, increased 5% for the three months ended March 31, 2003 from $1,336,000 to $1,400,000 for the three months ended March 31, 2004. This increase was primarily the result of increased license and maintenance revenues, particularly in our Northern European operations.

Cost of Revenues

     Total cost of revenues decreased 23% from $1,238,000 for the three months ended March 31, 2003 to $953,000 for the three months ended March 31, 2004. This decrease was due primarily to a decrease in professional service costs resulting from the cost saving measures implemented in July 2003 as part of a corporate restructuring.

     The cost of software-related revenue, which consists of royalties for third-party software, product media, product duplication, manuals and maintenance costs decreased as a percentage of revenues from 14% for the three months ended March 31, 2003 to 10% for the three months ended March 31, 2004. In January 2004, we acquired the copyrights to the software code underlying the “S” Programming language for $1.8 million resulting in a cessation of future royalty payments to Lucent Technologies after that date. The decrease in software-related costs of revenues primarily relates to a reduction in royalty costs of $214,000 due to the purchase of the “S” Programming Language, offset by $98,000 of amortization expense resulting from the purchased technology, which is being amortized over a three year period. We expect the cost of software-related revenue to remain at the current levels as a percentage of revenues for the remainder of 2004.

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     The cost of professional services consists primarily of salaries and other operating costs of employees who provide consulting services and product training. The cost of professional services as a percentage of professional services revenue increased from 89% for the three months ended March 31, 2003 to 100% for the three months ended March 31, 2004. This increase is due to lower utilization as the result of fewer projects. We expect the cost of professional services to remain flat for the remainder of 2004.

Operating Expenses

     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. Sales and marketing expenses decreased 17% from $1,805,000 for the three months ended March 31, 2003 to $1,493,000 for the three months ended March 31, 2004. As a percentage of total revenues, sales and marketing expenses decreased from 42% for the three months ended March 31, 2003 to 34% for the three months ended March 31, 2004. This decrease primarily relates to a reduction in force in our Swiss office in July 2003, reduced usage of outside consultants and the closing of our German office July 2003. We expect sales and marketing expenses to increase both in amount and as a percentage of revenues in 2004 as we allocate more resources to this area.

     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. Net research and development expenses decreased 44% from $710,000 for the three months ended March 31, 2003 to $397,000 for the three months ended March 31, 2004. Net research and development expenses decreased as a percentage of total revenues from 16% for the three months ended March 31, 2003 to 9% for the three months ended March 31, 2004. Gross research and development expenses decreased 16% from $1,682,000 for the three months ended March 31, 2003 to $1,409,000 for the three months ended March 31, 2004. This decrease is primarily due to the reduction in force measures taken in July 2003. Funded research, which consists primarily of government grants for research projects, increased 4% from $972,000 for the three months ended March 31, 2003 to $1,012,000 for the three months ended March 31, 2004. This increase was primarily due to increased research funding for text analysis projects. 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 decrease our funded research by focusing our research efforts on technology that is more closely aligned with our product lines.

     General and administrative expenses, which consist primarily of salaries and related costs associated with finance, accounting, investor relations, administration and facilities activities, increased 55% from $773,000 for the three months ended March 31, 2003 to $1,197,000 for the three months ended March 31, 2004. As a percentage of total revenues, general and administrative expenses increased from 18% for the three months ended March 31, 2003, to 28% for the three months ended March 31, 2004. This increase was primarily attributable to $250,000 in legal fees incurred in resolving a dispute with Lucent Technology, and to increased insurance, compliance and audit expenses. We expect our general and administrative expenses to be slightly higher in the second quarter due to the 2003 audit investigation costs which were incurred early in the second quarter, and then to decrease to approximately $1 million per quarter for the remainder of 2004.

Other Income, Net

     Total other income and (expense), net changed from $15,000 in net income for the three months ended March 31, 2003 to a $30,000 net expense for the three months ended March 31, 2004. This change was primarily attributable to an exchange loss of $45,000 during the quarter ended March 31, 2004 related to foreign currency transactions.

Income Tax Provision

     The decrease in the tax provision from $71,000 for the three months ended March 31, 2003 to $11,000 for the three months ended March 31, 2004 primarily relates to a decrease in taxes payable for our German and French operations.

Net Income (Loss)

     Net income for the three months ended March 31, 2004 was $225,000 compared to a net loss of $355,000 for the three months ended March 31, 2003. The change in net income (loss) was primarily attributable to an increase in software license revenues and reductions in professional service costs, sales and marketing expenses and gross research and development expenses that resulted from corporate restructuring and reduction in force in July 2003, partially offset by an increase of general and administrative expenses. We expect that it will be difficult to achieve a profit in the second quarter due primarily to higher general and administrative expenses.

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Liquidity and Capital Resources

     Cash and cash equivalents increased from $7.1 million at December 31, 2003 to $7.2 million at March 31, 2004. We generated $637,000 from operating activities for the three months ended March 31, 2004 compared to the use of $765,000 from operating activities for the three months ended March 31, 2003. The increase in operating cash inflows primarily relates to an increase in profitability as well as a reduction of prepaid expenses primarily related to Lucent exclusivity royalties not paid in the first quarter of 2004 due to the purchase of the “S” Programming Language and an increase of deferred revenue from the sale of our InFact product.

     Investing activities resulted in net cash outflows of $1,527,000 for the three months ended March 31, 2004 compared to $73,000 for the three months ended March 31, 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 $960,000 for the three months ended March 31, 2004 compared to net cash outflows of $36,000 for the three months ended March 31, 2003. The increase in cash inflows from financing activities relates to cash received of $1,021,000 from proceeds of exercise of employee stock options and employee stock purchase plan contributions.

     In March 2004, we 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. 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 4.0% as of March 31, 2004, plus 1%. At March 31, 2004, no amounts had been borrowed and $1,566,000 was available for future borrowings under the line of credit facility through December 26, 2004.

     In March 2004, we also renewed 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. 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. We previously borrowed $450,000 under this facility in 2002 and the remaining outstanding balance was $258,000 at March 31, 2004. These term loan advances bear interest at the prime rate, which was 4.0% as of March 31, 2004, plus 1%. Advances are repaid over a 36 or 24-month period. At March 31, 2004, $500,000 was available under this facility for future equipment borrowings through December 26, 2004.

     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 from paying dividends. We were in compliance with these covenants as of March 31, 2004 

     The following are our contractual commitments associated with our operating and equipment financings:

     As of March 31, 2004 we had tax net operating loss carryforwards of approximately $22 million and research and development tax credit carryforwards of approximately $2 million. The net operating loss and credit carryforwards will expire at various dates beginning 2004 through 2021, if not used. Under the provisions of the Internal Revenue Code, substantial changes in our ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset taxable income. A full valuation allowance has been established in our financial statements to reflect the uncertainty of our ability to use available tax loss carryforwards and other deferred tax assets.

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     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 would likely 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.

Business Outlook

     We provide our customers with useful and innovative software and services to derive intelligence from the data they collect. Several converging trends point to a significant long-term potential for the data analysis software market. First, organizations currently collect far more data, in a variety of formats, than they actually analyze. Second, increasing amounts of additional information are being collected by organizations. Third, organizations are seeking to apply new and increasingly complex analytic techniques to their ever-increasing collection of data in order to gain significant improvements in the quality and efficacy of products built, marketed, and sold and to improvements in the efficiency of business processes. Overall, the confluence of these trends should result in significant long-term potential for data analysis software companies such as Insightful.

     Our product direction for the S-PLUS Product Family mirrors these data analysis industry trends. Our focus has been, and will continue to be, to build on S-PLUS’ position as a leader for statistical model prototyping and data visualization used extensively by individual statisticians building statistical models. Our vision is to continually enhance the S-PLUS product family to provide a seamless environment where sophisticated business analytics can be developed on the desktop and then deployed to production on servers handling many gigabytes of data and deployed to hundreds and even thousands of users, without the need for expensive re-implementation. We will increasingly enable S-PLUS programmers and other IT professionals to use the S-PLUS product family to deploy analytic applications to mission critical production environments.

     Our direction also involves tailoring our solutions to meet the needs of certain market segments. Throughout our history, we have, to varying degrees, tailored our data analysis solutions to the needs of the following industries: securities and banking, life sciences, manufacturing, telecommunications, environmental, and defense/intelligence. Our largest efforts have focused on life sciences and financial services. We also serve the academic community, though our objective there is not to drive short-term increased revenues but rather seed for future commercial sales. Since we are seeing more of our customers explore and adopt open-source data analysis technologies, instead of purchasing commercial software products, our direction involves extending our products to provide increasing value add in the form of scaling to large amounts of data as well as tailored to specific vertical markets. We are focusing our resources on higher-value initiatives in the three industries that currently account for the majority of our revenues: life sciences, securities and banking for data analysis, and defense/intelligence.

     We will continue to invest in both our existing and new products, as well as in expanding our sales and marketing efforts. We anticipate that our growth will primarily be driven by software license revenues and that our professional services revenue will begin to increase. Growth for our software license and maintenance revenues will be driven primarily by our high-end products, Insightful Miner, S-PLUS Server, and our vertical application modules such as S+Finmetrics and S+ArrayAnalyzer.

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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;
  
  
• our ability to develop, introduce and market new products on a timely basis;
  
  
• 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 research contracts;
  
  
• 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;
  
  
• our inability to protect our intellectual property rights;
  
  
• our ability to attract and retain key employees or management team members; and
  
  
• general economic conditions, which may affect our customers' purchasing decisions;

     As a result of these factors, we cannot predict our revenues and expenses with certainty, and future product revenues may differ from historical patterns. 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;  
  
  
• for our newest products, we have no history by which to gauge the sales cycles or acceptance rates;  
  
  
• 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 at the beginning of a quarter 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 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.

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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 nearly all of our license revenues. We expect license revenues from the S-PLUS product family to continue to account for a substantial amount of our future revenues. 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 at a satisfactory rate, 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.

If we are unsuccessful in the marketing and selling of InFact and Insightful Miner, our revenues and operating results will be adversely affected.

     We cannot predict the degree to which our newest products, InFact and Insightful Miner, will achieve market acceptance or the extent to which they will perform as our customers expect. If our new products contain defects or errors, or otherwise do not operate as expected, their market acceptance may be delayed or limited, and our reputation may be damaged. If our new products such as InFact do not achieve market acceptance in the timeframe we expect, we may decide to discontinue further investment in them. If we are unsuccessful in selling new products such as InFact, the growth of our business will be limited and our revenues and operating results will be adversely affected.

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.

     The market for knowledge access solutions is still emerging and continued 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. We intend to spend considerable resources educating potential customers not only about our solutions but also about the value of such systems in general. Even with these educational efforts, however, market acceptance of our solutions may not increase. If our products do not achieve market acceptance, our results will suffer.

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 also face competition from providers of software for specific statistical applications.

     In the data mining and knowledge access markets, 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, 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.   

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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. 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 annual 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 and when the number of our employees or the amount of our revenues grow 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.

     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 place 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. 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 and 2003 and we expect to continue to experience longer sales cycles over the next several quarters. 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.

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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 March 31, 2004, we had an accumulated deficit of over $30 million. In future periods we may not realize the anticipated revenue increases from our new product and positioning initiatives. In addition, we may be unable to achieve cost savings without adversely affecting our business and operating results. We may also experience losses and negative cash flows in the near term, even if sales of our products and services continue to grow.

     In April of 2004, we incurred approximately $276,000 in legal and accounting fees associated with an independent investigation of allegations made by a former employee that we improperly recognized services revenues in 2001 and 2002. Based on the investigation, our audit committee determined, with the advice of management, that our financial statements for the 2001 and 2002 years, and for the quarters included therein, present fairly, in all material respects, the consolidated financial position, results of operations, and cash flows of the Company in the conformity with accounting principles generally accepted in the United States. However, the one–time charges we recorded as general and administrative expense in the second quarter will make it more difficult for us to achieve a quarterly operating profit in the second quarter of 2004.  

     We believe that we may need to significantly increase our product development and professional services efforts 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 our business, financial condition and results of operations. In the completion of our year–end audit, our independent auditors advised us that they observed deficiencies in the design or operation of our internal controls that, in their judgment, if not remedied could in the future 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 independent auditors observed the following issues:

• Due to an instance of employee theft we discovered in late 2003, our independent auditors have recommended 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.
  
  
• Due to challenges that we faced during the completion of our 2003 financial statement close process, our independent auditors have recommended that we initiate a study of our financial close processes, procedures and controls in order to enhance the quality, efficiency and timeliness of our financial statement preparation and to ensure proper identification and accounting treatment for our activities.

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.

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;  
  
  
• 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.  

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     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. 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  

Integration of future acquisitions may be difficult and disruptive.  

     We have completed several acquisitions of businesses with complementary technologies or service offerings. In addition to our acquisition of Predict AG in Switzerland in September 2001, we acquired the statistics businesses of Waratah Corporation in North Carolina in July 2001, GraS Graphische Systeme GmbH in Germany in July 2001 and Sigma-Plus SA in France in July 2001. We have since closed the operation in Germany and have lost certain key personnel acquired with Predict AG in Switzerland. In the future, we may acquire additional complementary companies or technologies. Managing these acquisitions has entailed, and may in the future entail, numerous operational and financial risks and strains, including  

• dilution of stockholders’ equity;  
  
  
• Difficulty and cost in combining the operations and personnel of acquired businesses with our operations and personnel;  
  
  
• disruption of our ongoing business and diversion of management’s time and attention to integrating or completing the development or commercialization of any acquired technologies;  
  
  
• impairment of relationships with key customers of acquired businesses due to changes in management and ownership of the acquired businesses;
  
  
• impairment of goodwill arising as a result of completed or future acquisitions, resulting in a financial loss; and  
  
  
• inability to retain key employees of any acquired businesses.

     If we do not successfully integrate any technologies, products, personnel or operations of companies that we may acquire in the future, our business will be harmed.  

Continued decreases in service revenues could decrease our total revenues or decrease our gross margins, which could cause a decrease in our stock price.  

     During 2003, our services revenues decreased 31% from the prior twelve-month period. Consulting and training (service) revenues represented 17% of our total revenues for the year ended December 31, 2003. Our service revenues may continue to decline in the near term, and our total revenue may fall as a result.

Our workforce reductions and financial performance may place additional strain on our resources and may harm the morale and performance of our personnel and our ability to hire new personnel.

     In connection with our effort to streamline our operations, reduce costs and bring our staffing and structure in line with our revenue base, we restructured our organization with reductions in our workforce by 23 employees in July 2003. Further reductions could occur if we are unable to grow our revenues. There have been and may continue to be substantial costs associated with the workforce reduction related to severance and other employee-related costs, and our restructuring plan may yield unanticipated consequences, such as attrition beyond our planned

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reduction in workforce. In addition, many of the employees who were terminated possessed specific knowledge or expertise, and that knowledge or expertise may prove to have been important to our operations. In that case, their absence may create significant difficulties. Past or future reductions in Research and Development could adversely affect our ability to innovate and compete. Further, the reduction in workforce may reduce employee morale and may create concern among potential and existing employees about job security at Insightful, which may lead to difficulty in hiring and increased turnover in our current workforce. In addition, this headcount reduction may subject us to the risk of litigation, which could result in substantial costs to us and could divert management’s time and attention away from business operations. Any further workforce reductions may significantly strain our operational and financial resources and may result in increasing responsibilities for each of our management personnel. As a result, our ability to respond to unexpected challenges may be impaired, and we may be unable to take advantage of new opportunities.

We may be unable to obtain the funding 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 market conditions worsen, 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 new 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 we may experience difficulty in obtaining funding 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.

World events and 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 the economic downturn, 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 retain our 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. 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. Our key employees are not obligated to continue their employment with us and could leave at any time.

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     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, 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/or 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 we, our competitors or major hardware, systems or software vendors introduce or announce new products or product enhancements.

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.  

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     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 $1.09 per share on May 19, 2003. 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;
  
  
• 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, Germany, 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.

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     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

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.

There were no significant changes in our internal controls during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal controls.

However, in the completion of our year–end audit, our independent auditors advised us that they observed deficiencies in the design or operation of our internal controls that, in their judgment, if not remedied could in the future 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 independent auditors observed the following issues:

• Due to an instance of employee theft we discovered in late 2003, our independent auditors have recommended that we review all significant process 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.
  
• Due to challenges that we faced during the completion of our 2003 financial statement close process, our independent auditors have recommended that we initiate a study of our financial close process, procedures and controls in order to enhance the quality, efficiency and timeliness of our financial statement preparation and to ensure proper identification and accounting treatment for our activities.
  

We continue to evaluate our operational, financial, and accounting systems and our managerial controls and procedures to address these issues and to determine what additional changes, if any, might help us to manage our current operations better.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

In December 2002, Wajih Alaiyan, a former Insightful employee, filed a complaint against the Company in the Superior Court for King County, Washington. Mr. Alaiyan alleges that his employment was wrongfully terminated, and he seeks an unspecified amount of damages. On December 5, 2003, a judge for the Superior Court for King County, Washington granted summary judgment in our favor and dismissed. Mr. Alaiyan has appealed the decision. 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 6. Exhibits and Reports on Form 8-K

     (a) See Index to Exhibits.

     (b) Reports filed on Form 8-K.

     On February 3, 2004 we filed a current report on From 8-K reporting our entering into an Assignment and License Agreement with Lucent Technologies, Inc., pursuant to which we acquired all of Lucent’s right, title and interest to Lucent’s “S” software.

     On February 18, 2004, we furnished a current report Form 8-K announcing the rescheduling of the announcement of financial results for the quarter and year ended December 31, 2004.

     On February 26, 2004, we furnished a current report Form 8-K announcing the rescheduling of the announcement of financial results for the quarter and year ended December 31, 2004.

     On March 4, 2004, we furnished a current report Form 8-K announcing our financial results for the quarter and year ended December 31, 2004.

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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.

May 17, 2004

May 17, 2004

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EXHIBIT INDEX

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