##### Table of Contents

---



SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



FORM 10-QSB/A

(Amendment No. 1)



|x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------



For the Quarterly Period ended September 30, 2005



OR



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



For the transition period from  to



Commission file number 0-020992



INSIGHTFUL CORPORATION

(Exact name of small business issuer as specified in its charter)



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



1700 Westlake Avenue
North, Suite 500, Seattle, Washington 98109-3044

(Address of principal executive offices) (Zip code)



(206) 283-8802

Issuers telephone number, including area code



Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 xNO ̈



Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ̈NO x



The number of shares outstanding of the
Issuers Common Stock, $0.01 par value, was 12,505,408 as of November 7, 2005.



Transitional Small Business Disclosure Format (Check one) YES ̈NO x



---







---

##### Table of Contents

EXPLANATORY NOTE



Insightful Corporation is filing this Amendment No. 1 to Quarterly Report on Form 10-QSB/A for the fiscal quarter ended September 30, 2005 solely to correct a
typographical error regarding the number of Insightfuls employees contained in Description of the Company in Item 2 of Part 1 of Insightfuls Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on
November 14, 2005.



The fourth paragraph under Description of the
Company should read in its entirety as follows:



Headquartered in
Seattle, Washington, we also have a North American office in North Carolina and international offices in France, Switzerland, and the United Kingdom, with distributors around the world. The following table illustrates the breakdown of our headcount
at September 30, 2005, which totaled 119 employees, 93 of which were located in the United States and 26 were located internationally:



|                           |  |    
|-------------------------- |  | ---
|Consulting Services        |  | 18 
|Technical Support          |  | 4  
|Sales and Marketing        |  | 36 
|Research and Development   |  | 40 
|General and Administrative |  | 21 
|                           |  |    
|Total                      |  | 119
|                           |  |    



Except for the correcting error noted
above, no other information is being amended by this Form 10-QSB/A. Insightful has not updated disclosures in this Form 10-QSB/A to reflect any event subsequent to Insightfuls filing of the original Form 10-QSB.



i



---

##### Table of Contents

TABLE OF CONTENTS



|                              |  |                                                                                                             |  |     
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                             |  | Page
|PART I. FINANCIAL INFORMATION |  |                                                                                                            
|                              |  |                                                                                                            
|ITEM 1.                       |  | Consolidated Financial Statements (Unaudited)                                                               |  |     
|                              |  |                                                                                                            
|                              |  | Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004                        |  | 3   
|                              |  |                                                                                                            
|                              |  | Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2005 and 2004 |  | 4   
|                              |  |                                                                                                            
|                              |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004       |  | 5   
|                              |  |                                                                                                            
|                              |  | Notes to Condensed Consolidated Financial Statements                                                        |  | 6   
|                              |  |                                                                                                            
|ITEM 2.                       |  | Managements Discussion and Analysis or Plan of Operations                                                  |  | 13  
|                              |  |                                                                                                            
|ITEM 3.                       |  | Controls and Procedures                                                                                     |  | 32  
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                            
|                              |  |                                                                                                            
|ITEM 1.                       |  | Legal Proceedings                                                                                           |  | 33  
|                              |  |                                                                                                            
|ITEM 6.                       |  | Exhibits                                                                                                    |  | 33  
|                              | 
|SIGNATURES                    |  | 34                                                                                                         
|                              | 
|EXHIBIT INDEX                 |  | 35                                                                                                         



2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM 1. | CONSOLIDATED FINANCIAL STATEMENTS
|------- | ---------------------------------



INSIGHTFUL CORPORATION AND SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)



|                                                                                                                    |  |                   |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                    |  | September 30,2005 |         |   | December 31,2004 |  
|                                                                                                                    |  | (unaudited)       |         |   |                  |  
|ASSETS                                                                                                              |  |                   |         |   |                  |   |         |  
|Current Assets:                                                                                                     |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                           |  | $                 | 9,650   |   |                  | $ | 9,650   |  
|Trade accounts receivable, net                                                                                      |  |                   | 3,020   |   |                  |   | 4,157   |  
|Short-term investments                                                                                              |  |                   | 632     |   |                  |   |        |  
|Other receivables                                                                                                   |  |                   | 553     |   |                  |   | 501     |  
|Prepaid expenses and other current assets                                                                           |  |                   | 495     |   |                  |   | 453     |  
|                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total current assets                                                                                                |  |                   | 14,350  |   |                  |   | 14,761  |  
|Property and equipment, net                                                                                         |  |                   | 912     |   |                  |   | 966     |  
|Purchased technology, net                                                                                           |  |                   | 785     |   |                  |   | 1,226   |  
|Goodwill                                                                                                            |  |                   | 800     |   |                  |   | 800     |  
|Other assets                                                                                                        |  |                   | 45      |   |                  |   | 60      |  
|                                                                                                                    |  |                   |         |   |                  |   |         |  
|                                                                                                                    |  | $                 | 16,892  |   |                  | $ | 17,813  |  
|                                                                                                                    |  |                   |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                |  |                   |         |   |                  |   |         |  
|Current Liabilities:                                                                                                |  |                   |         |   |                  |   |         |  
|Current portion of long-term debt                                                                                   |  | $                 | 65      |   |                  | $ | 129     |  
|Accounts payable                                                                                                    |  |                   | 555     |   |                  |   | 1,644   |  
|Accrued payroll-related liabilities                                                                                 |  |                   | 1,378   |   |                  |   | 1,358   |  
|Accrued expenses and other current liabilities                                                                      |  |                   | 397     |   |                  |   | 554     |  
|Deferred revenue                                                                                                    |  |                   | 5,499   |   |                  |   | 6,318   |  
|                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total current liabilities                                                                                           |  |                   | 7,894   |   |                  |   | 10,003  |  
|Long-term debt, less current portion                                                                                |  |                   |        |   |                  |   | 32      |  
|Commitments and contingencies                                                                                       |  |                   |         |   |                  |   |         |  
|Stockholders Equity:                                                                                               |  |                   |         |   |                  |   |         |  
|Preferred stock, $0.01 par value-                                                                                   |  |                   |         |   |                  |   |         |  
|Authorized - 1,000,000 shares                                                                                       |  |                   |         |   |                  |   |         |  
|Issued and outstanding-none                                                                                         |  |                   |        |   |                  |   |        |  
|Common stock, $0.01 par value-                                                                                      |  |                   |         |   |                  |   |         |  
|Authorized - 30,000,000 shares and 20,000,000 shares at September 30, 2005 and December 31, 2004, respectively      |  |                   |         |   |                  |   |         |  
|Issued and outstanding - 12,503,632 and 12,393,950 shares at September 30, 2005 and December 31, 2004, respectively |  |                   | 125     |   |                  |   | 124     |  
|Additional paid-in capital                                                                                          |  |                   | 36,531  |   |                  |   | 36,329  |  
|Accumulated deficit                                                                                                 |  |                   | (27,404 | ) |                  |   | (28,383 | )
|Other accumulated comprehensive loss                                                                                |  |                   | (254    | ) |                  |   | (292    | )
|                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                          |  |                   | 8,998   |   |                  |   | 7,778   |  
|                                                                                                                    |  |                   |         |   |                  |   |         |  
|                                                                                                                    |  | $                 | 16,892  |   |                  | $ | 17,813  |  
|                                                                                                                    |  |                   |         |   |                  |   |         |  



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



3



---

##### Table of Contents

INSIGHTFUL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(unaudited)



|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                 |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                 |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004   |  
|Revenues:                                        |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Software licenses                                |  | $                               | 2,227  |   |                                | $ | 2,164  |      |  | $ | 6,894  |   |  | $ | 6,183  |  
|Software maintenance                             |  |                                 | 1,681  |   |                                |   | 1,626  |      |  |   | 4,995  |   |  |   | 4,879  |  
|Professional services and other                  |  |                                 | 1,500  |   |                                |   | 979    |      |  |   | 3,887  |   |  |   | 2,519  |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total revenues                                   |  |                                 | 5,408  |   |                                |   | 4,769  |      |  |   | 15,776 |   |  |   | 13,581 |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Cost of revenues:                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Software related                                 |  |                                 | 538    |   |                                |   | 390    |      |  |   | 1,379  |   |  |   | 1,255  |  
|Professional services and other                  |  |                                 | 742    |   |                                |   | 526    |      |  |   | 2,177  |   |  |   | 1,634  |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenues                           |  |                                 | 1,280  |   |                                |   | 916    |      |  |   | 3,556  |   |  |   | 2,889  |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                     |  |                                 | 4,128  |   |                                |   | 3,853  |      |  |   | 12,220 |   |  |   | 10,692 |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Sales and marketing                              |  |                                 | 1,955  |   |                                |   | 1,678  |      |  |   | 5,855  |   |  |   | 4,830  |  
|Research and development                         |  |                                 | 1,407  |   |                                |   | 1,342  |      |  |   | 4,121  |   |  |   | 3,992  |  
|Less: Funded research                            |  |                                 | (533   | ) |                                |   | (650   | )    |  |   | (1,707 | ) |  |   | (2,439 | )
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Research and development, net                    |  |                                 | 874    |   |                                |   | 692    |      |  |   | 2,414  |   |  |   | 1,553  |  
|General and administrative                       |  |                                 | 1,074  |   |                                |   | 961    |      |  |   | 2,965  |   |  |   | 3,199  |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                         |  |                                 | 3,903  |   |                                |   | 3,331  |      |  |   | 11,234 |   |  |   | 9,582  |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Income from operations                           |  |                                 | 225    |   |                                |   | 522    |      |  |   | 986    |   |  |   | 1,110  |  
|Other income, net                                |  |                                 | 86     |   |                                |   | 90     |      |  |   | 19     |   |  |   | 55     |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Income before income taxes                       |  |                                 | 311    |   |                                |   | 612    |      |  |   | 1,005  |   |  |   | 1,165  |  
|Income tax expense                               |  |                                 |       |   |                                |   | 3      |      |  |   | 26     |   |  |   | 31     |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income                                       |  | $                               | 311    |   |                                | $ | 609    |      |  | $ | 979    |   |  | $ | 1,134  |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income per share                             |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic                                            |  | $                               | 0.02   |   |                                | $ | 0.05   |      |  | $ | 0.08   |   |  | $ | 0.09   |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Diluted                                          |  | $                               | 0.02   |   |                                | $ | 0.05   |      |  | $ | 0.07   |   |  | $ | 0.09   |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Weighted average common shares outstanding       |  |                                 | 12,494 |   |                                |   | 12,312 |      |  |   | 12,454 |   |  |   | 12,072 |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Weighted average common shares assuming dilution |  |                                 | 13,224 |   |                                |   | 12,572 |      |  |   | 13,123 |   |  |   | 12,768 |  
|                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  



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



4



---

##### Table of Contents

INSIGHTFUL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)



|                                                                                                                        |  |                                |        |   |      |   |        |  
|----------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                                                        |  | Nine Months EndedSeptember 30, |       
|                                                                                                                        |  | 2005                           |        |   | 2004 |  
|Operating activities:                                                                                                   |  |                                |        |   |      |   |        |  
|Net income                                                                                                              |  | $                              | 979    |   |      | $ | 1,134  |  
|Adjustments to reconcile net income from operations to net cash provided by (used in) operating activities:             |  |                                |        |   |      |   |        |  
|Depreciation, amortization and other non-cash charges                                                                   |  |                                | 885    |   |      |   | 1,059  |  
|Stock-based compensation                                                                                                |  |                                |       |   |      |   | 5      |  
|Changes in current assets and liabilities:                                                                              |  |                                |        |   |      |   |        |  
|Trade and other accounts receivable                                                                                     |  |                                | 903    |   |      |   | 13     |  
|Prepaid expenses and other assets                                                                                       |  |                                | (44    | ) |      |   | (63    | )
|Accounts payable                                                                                                        |  |                                | (558   | ) |      |   | (196   | )
|Accrued payroll-related liabilities and other accrued expenses                                                          |  |                                | (73    | ) |      |   | (856   | )
|Deferred revenue                                                                                                        |  |                                | (616   | ) |      |   | (82    | )
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Net cash provided by operating activities                                                                               |  |                                | 1,476  |   |      |   | 1,014  |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Investing activities:                                                                                                   |  |                                |        |   |      |   |        |  
|Purchases of short-term investments                                                                                     |  |                                | (632   | ) |      |   |       |  
|Purchases of property and equipment                                                                                     |  |                                | (418   | ) |      |   | (104   | )
|Payment made for purchase of technology                                                                                 |  |                                | (500   | ) |      |   | (1,265 | )
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Net cash used in investing activities                                                                                   |  |                                | (1,550 | ) |      |   | (1,369 | )
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Financing activities:                                                                                                   |  |                                |        |   |      |   |        |  
|Payments on debt                                                                                                        |  |                                | (97    | ) |      |   | (97    | )
|Proceeds from exercise of stock options and employee stock purchase plan                                                |  |                                | 203    |   |      |   | 1,861  |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Net cash provided by financing activities                                                                               |  |                                | 106    |   |      |   | 1,764  |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Effect of exchange rate changes on cash and cash equivalents                                                            |  |                                | (32    | ) |      |   | 20     |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Net increase in cash and cash equivalents                                                                               |  |                                |       |   |      |   | 1,429  |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, beginning of period                                                                          |  |                                | 9,650  |   |      |   | 7,139  |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                                                |  | $                              | 9,650  |   |      | $ | 8,568  |  
|                                                                                                                        |  |                                |        |   |      |   |        |  
|Supplemental disclosure of cash flow information:                                                                       |  |                                |        |   |      |   |        |  
|Cash paid for:                                                                                                          |  |                                |        |   |      |   |        |  
|Interest                                                                                                                |  | $                              | 2      |   |      | $ | 24     |  
|Income taxes (refund)                                                                                                   |  | $                              | 12     |   |      | $ | (1     | )
|Supplemental disclosure of non-cash investing information - portion of purchased technology accrued in accounts payable |  | $                              |       |   |      | $ | 500    |  



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



5



---

##### Table of Contents

INSIGHTFUL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

September 30,
2005



(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION



(a) Description of Business



Insightful provides enterprises with scalable data analysis solutions
designed to drive better decisions faster by revealing patterns, trends and relationships in data. Insightful is a supplier of software and services for the statistical data mining, business analytics, knowledge management, and information retrieval
industry segments enabling customers to gain intelligence from numerical data and text.



Insightfuls products include S-PLUS® and S-PLUS Server, Insightful Miner, InFact® and various S-PLUS toolkits for vertical market categories such as S+ArrayAnalyzer® for the life sciences sector and S+FinMetricsTMfor
the financial services sector. Insightfuls consulting services and training provide specialized expertise and processes for the design, development and deployment of analytical solutions.



Insightfuls customers include primarily companies in financial
services, pharmaceuticals, biotechnology, telecommunications and manufacturing, as well as government and research institutions.



Headquartered in Seattle, Washington, Insightful also has a North American office in North Carolina and international offices 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, 2004 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 consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2004 included in Insightfuls Annual Report on Form 10-K. The accompanying condensed consolidated financial statements reflect all
adjustments (consisting solely of normal, recurring adjustments), which, in the opinion of management, are necessary for a fair presentation of results for the interim periods presented. The results of operations for the three and nine month periods
ended September 30, 2005 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 No. 97-2 (SOP 97-2),
Software Revenue Recognition, as amended by SOP No. 98-9, Software Revenue Recognition, with Respect to Certain Transactions,as well as related interpretations including Technical Practice Aids.



Software license revenues consist principally of fees
generated from granting rights to use our software products under perpetual and fixed-term license agreements. The Company also refers to fixed-term license agreements as subscription-based license agreements.



6



---

##### Table of Contents

Perpetual software license fees are generally recognized upon delivery of the software after receipt of a
definitive purchase order, if collection of the resulting receivable is probable, the fee is fixed or determinable, and vendor-specific objective evidence (VSOE) of fair value exists for all undelivered elements if sold in a bundled
arrangement.



Revenues from fixed-term licenses are recognized
on a straight-line basis over the license term if all other aspects of SOP 97-2 are satisfied.



Revenues under arrangements that include several different software products and services sold together are allocated based on the residual method in accordance with SOP No. 98-9. Under the residual method, the
fair value of the undelivered non-essential elements is deferred and subsequently recognized when earned.



Insightful has established VSOE of fair value for professional services and training services. In addition, the Company has established VSOE for
maintenance related to most of its products. For software products sold with maintenance where VSOE for the maintenance element has not been established, such as InFact, 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.



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



Consulting revenues typically include
providing customers assistance in developing complex software models or data and text analysis techniques. In addition, they include deployment assistance, project management, integration with existing customer applications and related services
performed on a time-and-materials basis under separate service arrangements. Training consists of fee based courses offered on a per-attendee or a per-group rate. Revenues from consulting and training services are generally recognized as services
are performed.



Fees from licenses sold together with
consulting are generally recognized upon shipment of the software, provided that the above residual method criteria are met, payment of the license fees are not dependent upon the performance of the services, and the consulting services are not
essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees is dependent upon the performance of the services, both the software license and consulting
fees are recognized under the percentage of completion method of contract accounting. All sales made through indirect channels including value added resellers 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. An evaluation on the probability of collection is generally based upon the
assessment of the customers financial condition. For existing customers, this evaluation leverages a customers prior payment history. Insightful has an unconditional 30-day return policy on software license purchases, and therefore
provides for estimated returns at the time of sale based on historical experience.



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



(c) Stock-Based Compensation



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



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



7



---

##### Table of Contents

of the stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the
stock option.



In December 2004, the FASB reissued SFAS 123 as
SFAS No. 123R, Share Based Compensation. Under SFAS No. 123R, public entities will be required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value
of the award and recognize the cost over the period during which an employee is required to render services in exchange for the award. Additionally, SFAS No. 123R will require entities to record compensation expense for employee stock purchase
plans that may not have previously been considered compensatory under the existing rules. On April 14, 2005, the effective date of SFAS No. 123R was extended and will now be effective for the Company at the beginning of its 2006 fiscal
year. The Company has not yet determined the impact that adopting SFAS No. 123R will have on its results of operations, however, based on the FAS 123 footnote disclosures made in the current and prior financial statements, the Company expects
the impact to be material.



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



|                                                                               |  |                                 |      |                                |   |      |  |      |      |  |   |      
|------------------------------------------------------------------------------ |  | ------------------------------- | ---- | ------------------------------ | - | ---- |  | ---- | ---- |  | - | -----
|                                                                               |  | Three Months EndedSeptember 30, |      | Nine Months EndedSeptember 30,
|                                                                               |  | 2005                            |      | 2004                           |   | 2005 |  | 2004
|Net income, as reported                                                        |  | $                               | 311  |                                | $ | 609  |  | $    | 979  |  | $ | 1,134
|Employee stock-based compensation, as reported                                 |  |                                 |     |                                |   |     |  |      |     |  |   |     
|Less: Employee stock-based compensation determined under the fair value method |  |                                 | 273  |                                |   | 63   |  |      | 932  |  |   | 889  
|                                                                               |  |                                 |      |                                |   |      |  |      |      |  |   |      
|Pro forma net income (loss)                                                    |  | $                               | 38   |                                | $ | 546  |  | $    | 47   |  | $ | 245  
|                                                                               |  |                                 |      |                                |   |      |  |      |      |  |   |      
|Net income per share, as reported                                              |  |                                 |      |                                |   |      |  |      |      |  |   |      
|Basic                                                                          |  | $                               | 0.02 |                                | $ | 0.05 |  | $    | 0.08 |  | $ | 0.09 
|Diluted                                                                        |  | $                               | 0.02 |                                | $ | 0.05 |  | $    | 0.07 |  | $ | 0.09 
|Pro forma net income (loss) per share                                          |  |                                 |      |                                |   |      |  |      |      |  |   |      
|Basic                                                                          |  | $                               | 0.00 |                                | $ | 0.04 |  | $    | 0.00 |  | $ | 0.02 
|Diluted                                                                        |  | $                               | 0.00 |                                | $ | 0.04 |  | $    | 0.00 |  | $ | 0.02 



(3) PURCHASED TECHNOLOGY



In January 2004, the Company acquired title to the
software code underlying the S programming language from Lucent Technologies Inc. for $2.0 million. The $2.0 million purchase price included settlement in full for all royalties owed by the Company to Lucent at the date of the
acquisition in the amount of $235,000. As a result of this transaction, $1,765,000 was capitalized as purchased technology. This amount is being amortized to cost of revenues - software related over a 3-year estimated life. During each of the three
months ended September 30, 2005 and 2004, the Company recorded $147,000 in amortization expense related to this technology. Amortization recorded for the nine months ended September 30, 2005 and 2004 was approximately $441,000 and
$392,000, respectively. Under the agreement, $1,500,000 of the purchase price was paid in the first quarter of 2004; the remaining $500,000 was paid in the first quarter of 2005.



(4) FINANCING ARRANGEMENTS



In March 2005, the Company renewed a working capital revolving line of credit and security agreement with Silicon Valley Bank. The terms provide for up to
$3.0 million in borrowing availability through March 25, 2006. This facility is secured by the Companys accounts receivable and allows it to borrow up to the lesser of 75% of its eligible accounts receivable or $3.0 million and bears
interest at the prime rate plus 1%. At September 30, 2005, the prime rate was 6.75%, and no amounts had been borrowed under the line of credit facility.



At September 30, 2005, the Company also had an outstanding balance on an equipment loan with Silicon Valley Bank, secured by underlying assets. The
Company borrowed $450,000 under this facility in 2002 and the remaining outstanding balance was



8



---

##### Table of Contents

approximately $65,000 at September 30, 2005. This loan bears interest at the prime rate plus 1% and is being repaid over a 42-month period, ending in
March 2006.



These credit facilities contain covenants that
limit the Companys net losses and restrict the amount of capital expenditures not financed through the equipment term loan. In addition, the Company is prohibited under these facilities from paying dividends. The Company was in compliance with
these covenants as of September 30, 2005.



Future
maturities of debt as of September 30, 2005 are $33,000 before December 31, 2005 and $32,000 for the year ending December 31, 2006.



(5) NET INCOME PER SHARE



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



|                                                                        |  |                                 |  |                                |  |        |  |       
|----------------------------------------------------------------------- |  | ------------------------------- |  | ------------------------------ |  | ------ |  | ------
|                                                                        |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                                                                        |  | 2005                            |  | 2004                           |  | 2005   |  | 2004  
|Shares used in basic net income per share computation                   |  | 12,494                          |  | 12,312                         |  | 12,454 |  | 12,072
|Effect of dilutive potential common shares resulting from stock options |  | 730                             |  | 260                            |  | 669    |  | 696   
|                                                                        |  |                                 |  |                                |  |        |  |       
|Shares used in diluted net income per share computation                 |  | 13,224                          |  | 12,572                         |  | 13,123 |  | 12,768
|                                                                        |  |                                 |  |                                |  |        |  |       



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



The Company excludes all potentially dilutive securities from its diluted net
income per share computation when their effect would be anti-dilutive. The following common stock equivalents were excluded from the earnings per share computation because the exercise prices of the stock options and rights were greater than or
equal to the average price of the common shares, and therefore their inclusion would have been anti-dilutive (in thousands):



|                                                                         |  |                                 |  |                                |  |      |  |     
|------------------------------------------------------------------------ |  | ------------------------------- |  | ------------------------------ |  | ---- |  | ----
|                                                                         |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                                                                         |  | 2005                            |  | 2004                           |  | 2005 |  | 2004
|Stock options excluded from the computation of diluted net income (loss) |  | 375                             |  | 1,431                          |  | 396  |  | 554 



(6) OTHER COMPREHENSIVE INCOME



SFAS No. 130, Reporting Comprehensive
Income, establishes standards for reporting and display of comprehensive income and its components in the financial statements. As of September 30, 2005, comprehensive income includes foreign currency translation adjustments, and
unrealized losses on short-term investments in marketable securities. Total comprehensive income is as follows (in thousands):



|                                                                     |  |                                 |     |   |                                |   |     |      |  |   |       |   |  |   |       |  
|-------------------------------------------------------------------- |  | ------------------------------- | --- | - | ------------------------------ | - | --- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                     |  | Three Months EndedSeptember 30, |     |   | Nine Months EndedSeptember 30, |  
|                                                                     |  | 2005                            |     |   | 2004                           |   |     | 2005 |  |   | 2004  |  
|Net income                                                           |  | $                               | 311 |   |                                | $ | 609 |      |  | $ | 979   |   |  | $ | 1,134 |  
|Change in cumulative translation adjustment                          |  |                                 | (2  | ) |                                |   | (44 | )    |  |   | 39    |   |  |   | (3    | )
|Unrealized losses on short term investments in marketable securities |  |                                 | (1  | ) |                                |   |    |      |  |   | (1    | ) |  |   |      |  
|                                                                     |  |                                 |     |   |                                |   |     |      |  |   |       |   |  |   |       |  
|Comprehensive income                                                 |  | $                               | 308 |   |                                | $ | 565 |      |  | $ | 1,017 |   |  | $ | 1,131 |  
|                                                                     |  |                                 |     |   |                                |   |     |      |  |   |       |   |  |   |       |  



9



---

##### Table of Contents

(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. Business segment information includes the segments of North American Data Analysis,
International Data Analysis and Text Analysis. The Company measures segment performance based on their revenues and contribution margin, which is a measure of profitability that allocates only direct and controllable costs to a segment. Depreciation
expense is not allocated by segment. Assets are not allocated to segments for internal reporting presentations. Intercompany transactions have been eliminated from the segment information. Non-operating income and expenses are not tracked by
segment. Segment information is provided below (in thousands):



|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|------------------------------------- |  | -------------------------- | ----- | ------------------------- | - | ------------- |  | - | ----- | - |  | - | ------ | -
|                                      |  | NorthAmericanData Analysis |       | InternationalDataAnalysis |   | Text Analysis |  |   | Total |  
|Three months ended September 30, 2005 |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Revenues                              |  | $                          | 2,939 |                           | $ | 2,064         |  | $ | 405   |   |  | $ | 5,408  |  
|Contribution margin                   |  |                            | 1,373 |                           |   | 599           |  |   | 65    |   |  |   | 2,037  |  
|Unallocated costs and expenses        |  |                            |       |                           |   |               |  |   |       |   |  |   | (1,812 | )
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Income from operations                |  |                            |       |                           |   |               |  |   |       |   |  | $ | 225    |  
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Three months ended September 30, 2004 |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Revenues                              |  | $                          | 2,947 |                           | $ | 1,542         |  | $ | 280   |   |  | $ | 4,769  |  
|Contribution margin                   |  |                            | 1,608 |                           |   | 628           |  |   | (49   | ) |  |   | 2,187  |  
|Unallocated costs and expenses        |  |                            |       |                           |   |               |  |   |       |   |  |   | (1,665 | )
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Income from operations                |  |                            |       |                           |   |               |  |   |       |   |  | $ | 522    |  
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|                                      |  |                            |       |                          
|                                      |  | NorthAmericanData Analysis |       | InternationalDataAnalysis |   | Text Analysis |  |   | Total |  
|Nine months ended September 30, 2005  |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Revenues                              |  | $                          | 8,571 |                           | $ | 5,973         |  | $ | 1,232 |   |  | $ | 15,776 |  
|Contribution margin                   |  |                            | 4,027 |                           |   | 2,013         |  |   | 315   |   |  |   | 6,355  |  
|Unallocated costs and expenses        |  |                            |       |                           |   |               |  |   |       |   |  |   | (5,369 | )
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Income from operations                |  |                            |       |                           |   |               |  |   |       |   |  | $ | 986    |  
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Nine months ended September 30, 2004  |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Revenues                              |  | $                          | 8,499 |                           | $ | 4,490         |  | $ | 592   |   |  | $ | 13,581 |  
|Contribution margin                   |  |                            | 3,541 |                           |   | 1,619         |  |   | (68   | ) |  |   | 5,092  |  
|Unallocated costs and expenses        |  |                            |       |                           |   |               |  |   |       |   |  |   | (3,982 | )
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  
|Income from operations                |  |                            |       |                           |   |               |  |   |       |   |  | $ | 1,110  |  
|                                      |  |                            |       |                           |   |               |  |   |       |   |  |   |        |  



(8) BUSINESS RESTRUCTURING



On September 30, 2003, Shawn Javid, President and
Chief Executive Officer, resigned from the Company. Termination benefits associated with the resignation of Mr. Javid were included in restructuring expenses recorded in 2003. During the first and second



10



---

##### Table of Contents

quarters of 2005, the Company paid $52,000 and $60,000, respectively, associated with Mr. Javids termination benefits. As of September 30,
2005, no termination benefits remained to be paid. No additional expenses are expected to be incurred in connection with the 2003 restructuring or Mr. Javids termination.



(9) COMMITMENTS AND CONTINGENCIES



In certain of its licensing agreements, the Company provides intellectual property infringement indemnifications. These indemnifications are excluded from
the initial recognition and measurement requirements of FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others. The Companys
policy is to record any obligation under such indemnification when a required payment under such indemnification is probable and the amount of the future loss is estimable. At September 30, 2005, 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.



On December 13, 2002, Wajih Alaiyan, a former employee, filed a complaint against the Company in the Superior Court for King County, Washington.
Mr. Alaiyan alleged that his employment was wrongfully terminated. On December 5, 2003, the court granted summary judgment in the Companys favor, dismissing the complaint. On June 13, 2005, the Court of Appeals for the State of
Washington issued an unpublished opinion upholding the lower courts decision. On July 12, 2005, Mr. Alaiyan filed a petition with the Supreme Court of Washington seeking review of the Court of Appeals decision. If this petition
is granted and the Court of Appeals decision is modified or reversed, the Company will likely resume litigation in the lower court, where it expects to continue to vigorously defend itself against the former employees claim, which the
Company denies. The Company is unable to evaluate the likelihood of an adverse outcome.



(10) REVENUE CONCENTRATION



For the three
months ended September 30, 2005, the Company earned revenue of $709,000, or 13% of its total revenues, from a single customer. No customer accounted for 10% or more of revenues for the nine months ended September 30, 2005, or for the three
and nine-month periods ended September 30, 2004.



(11) MARKETABLE
SECURITIES



By policy, the Company invests primarily in
high-grade marketable securities, whereby the maximum maturity for any single issue shall not exceed 18 months, and the average maturity of the total portfolio of marketable securities shall not exceed 6 months. The Companys marketable
securities are accounted for under the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS 115, all of the Companys marketable securities are defined as available-for-sale
securities and, accordingly, they are accounted for at fair value with any unrealized gains and losses reported in stockholders equity as other comprehensive income. Realized net gains and losses on sales and maturities of marketable
securities are included in the consolidated statement of income as other income. Additionally, marketable securities having maturities of 90 days or less are classified as cash and cash equivalents, and those having maturities greater than 90 days
are classified as short-term investments. As of September 30, 2005, the companys total marketable securities were $5.9 million, of which $0.6 million were classified as short-term investments. Additionally, as of September 30, 2005,
all marketable securities had a maturity of less than one year.



11



---

##### Table of Contents

The following table identifies the fair values of the Companys marketable securities, and the
associated unrealized gains and losses, as of December 31, 2004 and September 30, 2005:



|                                  |  |             |       |                      |   |                       |  |   |    |  
|--------------------------------- |  | ----------- | ----- | -------------------- | - | --------------------- |  | - | -- | -
|                                  |  | MarketValue |       | GrossUnrealizedGains |   | GrossUnrealizedLosses | 
|Balance at December 31, 2004      |  |             |       |                      |   |                       |  |   |    |  
|Corporate debt securities         |  | $           |      |                      | $ |                      |  | $ |   |  
|Government and agency obligations |  |             |      |                      |   |                      |  |   |   |  
|                                  |  | $           |      |                      | $ |                      |  | $ |   |  
|Balance at September 30, 2005     |  |             |       |                      |   |                       |  |   |    |  
|Corporate debt securities         |  | $           | 5,070 |                      | $ |                      |  | $ | (1 | )
|Government and agency obligations |  |             | 826   |                      |   |                      |  |   |   |  
|                                  |  | $           | 5,896 |                      | $ |                      |  | $ | (1 | )



Gross unrealized
losses on marketable securities are due to market price movements. The Company has the ability to hold these investments to maturity and does not believe that any of the unrealized losses represented an other-than-temporary impairment as of
September 30, 2005.



The following table outlines the
proceeds received from the maturities of all marketable securities, and the associated zero realized gains and losses, for the three and nine months ended September 30, 2005:



|                                              |  |                                  |        |                    |   |                     |  |   |  
|--------------------------------------------- |  | -------------------------------- | ------ | ------------------ | - | ------------------- |  | - | -
|                                              |  | ProceedsFrom Sales andMaturities |        | GrossRealizedGains |   | GrossRealizedLosses
|For the three months ended September 30, 2005 |  |                                  |        |                    |   |                     |  |   |  
|Corporate debt securities                     |  | $                                |       |                    | $ |                    |  | $ | 
|Government and agency obligations             |  |                                  |       |                    |   |                    |  |   | 
|                                              |  | $                                |       |                    | $ |                    |  | $ | 
|For the nine months ended September 30, 2005  |  |                                  |        |                    |   |                     |  |   |  
|Corporate debt securities                     |  | $                                | 7,400  |                    | $ |                    |  | $ | 
|Government and agency obligations             |  |                                  | 2,850  |                    |   |                    |  |   | 
|                                              |  | $                                | 10,250 |                    | $ |                    |  | $ | 



12



---

##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
|------- | ----------------------------------------------------------



The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements included elsewhere in this report.



Forward-Looking Statements



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



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



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



| |  |  | statements about expected future trends for sales of our products and services;
| | - |  | -------------------------------------------------------------------------------



| |  |  | statements about the long-term potential of the data analysis market;
| | - |  | ---------------------------------------------------------------------



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



| |  |  | information about the anticipated release dates of new products;
| | - |  | ----------------------------------------------------------------



| |  |  | other statements about our plans, objectives, expectations and intentions; and
| | - |  | ------------------------------------------------------------------------------



| |  |  | other statements that are not historical facts.
| | - |  | -----------------------------------------------



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



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



Description of the Company



We provide enterprises with scalable data analysis solutions designed to drive better decisions faster by revealing patterns, trends and relationships
in data. We are 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.



Our products include S-PLUS® and S-PLUS Server, Insightful Miner, InFact® and various S-PLUS toolkits for vertical market categories such as
S+ArrayAnalyzer® for the life sciences sector and
S+FinMetrics for the financial services sector. Our consulting services and training provide specialized expertise and processes for the design, development and deployment of analytical solutions.



Our customers include primarily companies in financial services,
pharmaceuticals, biotechnology, telecommunications and manufacturing, as well as government and research institutions.



13



---

##### Table of Contents

Headquartered in Seattle, Washington, we also have a North American office in North Carolina and
international offices in France, Switzerland, and the United Kingdom, with distributors around the world. The following table illustrates the breakdown of our headcount at September 30, 2005, which totaled 119 employees, 93 of which were
located in the United States and 26 were located internationally:



|                           |  |    
|-------------------------- |  | ---
|Consulting Services        |  | 18 
|Technical Support          |  | 4  
|Sales and Marketing        |  | 36 
|Research and Development   |  | 40 
|General and Administrative |  | 21 
|                           |  |    
|Total                      |  | 119
|                           |  |    



We originally
incorporated in Massachusetts in 1984 as Mathsoft, Inc. 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



Software licenses for our Data Analysis products are
typically sold as perpetual software license grants. The revenues generated from perpetual software license grants are generally recognized upon delivery of the software, if all other aspects of Statement of Position No. 97-2 (SOP
97-2), Software Revenue Recognition, as amended by SOP No. 98-9, have been satisfied at the time of delivery of the software.



In the instances where our Data Analysis software products are sold under fixed-term license grants (also known as subscription-based grants), the related
software license revenue is typically recognized ratably over the term of the license grant.



See Note 2 of the condensed consolidated financial statements for a more thorough description of our revenue recognition policy.



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 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 scalable data analysis workbench for predictive modeling, data mining and statistical data analysis. It has a drag-and-drop interface intended to make it easy to create self-documenting visual workmaps. Insightful
Miner provides data miners, business analysts and data analysis professionals with a suite of scalable components for data access, management and modeling, and its pipeline architecture is designed to allow the user to process 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 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 subscription-based agreements.



Toolkits for Vertical Markets



To complement S-PLUS and Insightful Miner, we offer toolkits for the
financial services and life sciences markets to allow users to perform specialized data analysis. For example, S+FinMetrics is designed to provide the financial services market with comprehensive software for modeling, analyzing and
visualizing financial market data, offering a modern and flexible analytic environment for reliable and robust predictive econometric modeling. S+ArrayAnalyzer® is designed to enable pharmaceutical companies to obtain statistically rigorous information from microarray technology,
shortening time-to-discovery for competitive advantage.



14



---

##### Table of Contents

Server Products



Our S-PLUS Server products are designed to 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 designed to be data warehouse-independent and integrate with standard database and
file formats. With our server products, 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 Web browser interface or
dedicated graphical user interfaces written using Java® technology. Our server products are designed to enable end-users to analyze and understand technical or business information without requiring expertise in statistics or statistical tools.



Text Analysis Products



Software licenses for our Text Analysis product are typically sold as
fixed-term software license grants (also known as subscription-based grants). Revenue from fixed-term software license grants are generally recognized ratably on a straight-line basis over the term of the software license grant, if all other aspects
of SOP 97-2 have been satisfied.



We have not yet established
Vendor Specific Objective Evidence (VSOE) of fair value on the software maintenance element of our Text Analysis software sales arrangements, and therefore, when Text Analysis products are sold under perpetual software license grants,
the related software license revenues are generally recognized ratably on a straight-line basis over the term of the initial software maintenance agreement, if all other aspects of SOP 97-2 have been satisfied. If and when we develop a substantive
history of selling Text Analysis products as perpetual license grants, and if, through these sales, we develop consistent objective pricing on the related software maintenance renewals, then VSOE may become established. If this occurs, we may then
be required to recognize the revenue related to the software license upon delivery of the software, if all other aspects of SOP 97-2 have been satisfied.



See Note 2 of the condensed consolidated financial statements for a more thorough description of our revenue recognition policy.



InFact®



We launched our text analysis and search product, InFact, in April 2002 to provide text analysis and relationship search 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
tabular exploratory search interfaces and text query language to efficiently uncover information for which they are searching. InFact is designed to enable researchers to experience higher levels of productivity, and to improve the quality of their
research. InFact has been initially targeted at the defense/intelligence and pharmaceutical markets.



Maintenance and Support



We provide product updates and unspecified product upgrades and customer support services under an annual maintenance agreement, and are included as part of our annual subscription-based licenses. The initial one-year
maintenance contract is bundled into the license fees on most of our perpetual license agreements.



Technical support for our products is provided by a staff of engineers located in Seattle and other direct offices in Europe. Support is only available to
customers who purchase our annual maintenance service. International customers who purchase products from distributors may receive first-line technical support from their respective local distributors, with further support and escalation provided by
our direct offices.



Services



Our consulting and training organization provides fee-based services,
including providing assistance in developing complex statistical models or data or text analysis techniques. These services also include 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s 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



15



---

##### Table of Contents

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



Revenue Recognition



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



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



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



Sales Returns



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



Bad Debts



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



Impairment of Goodwill and Other Long
Lived Assets



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



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



Contingencies



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



16



---

##### Table of Contents

Results of Operations for the Three and Nine Months Ended September 30, 2005 and 2004



Revenues by Type



|                                           |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  
|------------------------------------------ |  | ------------------------------- | ----- | - | --------------- | - | ----- | ------------------------------ | ---- | -- | --------------- | ---- | - | ------ | - |  | - | ------ | - |  | -- | -
|                                           |  | Three Months EndedSeptember 30, |       |   | PercentIncrease |   |       | Nine Months EndedSeptember 30, |      |    | PercentIncrease |     
|                                           |  | 2005                            |       |   | 2004            |   |       |                                | 2005 |    |                 | 2004 |   |       
|Revenues (in thousands):                   |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  
|Software licenses                          |  | $                               | 2,227 |   |                 | $ | 2,164 |                                |      | 3  | %               |      | $ | 6,894  |   |  | $ | 6,183  |   |  | 12 | %
|Software maintenance                       |  |                                 | 1,681 |   |                 |   | 1,626 |                                |      | 3  | %               |      |   | 4,995  |   |  |   | 4,879  |   |  | 2  | %
|Professional services and other            |  |                                 | 1,500 |   |                 |   | 979   |                                |      | 53 | %               |      |   | 3,887  |   |  |   | 2,519  |   |  | 54 | %
|                                           |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  
|Total                                      |  | $                               | 5,408 |   |                 | $ | 4,769 |                                |      | 13 | %               |      | $ | 15,776 |   |  | $ | 13,581 |   |  | 16 | %
|                                           |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  
|Revenues by type (as % of total revenues): |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  
|Software licenses                          |  |                                 | 41    | % |                 |   | 45    | %                              |      |    |                 |      |   | 43     | % |  |   | 45     | % |  |    |  
|Software maintenance                       |  |                                 | 31    | % |                 |   | 34    | %                              |      |    |                 |      |   | 32     | % |  |   | 36     | % |  |    |  
|Professional services and other            |  |                                 | 28    | % |                 |   | 21    | %                              |      |    |                 |      |   | 25     | % |  |   | 19     | % |  |    |  
|                                           |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  
|Total                                      |  |                                 | 100   | % |                 |   | 100   | %                              |      |    |                 |      |   | 100    | % |  |   | 100    | % |  |    |  
|                                           |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |    |  



Software license
revenues consist principally of fees generated from granting rights to use our Data and Text Analysis software products under both perpetual and fixed-term license agreements. Total software license revenues increased during the three and nine
months ended September 30, 2005, as compared to the corresponding periods of 2004. The increase in license revenue for the nine months ended September 30, 2005, as compared to the corresponding period of 2004, was due to increased sales
from both our Data and Text Analysis product offerings. The increase in Data Analysis revenues during this nine-month period was primarily due to a large license sale in Europe during the first quarter of 2005. Data Analysis license revenues during
the three months ended September 30, 2005, as compared to the corresponding period of 2004, were flat. Text Analysis license revenue increased during the three and nine months ended September 30, 2005, as compared to the corresponding
periods of 2004, as a result of ongoing additions to the Text Analysis license base, which is primarily fixed-term in nature, and therefore, because we have been generally successful in renewing most of our Text Analysis license agreements, revenues
from this base have incrementally added to previously established revenue streams, thereby increasing the total revenues realized quarter over quarter. If we are unable to maintain our current level of pricing or renewals for our Text Analysis
products, future revenue streams generated by our Text Analysis products may decrease.



Software maintenance is generally included with the initial purchase of products under perpetual licenses, and the related revenue is typically recognized as maintenance revenue ratably over the initial contractual
maintenance period, which is generally one year following the initial product sale. Software maintenance revenues increased by 3% and 2% for the three and nine months ended September 30, 2005, respectively, as compared to the corresponding
periods of 2004. These increases were due to an increase in our list pricing that occurred in the beginning of the second quarter of 2005, as well as a slight increase in the renewal rates for Data Analysis software maintenance. If we are unable to
maintain our current level of renewals for our Data Analysis products, then future maintenance revenue streams generated by our Data Analysis products may decrease.



Professional services revenue is generated from consulting and training activities. The increase in total professional
services and other revenues for the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004, was primarily attributable to a large International Data Analysis consulting project that was initiated and
performed through the first three quarters of 2005. Professional services revenues from this project were approximately $0.7 million and $1.3 million for the three and nine months ended September 30, 2005, respectively. North American Data
Analysis professional services revenue decreased by $0.1 million (or 15%) for the three months ended September 30, 2005, and increased by $0.1 million (or 5%) for the nine months ended September 30, 2005, when compared to the corresponding
periods of 2004. These changes in North American Data Analysis professional services revenues were a result of resource allocation management, whereby revenue generating North American Data Analysis resources were diverted to Europe to work on the
aforementioned large International Data Analysis consulting project initiated and performed through the first three quarters of 2005. North American Text Analysis professional services revenue increased by $0.03 million (or 28%) for the three months
ended September 30, 2005, and increased by $0.2 million (or 215%) for the nine months ended September 30, 2005, when compared to the corresponding periods of 2004. These increases were a result of work performed for a new commercial
customer for Text Analysis.



17



---

##### Table of Contents

Revenues by Segment



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



|                                   |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  
|---------------------------------- |  | ------------------------------- | ----- | - | --------------- | - | ----- | ------------------------------ | ---- | -- | --------------- | ---- | - | ------ | - |  | - | ------ | - |  | --- | -
|                                   |  | Three Months EndedSeptember 30, |       |   | PercentIncrease |   |       | Nine Months EndedSeptember 30, |      |    | PercentIncrease |     
|                                   |  | 2005                            |       |   | 2004            |   |       |                                | 2005 |    |                 | 2004 |   |       
|Revenues (in thousands):           |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  
|North American Data Analysis       |  | $                               | 2,939 |   |                 | $ | 2,947 |                                |      | 0  | %               |      | $ | 8,571  |   |  | $ | 8,499  |   |  | 1   | %
|International Data Analysis        |  |                                 | 2,064 |   |                 |   | 1,542 |                                |      | 34 | %               |      |   | 5,973  |   |  |   | 4,490  |   |  | 33  | %
|Text Analysis                      |  |                                 | 405   |   |                 |   | 280   |                                |      | 45 | %               |      |   | 1,232  |   |  |   | 592    |   |  | 108 | %
|                                   |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  
|Total                              |  | $                               | 5,408 |   |                 | $ | 4,769 |                                |      | 13 | %               |      | $ | 15,776 |   |  | $ | 13,581 |   |  | 16  | %
|                                   |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  
|Revenues (as % of total revenues): |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  
|North American Data Analysis       |  |                                 | 54    | % |                 |   | 62    | %                              |      |    |                 |      |   | 54     | % |  |   | 63     | % |  |     |  
|International Data Analysis        |  |                                 | 38    | % |                 |   | 32    | %                              |      |    |                 |      |   | 38     | % |  |   | 33     | % |  |     |  
|Text Analysis                      |  |                                 | 8     | % |                 |   | 6     | %                              |      |    |                 |      |   | 8      | % |  |   | 4      | % |  |     |  
|                                   |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  
|Total                              |  |                                 | 100   | % |                 |   | 100   | %                              |      |    |                 |      |   | 100    | % |  |   | 100    | % |  |     |  
|                                   |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |        |   |  |   |        |   |  |     |  



The slight decrease in
total North American Data Analysis revenues for the three months ended September 30, 2005, as compared to the corresponding period of 2004, is due primarily to a $0.1 million decrease in professional services revenue, partially offset by
increases in both software license and maintenance revenues. The slight increase in North American Data Analysis revenues for the nine months ended September 30, 2005, as compared to the corresponding period of 2004, is due primarily to a
combined increase of $0.1 million in professional services and software maintenance revenue, which was slightly offset by a small decrease in software license revenue.



The increase in International Data Analysis revenues for the three and nine months ended September 30, 2005, as
compared to the corresponding periods of 2004, is primarily attributable to revenues generated from the large European consulting engagement mentioned previously. Total revenues from this customer, which include license, maintenance, and
professional services revenues, were $0.7 million and $1.5 million for the three and nine months ended September 30, 2005, respectively.



The increase in total Text Analysis revenues recognized for the three and nine months ended September 30, 2005, as compared to the corresponding
periods of 2004, relates largely to increases in subscription license revenues, which are recognized ratably over the subscription period, generally one year. Bookings of InFact subscription (fixed-term) licenses during the three and nine months
ended September 30, 2005 were greater than bookings in the corresponding periods of 2004, thereby resulting in increased revenues in the 2005 periods reported, which included the addition of our first two new commercial customers for Text
Analysis.



Cost of Revenues



|                                                                                                    |  |                                 |       |   |                 |   |     |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  
|--------------------------------------------------------------------------------------------------- |  | ------------------------------- | ----- | - | --------------- | - | --- | ------------------------------ | ---- | -- | --------------- | ---- | - | ----- | - |  | - | ----- | - |  | -- | -
|                                                                                                    |  | Three Months EndedSeptember 30, |       |   | PercentIncrease |   |     | Nine Months EndedSeptember 30, |      |    | PercentIncrease |     
|                                                                                                    |  | 2005                            |       |   | 2004            |   |     |                                | 2005 |    |                 | 2004 |   |      
|Cost of revenues (in thousands):                                                                    |  |                                 |       |   |                 |   |     |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  
|Software-related                                                                                    |  | $                               | 538   |   |                 | $ | 390 |                                |      | 38 | %               |      | $ | 1,379 |   |  | $ | 1,255 |   |  | 10 | %
|Professional services and other                                                                     |  |                                 | 742   |   |                 |   | 526 |                                |      | 41 | %               |      |   | 2,177 |   |  |   | 1,634 |   |  | 33 | %
|                                                                                                    |  |                                 |       |   |                 |   |     |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  
|Total                                                                                               |  | $                               | 1,280 |   |                 | $ | 916 |                                |      | 40 | %               |      | $ | 3,556 |   |  | $ | 2,889 |   |  | 23 | %
|                                                                                                    |  |                                 |       |   |                 |   |     |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  
|Cost of software related revenues as a % of software related revenues                               |  |                                 | 14    | % |                 |   | 10  | %                              |      |    |                 |      |   | 12    | % |  |   | 11    | % |  |    |  
|Cost of professional services and other revenues as a % of professional services and other revenues |  |                                 | 49    | % |                 |   | 54  | %                              |      |    |                 |      |   | 56    | % |  |   | 65    | % |  |    |  
|                                                                                                    |  |                                 |       |   |                 |   |     |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  
|Total                                                                                               |  |                                 | 24    | % |                 |   | 19  | %                              |      |    |                 |      |   | 23    | % |  |   | 21    | % |  |    |  
|                                                                                                    |  |                                 |       |   |                 |   |     |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  



18



---

##### Table of Contents

Cost of software-related revenues consists of royalties for third-party software, product media, product
duplication, manuals and maintenance and technical support costs, and amortization of the costs of the software code underlying the S programming language purchased from Lucent Technologies Inc.



The costs directly related to software revenues increased, both on an
absolute dollar and percentage basis, for both the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004. These increases were largely due to increased upgrade costs relating to the recent release of
version 7.0 of the S-PLUS product, as well as adjustments made to inventory balances during the quarter ended September 30, 2005, which included the write-off of inventory deemed obsolete due to the new product release. Cost of software-related
revenues fluctuates from period to period depending on the mix and level of revenues and depending on whether a particular quarter includes the cost of a license upgrade to existing maintenance customers. Significant components of software-related
costs of revenues are fixed, including amortization of the software code purchased from Lucent and costs associated with technical support.



Cost of professional services and other revenues consist primarily of salaries and other labor-related costs of employees or contractors who provide
consulting services and training. The increase in cost of professional services and other revenues for the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004, is due primarily to increases in the
number and size of revenue-generating consulting projects, the resulting increase in headcount needed to support these revenue-generating projects, various discretionary compensation paid to quota-exceeding consultants, and the redeployment of team
members from both our Text Analysis and research and development teams (who were previously utilized primarily for government grant-funded research projects) to revenue-generating professional services engagements. Additionally, although the total
costs of professional services and other revenues increased for the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004, the costs of professional services and other revenues as a percentage of
professional services revenues decreased for the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004. This decrease was primarily due to improved utilization of consulting resources, which
improvements were aided by an increase in the number and size of revenue-generating consulting projects that utilized available consulting resources.



Cost of professional services and other revenues are predominantly made up of headcount-related costs, which are relatively fixed in the short-term.
Consequently, these costs can fluctuate from quarter to quarter, in both absolute dollars and as a percentage of revenues, based primarily on the utilization levels of our consultants and the profitability of our consulting contracts.



Operating Expenses



Sales and Marketing



|                                                               |  |                                 |       |   |                 |   |       |                                |      |    |                 |      |   |       |   |  |   |       |   |  |    |  
|-------------------------------------------------------------- |  | ------------------------------- | ----- | - | --------------- | - | ----- | ------------------------------ | ---- | -- | --------------- | ---- | - | ----- | - |  | - | ----- | - |  | -- | -
|                                                               |  | Three Months EndedSeptember 30, |       |   | PercentIncrease |   |       | Nine Months EndedSeptember 30, |      |    | PercentIncrease |     
|                                                               |  | 2005                            |       |   | 2004            |   |       |                                | 2005 |    |                 | 2004 |   |      
|Sales and marketing expenses (in thousands)                    |  | $                               | 1,955 |   |                 | $ | 1,678 |                                |      | 17 | %               |      | $ | 5,855 |   |  | $ | 4,830 |   |  | 21 | %
|Sales and marketing expenses (as percentage of total revenues) |  |                                 | 36    | % |                 |   | 35    | %                              |      |    |                 |      |   | 37    | % |  |   | 36    | % |  |    |  



Sales and marketing
expenses consist primarily of salaries, travel, allocation of facilities costs, promotional activities, and costs of advertising and trade shows. The increase in sales and marketing expenses for the three and nine months ended September 30,
2005, as compared to the corresponding periods of 2004, is due primarily to the hiring of additional salespeople in both the United States and Europe, the hiring of our Vice President of Marketing in the second quarter of 2005, product launch costs
for version 7.0 of the S-PLUS product, and higher expenditures on certain marketing events and promotional activities. We expect sales and marketing expenses to increase in future periods as we recruit and hire additional personnel and expand our
marketing programs.



19



---

##### Table of Contents

Research and Development, Net



|                                                            |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   
|----------------------------------------------------------- |  | ------------------------------- | ----- | -- | ------------------------- | - | ----- | ------------------------------ | ---- | --- | ------------------------- | ---- | - | ------ | -- |  | - | ------ | -- |  | --- | --
|                                                            |  | Three Months EndedSeptember 30, |       |    | PercentIncrease(Decrease) |   |       | Nine Months EndedSeptember 30, |      |     | PercentIncrease(Decrease) |     
|                                                            |  | 2005                            |       |    | 2004                      |   |       |                                | 2005 |     |                           | 2004 |   |       
|Research and development (in thousands):                    |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   
|Research and development                                    |  | $                               | 1,407 |    |                           | $ | 1,342 |                                |      | 5   | %                         |      | $ | 4,121  |    |  | $ | 3,992  |    |  | 3   | % 
|Less - funded research                                      |  |                                 | (533  | )  |                           |   | (650  | )                              |      | (18 | )%                        |      |   | (1,707 | )  |  |   | (2,439 | )  |  | (30 | )%
|                                                            |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   
|Research and development, net                               |  | $                               | 874   |    |                           | $ | 692   |                                |      | 26  | %                         |      | $ | 2,414  |    |  | $ | 1,553  |    |  | 55  | % 
|                                                            |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   
|Research and development (as percentage of total revenues): |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   
|Research and development                                    |  |                                 | 26    | %  |                           |   | 28    | %                              |      |     |                           |      |   | 26     | %  |  |   | 29     | %  |  |     |   
|Less - funded research                                      |  |                                 | (10   | )% |                           |   | (14   | )%                             |      |     |                           |      |   | (11    | )% |  |   | (18    | )% |  |     |   
|                                                            |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   
|Research and development, net                               |  |                                 | 16    | %  |                           |   | 14    | %                              |      |     |                           |      |   | 15     | %  |  |   | 11     | %  |  |     |   
|                                                            |  |                                 |       |    |                           |   |       |                                |      |     |                           |      |   |        |    |  |   |        |    |  |     |   



Research and
development expenses consist primarily of salaries and related benefits, equipment for software developers, allocation of facilities costs, and payments to outside contractors. Further, research and development is split into two teams, one being
Research, and the other Development. Generally, the Research team is focused on performing work relating to government grants and contracts, whereas the Development team is generally focused on work that is geared toward commercial applications that
are intended to be immediately deployed. Funded research amounts result from fees generated from research work performed under government grants, which fees are netted against total research and development costs.



The increase in gross research and development expenses for the three and
nine months ended September 30, 2005, as compared to the corresponding periods of 2004, is due primarily to the hiring of additional development personnel in both the Data and Text Analysis groups, as well as deploying a greater number of
outside consultants and sub-contractors in connection with the development and launch of version 7.0 of the S-PLUS product in the second quarter of 2005. These increased costs were partially offset by a corresponding reduction in research personnel
that occurred in late 2004 and continued in 2005. We expect our combined research and development expenses to increase in future periods as we place increased efforts toward further development of technology more closely aligned with our commercial
product lines, while maintaining our current level of research efforts on government grants.



Funded research declined for the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004. This decrease was due to a decline in the offsetting fees generated from work
performed under government research grants, which was a result of a decrease in government research grant activity. Government research grant activity declined due to a decrease in the pursuit of government grants as we aligned our research
activities more closely with our commercial initiatives and product lines.



As a result of the increase in gross research and development costs and a decline in the offsetting fees generated from funded research, total net research and development costs increased, in absolute dollars and as a
percentage of revenues, for the three and nine months ended September 30, 2005, as compared to the corresponding periods of 2004.



General and Administrative



|                                                       |  |                                 |       |   |                 |   |     |                                |      |    |                            |      |   |       |   |  |   |       |   |  |    |   
|------------------------------------------------------ |  | ------------------------------- | ----- | - | --------------- | - | --- | ------------------------------ | ---- | -- | -------------------------- | ---- | - | ----- | - |  | - | ----- | - |  | -- | --
|                                                       |  | Three Months EndedSeptember 30, |       |   | PercentIncrease |   |     | Nine Months EndedSeptember 30, |      |    | PercentIncrease (Decrease) |     
|                                                       |  | 2005                            |       |   | 2004            |   |     |                                | 2005 |    |                            | 2004 |   |      
|General and administrative (in thousands)              |  | $                               | 1,074 |   |                 | $ | 961 |                                |      | 12 | %                          |      | $ | 2,965 |   |  | $ | 3,199 |   |  | (7 | )%
|General and administrative (as percentage of revenues) |  |                                 | 20    | % |                 |   | 20  | %                              |      |    |                            |      |   | 19    | % |  |   | 23    | % |  |    |   



General and
administrative expenses consist primarily of salaries and related costs associated with finance, accounting, legal, Human Resources, corporate governance, investor relations and administration, as well as allocation of facilities and benefits costs.



General and administrative expenses increased, in absolute
dollars only, for the three months ended September 30, 2005, as compared to the corresponding period of 2004. This increase was due to increased headcount-related costs in both the United States and Europe in connection with ongoing efforts to
improve our processes, controls, and scalability.



20



---

##### Table of Contents

General and administrative expenses declined, in both absolute dollars and as a percentage of revenues,
for the nine months ended September 30, 2005, as compared to the corresponding period of 2004. The decline in absolute dollars was due primarily to significant one-time related costs that occurred in the corresponding period of 2004. These
included legal costs incurred in the first quarter of 2004 associated with the acquisition of the copyrights to the S programming language from Lucent Technologies Inc. and unusual audit and audit-related costs incurred in the second
quarter of 2004. The comparative effect of the absence of these costs in 2005 was partially diminished by increases in personnel and consulting costs incurred during 2005 in ongoing efforts to improve our processes, controls, and scalability. The
decline of general and administrative expenses as a percentage of revenues for the nine months ended September 30, 2005, as compared to the corresponding period of 2004, was due primarily to increased revenues during the same corresponding
nine-month periods.



In general, we expect to incur expenses in
connection with our efforts to enhance our information technology resources and improve our financial and managerial systems in connection with the enhanced regulatory and corporate governance requirements of the Sarbanes-Oxley Act of 2002. Because
some of these costs are allocated to the income statement expense line items based on headcount, all the expense line items in the statement of income will be affected by some of these added costs.



Other Income (Expense)



Other income (expense) consists of the following:



|                                            |  |                                 |    |   |                                 |   |     |      |  |   |      |   |  |   |     |  
|------------------------------------------- |  | ------------------------------- | -- | - | ------------------------------- | - | --- | ---- |  | - | ---- | - |  | - | --- | -
|                                            |  | Three Months EndedSeptember 30, |    |   | Nine Months Ended September 30, |  
|                                            |  | 2005                            |    |   | 2004                            |   |     | 2005 |  |   | 2004 |  
|Interest income                             |  | $                               | 76 |   |                                 | $ | 42  |      |  | $ | 183  |   |  | $ | 75  |  
|Interest expense                            |  |                                 | (2 | ) |                                 |   | (12 | )    |  |   | (10  | ) |  |   | (28 | )
|Foreign exchange transaction gains (losses) |  |                                 | 12 |   |                                 |   | 60  |      |  |   | (164 | ) |  |   | 7   |  
|Other                                       |  |                                 |   |   |                                 |   |    |      |  |   | 10   |   |  |   | 1   |  
|                                            |  |                                 |    |   |                                 |   |     |      |  |   |      |   |  |   |     |  
|                                            |  | $                               | 86 |   |                                 | $ | 90  |      |  | $ | 19   |   |  | $ | 55  |  
|                                            |  |                                 |    |   |                                 |   |     |      |  |   |      |   |  |   |     |  



Interest income



The increase in interest income for the three and nine
months ended September 30, 2005, as compared to the corresponding periods of 2004, is a result of both increased invested cash balances and the investment of a greater portion of our cash reserves into higher yielding instruments.



Interest expense



The decrease in interest expense for the three and nine months ended
September 30 2005, as compared to the corresponding periods of 2004, is due to the continual pay-down of our equipment loan with Silicon Valley Bank, which balance as of September 30, 2005 totaled approximately $65,000.



Foreign exchange transaction gains (losses)



Foreign exchange transaction gains and losses result from changes in
exchange rates on transactions denominated and or settled in currencies other than that of an entitys functional currency. This includes the effect that foreign exchange rate fluctuations have on intercompany amounts due from our international
subsidiaries to the U.S. parent company, or to the other international subsidiaries, that are expected to be settled within the foreseeable future.



Foreign currency gains or losses resulting from intercompany amounts due from our international subsidiaries to the U.S. parent company, or to the other
international subsidiaries, that are not expected to be settled within the foreseeable future are included in Other Comprehensive Income (Loss) during the period in which the exchange rates fluctuate.



During the three months ended September 30, 2005 and 2004, the effect of
fluctuations in currency exchange rates resulted in foreign exchange transaction gains, but these gains declined during the three months ended September 30, 2005, as compared to the corresponding period of 2004. This decline was a result of
lower intercompany balances subject to foreign currency transaction gains and losses, as well as less severe fluctuations in currency exchange rates.



21



---

##### Table of Contents

The effect of currency exchange rates during the nine months ended September 30, 2005, as compared
to the corresponding period of 2004, changed from a gain position to a loss position. This change was primarily due to a strengthening in the first quarter of 2005 of the U.S. dollar rate on U.S. dollar denominated intercompany amounts, specifically
those intercompany amounts due from our international subsidiaries to the U.S. parent company that are expected to be settled within the foreseeable future. During the nine months ended September 30, 2005, we reduced our intercompany balances
due from, and cash held by, our international subsidiaries, thereby making us less susceptible to exchange rate fluctuations during 2005. This, along with favorable changes in foreign currency exchange rates, aided in the change from a loss position
in the first quarter of 2005 to a gain position in the third quarter of 2005.



Because we are subject to foreign currency exchange rate fluctuations, and because such fluctuations are part of the global economic environment, we expect foreign currency gains and losses to continue in future
quarters.



Income Tax Expense



Income tax expense for the three and nine months ended September 30,
2005 was zero and $26,000, respectively, compared to $3,000 and $31,000 for the corresponding periods of 2004. Utilization of net operating loss carryforwards minimized our income taxes in each of the respective periods reported. This is expected to
continue for the remainder of 2005 and possibly into future periods. Changes in income tax expense from period to period are attributed primarily to relative changes in the mix of operating income generated in the various tax jurisdictions in which
we operate.



Liquidity and Capital Resources



Cash and cash equivalents were $9.7 million at each of September 30,
2005 and December 31, 2004. Our working capital increased from $4.8 million at December 31, 2004 to $6.4 million at September 30, 2005.



We generated $1.5 million in cash from operating activities for the nine months ended September 30, 2005 compared to $1.0 million for the
corresponding period of 2004.



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



|                                                            |  |                                |       |   |      |   |        |  
|----------------------------------------------------------- |  | ------------------------------ | ----- | - | ---- | - | ------ | -
|                                                            |  | Nine MonthsEnded September 30, |      
|                                                            |  | 2005                           |       |   | 2004 |  
|Net income                                                  |  | $                              | 979   |   |      | $ | 1,134  |  
|Add: non-cash expenses                                      |  |                                | 885   |   |      |   | 1,064  |  
|Changes in operating assets and liabilities, excluding cash |  |                                | (388  | ) |      |   | (1,184 | )
|                                                            |  |                                |       |   |      |   |        |  
|Net cash provided by operating activities                   |  | $                              | 1,476 |   |      | $ | 1,014  |  
|                                                            |  |                                |       |   |      |   |        |  



Non-cash expenses are
associated with the amortization of intangible assets, including purchased technology, and depreciation and amortization of property and equipment. Changes in non-cash operating assets and liabilities reflect changes in working capital components of
the balance sheet apart from cash and cash equivalents.



Investing activities resulted in net cash outflows of $1.6 million for the nine months ended September 30, 2005 compared to net cash outflows of $1.4 million for the corresponding period of 2004. This increase in cash outflows from
investing activities relates primarily to the investment of $0.6 million of cash into short-term investments, as well as an increase in purchases of property and equipment. Cash outflows from investing activities in the nine months ended
September 30, 2005 included a final installment payment of $0.5 million in the first quarter of 2005 for the purchase of the S programming language from Lucent Technologies, whereas the same period in 2004 included the first
installment of $1.3 million.



Financing activities resulted in
net cash inflows of $0.1 million for the nine months ended September 30, 2005 compared to net cash inflows of $1.8 million for the nine months ended September 30, 2004. The decrease in cash inflows from financing activities relates
primarily to a decrease in the proceeds received from the exercise of employee stock options and contributions to our employee stock purchase plan.



In March 2005, we renewed a working capital revolving line of credit and security agreement with Silicon Valley Bank. The terms provide for up to $3.0
million in borrowing availability through March 25, 2006. This facility is secured by our accounts receivable and allows us to borrow up to the lesser of 75% of our eligible accounts receivable or $3.0 million and bears interest at the prime
rate



22



---

##### Table of Contents

plus 1%. At September 30, 2005, the prime rate was 6.75%, and no amounts had been borrowed under the line of credit facility.



At September 30, 2005, we also had an outstanding balance on an
equipment loan with Silicon Valley Bank, secured by the underlying assets. We borrowed $450,000 under this facility in 2002 and the remaining outstanding balance was approximately $65,000 at September 30, 2005. This loan bears interest at the
prime rate plus 1% and is being repaid over a 42-month period, ending in March 2006.



These credit facilities contain covenants that limit our net losses and restrict the amount of capital expenditures not financed through the equipment term loan. In addition, we are prohibited under these facilities
from paying dividends. We were in compliance with these covenants as of September 30, 2005.



At September 30, 2005, our principal unused sources of liquidity consisted of cash and cash equivalents of $9.7 million, $0.6 million in short-term
investments, and our bank line of credit. Our liquidity needs are principally for financing of accounts receivable, capital assets, strategic investments, product development, and flexibility in a dynamic and competitive operating environment.



Commitments



As of September 30, 2005, our contractual commitments associated with
our operating leases, primarily for our office space in Seattle, Washington, as well as other domestic and international locations, and equipment financing are as follows (in thousands):



|                            |  |                    |     |                          |   |      |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      
|--------------------------- |  | ------------------ | --- | ------------------------ | - | ---- |  | ---- | --- | ---- | - | ---------- |  | ----- | -- |  | - | -- |  | - | -----
|                            |  | BeforeDecember 31, |     | Year Ending December 31, |   |      |  |     
|                            |  | 2005               |     | 2006                     |   | 2007 |  | 2008 |     | 2009 |   | Thereafter |  | Total
|Equipment term loan         |  | $                  | 33  |                          | $ | 32   |  | $    |    |      | $ |           |  | $     |   |  | $ |   |  | $ | 65   
|Operating lease obligations |  |                    | 155 |                          |   | 625  |  |      | 514 |      |   | 43         |  |       | 37 |  |   | 28 |  |   | 1,402
|                            |  |                    |     |                          |   |      |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      
|Total                       |  | $                  | 188 |                          | $ | 657  |  | $    | 514 |      | $ | 43         |  | $     | 37 |  | $ | 28 |  | $ | 1,467
|                            |  |                    |     |                          |   |      |  |      |     |      |   |            |  |       |    |  |   |    |  |   |      



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



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



In
addition to the other information contained in this report, you should carefully read and consider the following risk factors. If any of these risks is actually realized, 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 our expectations and those 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 our expectations or those 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 compete in the highly competitive statistics, data mining and text analysis markets;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | market acceptance of open source alternatives to our products and services;
| | - |  | ---------------------------------------------------------------------------



| |  |  | our ability to penetrate new markets;
| | - |  | -------------------------------------



23



---

##### Table of Contents

| |  |  | market awareness and acceptance of our products;
| | - |  | ------------------------------------------------



| |  |  | our ability to obtain government contracts and research grants;
| | - |  | ---------------------------------------------------------------



| |  |  | our ability to expand our sales and support infrastructure;
| | - |  | -----------------------------------------------------------



| |  |  | our ability to maintain our relationships with key partners;
| | - |  | ------------------------------------------------------------



| |  |  | elongated sales cycles and potential sales delays;
| | - |  | --------------------------------------------------



| |  |  | fluctuations in foreign currency exchange rates;
| | - |  | ------------------------------------------------



| |  |  | losses associated with expected increases in our expenses;
| | - |  | ----------------------------------------------------------



| |  |  | our ability to maintain effective internal financial and managerial systems, controls and procedures;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | costs associated with being a public company, such as the cost of complying with the provisions of The Sarbanes-Oxley Act of 2002, or SOX;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to attract and retain key employees or management team members;
| | - |  | ---------------------------------------------------------------------------



| |  |  | our ability to obtain funding that may be necessary to support the expansion of our business;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | our ability to successfully expand our international operations;
| | - |  | ----------------------------------------------------------------



| |  |  | general economic conditions, which may affect our customers purchasing decisions;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | integration of our new key employees, including our senior management team members;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | rapid changes in technology and our ability to develop, introduce and market new products on a timely basis;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | our ability to protect our intellectual property rights;
| | - |  | --------------------------------------------------------



| |  |  | our ability to maintain third-party licenses; and
| | - |  | -------------------------------------------------



| |  |  | defects or errors in our software, which may result in losses of customers or revenues.
| | - |  | ---------------------------------------------------------------------------------------



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



| |  |  | our sales cycles are variable, typically ranging between one and eight months from our initial contact with a current or potential data analysis product customer, and much longer
for current or potential text analysis customers;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | the amount of unfulfilled orders for our products is typically small; and
| | - |  | -------------------------------------------------------------------------



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



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



24



---

##### Table of Contents

If potential customers do not purchase the S-PLUS product family, or if current customers do not continue to renew
maintenance or license subscriptions, our revenues and operating results will be adversely affected.



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



On April 11, 2005, we released a significant new update of S-PLUS. In addition to new software features, the product has licensing terms end enforcement mechanisms
that differ from previous versions and about which we have received complaints from customers. If the update of S-PLUS does not meet the expectations of our customersor does not achieve market acceptance, our reputation may suffer and
our operating results will be harmed.



If we are unable to compete
successfully in the statistics, data mining and text analysis 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 from our potential customers information technology departments, which may seek to develop their own solutions. 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., The Mathworks and Minitab, Inc. In addition to competition from other statistical software companies, we face competition from providers of software for specific statistical applications.
In the data mining and text analysis market, we face competition from many companies, including SAS Institute, SPSS, IBM, NCR, Autonomy, Verity, Inxight, ClearForest and Iphrase, many of which are much larger than we are.



We also face competition from R, an open-source software package that performs operations
similar to the S language that forms the core of our S-PLUS product.



Market acceptance of open source alternatives to proprietary software poses a threat to our potential growth in revenue and market share.



Our business model has been based upon customers agreeing to pay a fee to license software developed and distributed by us. In recent years,
there has been a growing challenge to the commercial software model. Under the non-commercial software model, open source software produced by loosely associated groups of unpaid programmers and made available for license to end users without charge
is distributed at nominal cost by firms that earn revenue on complementary services and products, without having to bear the full costs of research and development for the open-source software. The most notable example of open source software is the
Linux operating system, which has presented a competitive challenge to leading vendors of proprietary operating systems. In the markets we serve, we face similar challenges because of the availability of R, an open source implementation of the S
language that forms the core of our S-PLUS product. While we believe our products provide customers with significant advantages, the popularization of the non-commercial software model continues to pose a significant challenge to our business model.
To the extent open-source software gains increasing market acceptance, sales of our products may decline, we may have to reduce the prices we charge for our products, and revenue and operating margins may consequently decline.



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 life sciences. In order to grow our business, we will need to expand into new end-user markets within these two vertical markets for our statistics software and services, 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 text analysis 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.



25



---

##### Table of Contents

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



Our
text analysis product, InFact, was released in 2002 and has not contributed substantial revenues to date. The market for relationship search solutions like InFact is still emerging, with many competitors coming to market with alternative solutions.
Growth in demand for and acceptance of these solutions, if any, remains uncertain. Even if this market grows, businesses may purchase our competitors solutions or develop their own. If InFact does not achieve market acceptance, our business
may not grow.



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 our markets. An increase in competitive pressures in our
market or our failure to compete effectively may result in pricing reductions, reduced gross margins and loss of market share. Many of our competitors have longer operating histories, greater name recognition, greater market share, larger customer
bases and significantly greater financial, technical, marketing and other resources than we do. We could also experience competition from companies in other sectors of the broader market for business intelligence software, like providers of on-line
analytical processing, business intelligence and analytical application software, as well as from companies in other sectors.



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



We regularly apply for and are granted research contracts from a variety of government agencies and funding programs. During the fiscal
years 2001 through 2003, these contracts generated from $4.3 to $4.8 million annually in offsets to our research and development expenses. During 2004, we began realigning our research and development efforts to ensure that we only pursue projects
that directly support our business strategy. As a result of this realignment, we have applied for and received fewer government research contracts, and for the year ended December 31, 2004, research contracts generated $2.9 million. Further
reductions in these offsets to our research and development expenses are likely and will negatively affect our operating results. Further, we may not receive new funded research contracts or any renewals of government-funded projects currently in
process, and we may decide to cancel or reassign certain ongoing projects that are not aligned with our core business needs. The personnel and other costs associated with these programs are relatively fixed in the short run, and a sudden
cancellation or non-renewal of a major funding program or multiple smaller programs would be harmful to our operating results. A substantial portion of the research grant money we receive is granted to us based on our status as a small business, the
definition of which varies depending on the individual contract terms. If the number of our employees or the amount of our revenues ever grows beyond the limits prescribed in any of these contracts, we will no longer be eligible for such research
contracts and we will have to incur certain research and development expenses without the benefit of offsets.



Furthermore, a significant portion of our license revenues come from U.S. 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 revenues and operating results.



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



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



Our sales cycle is variable, and our limited ability to predict revenues 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 text analysis software and services is discretionary, involves a significant commitment of its resources and is influenced by its budget cycles. Our sales cycles can be variable, typically ranging between one 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, making our revenues difficult to predict in the
short term. Occasionally sales require substantially more time, and sales cycles have shown to be substantially longer for our higher-priced text analysis product, InFact. In addition, sales delays could cause our operating results for any given
period to fall below the expectations of securities analysts or investors, which could result in a decrease in our stock price.



26



---

##### Table of Contents

Our services business can be dependent on a few large customers, the unexpected loss of which would affect our
operating results and could cause a decline in our stock price.



We
perform consulting projects primarily on a time-and-materials basis, under which a customer may order us to cease work at any time. When the magnitude of any such project requires us to allocate a significant portion of our consulting time to its
performance during a reporting period, the unplanned or otherwise untimely cessation of the project would create a shortfall in revenue that would result in a negative impact on operating results for the services segment. We are currently engaged on
one project that accounted for more than 10% of our total revenue for the quarter ended September 30, 2005, and we expect to receive a significant amount of revenue from this project in the quarter ending December 31, 2005, which may or
may not exceed 10% of our total revenue for the quarter ended December 31, 2005. We have allocated resources to this project that have limited, and may continue to limit, our ability to pursue other opportunities. If we cease work on this
project prior to its intended completion, we would suffer significant reductions in our expected level of revenue and would continue to bear the generally fixed costs associated with our professional services staff. This would have a negative impact
on our operating results and could negatively affect our stock price.



We
have incurred losses in past periods, and may again incur losses in future periods, which could cause a decrease in our stock price.



Until the fourth quarter of 2003, we had posted net losses for each fiscal quarter since the fourth quarter of 2001. As of September 30, 2005, we had an accumulated
deficit of over $27 million. We achieved only slight profits in recent quarters and a small shortfall in revenue or unexpected increase in expenses could again cause us to suffer a quarterly net loss. As a result, we may experience losses and
negative cash flows in the near term, even if sales of our products and services continue to grow.



While we have shown a trend of growth in revenue and profit in recent quarters, there is no guarantee that these trends will continue. We expect our expenses to be higher in 2005 than in 2004, in part due to our
efforts to enhance our information technology resources and improve our financial and managerial systems, and we believe that we may need to significantly increase our product development and professional services personnel costs to expand our
market position and further increase acceptance of our products.We may not be able to increase our revenues sufficiently to keep pace with these growing expenditures, if at all, and as a result we 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.



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



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



Pursuant to
Section 404 of the Sarbanes-Oxley Act of 2002, we will be required to furnish an internal controls report of managements assessment of the design and effectiveness of our internal controls as part of our Annual Report beginning with the
fiscal year ended December 31, 2007. Our auditors will then be required to attest to, and report on, managements assessment. In order to issue our report, our management must document both the design of our internal controls and the
testing processes that support managements evaluation and conclusion. This process will likely require us to hire additional personnel and engage outside advisory services, which will result in additional accounting and legal expenses. In
addition, the evaluation and attestation processes required by Section 404 are new and neither companies nor auditing firms have significant experience in complying with these requirements. Accordingly, we may encounter problems or delays in
completing the review and evaluation, the implementation of improvements and the receipt of an attestation by our independent auditors.



Additionally, during our assessment of internal controls, certain deficiencies may be discovered that will require remediation. This remediation may require implementing
additional controls, the costs of which could have a material adverse effect on our results of operations. If we are unable to implement the requirements of Section 404 in a timely manner or with adequate compliance, in addition to receiving an
adverse opinion from our auditors, we might be subject to sanctions or investigation by regulatory authorities. Any such action could adversely affect our business and financial results. Further, our testing may not reveal all material weaknesses or
significant deficiencies in our internal controls. Material weaknesses or significant deficiencies in our internal controls could have a material adverse effect on our results of operations.



27



---

##### Table of Contents

Our management has started the necessary processes and procedures for issuing its report on our internal controls. We
expect to remain a non-accelerated filer in 2005 because we are eligible to use Forms 10-QSB and 10-KSB for our 2005 quarterly and annual reports. However, if a determination is made that we qualify as an accelerated filer as of December 31,
2006, we will be required to furnish our internal controls report with our Annual Report for 2006 rather than for 2007. In either case, we may not be able to complete the work necessary for our management to issue its management report in a timely
manner and our management may be unable to report that our internal controls are effective.



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



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



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



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



Our future performance will depend largely on the efforts and abilities of our key technical, sales, customer support, accounting and managerial personnel and on our
ability to attract and retain them. In addition, our ability to execute our business strategy will depend on our ability to recruit additional experienced senior managers and to retain our existing executive officers. Departures of key executives
could adversely impact our reputation. We may be unable to attract and retain such personnel in the future. In addition, due to competition for qualified employees, we may have difficulty recruiting staff with appropriate skills, and we may be
required to increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses.



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



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;
| | - |  | --------------------------------------------------------------------------------



28



---

##### Table of Contents

| |  |  | separate management information systems and control procedures;
| | - |  | ---------------------------------------------------------------



| |  |  | reduced protection of intellectual property rights and increased liability exposure; and
| | - |  | ----------------------------------------------------------------------------------------



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



Our foreign subsidiaries operate primarily in local currencies,
and their results are translated into U.S. dollars. We do not currently engage in foreign currency contracts that are designed to hedge foreign currency risk, but we may do so in the future. Future currency exchange rate fluctuations may have an
adverse effect on our results of operations in future periods. 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.



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



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



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



Our credit line and equipment term loan with Silicon Valley Bank contain covenants that require us to maintain a certain level of profitability. 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.



General or specific economic conditions could adversely affect our revenue growth
and ability to forecast revenue.



We focus our statistics business
primarily on the financial services and life sciences markets and are thus sensitive to changes in the specific economic conditions that affect them. A substantial change in the economic condition of either or both of these markets will affect our
ability to sell our products and to forecast sales.



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



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



Substantially all of our executive leadership team has been replaced in the last 21 months.
Since January 2004, we hired a new Chief Executive Officer, Chief Financial Officer, Vice President of Research and Development, Vice President of North American Sales and Vice President of Worldwide Marketing. Additionally, we have appointed two
new members to our board of directors and audit committee. In addition, we have experienced turnover of other key finance and administration personnel in recent months. The restructuring of our senior management and finance leadership and the
integration of these key employees and directors may result in some disruption in our business.



29



---

##### Table of Contents

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 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.



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 patents on InFact technology and our rights in the software code underlying
the S programming language that we purchased from Lucent Technologies Inc. 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. Historically, our products have not been 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.



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.



The outcome of current litigation could disrupt our operations and damage our
reputation.



On December 13, 2002, Wajih Alaiyan, a former
employee, filed a complaint against us in the Superior Court for King County, Washington. Mr. Alaiyan alleged that his employment was wrongfully terminated. On December 5, 2003, court granted summary judgment in our favor, dismissing the
complaint. On June 13, 2005, the Court of Appeals for the State of Washington issued an unpublished opinion upholding the lower courts decision. On July 12, 2005, Mr. Alaiyan filed a petition with the Supreme Court of Washington
seeking review of the Court of Appeals decision. If the petition is granted, we expect to incur considerable expense in defending this action. If the Court of Appeals decision is modified or reversed, we will likely resume litigation in
the lower court, where we expect to continue to vigorously defend ourself against the former employees claim, which we deny. As a consequence of vigorously defending ourselves, we may incur considerable expenses. Discovery obligations imposed
on us during the course of such litigation will be disruptive to our normal operations. We cannot predict the outcome of the litigation, but an unfavorable outcome may require us to pay the employee significant damages and would have a material
effect on our operating position, results of operations, and cash flows. Regardless of the outcome of the lower courts review, the court may issue a written opinion that will address only those issues of law that arose from the lower
courts decision to grant summary judgment. The veracity of the facts alleged by the former employee in such an analysis is not at issue, and for the purposes of review the court will deem the allegations to be true. Because the allegations of
the former employee included deceptive accounting practices, the published opinion in either case will make reference to improprieties that we will be deemed to have committed solely for the purposes of this legal analysis. Such
references, when separated from the parties ability to support or refute the facts, may be damaging to our reputation and may adversely affect our stock price.



30



---

##### Table of Contents

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



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



| |  |  | stop or delay selling, incorporating or using products that incorporate the challenged intellectual property;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | pay damages;
| | - |  | ------------



| |  |  | enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or
| | - |  | --------------------------------------------------------------------------------------------



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



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



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.



Market risks may affect the value of our assets, cash flows and financial results.



We sell products, which are developed in the U.S., worldwide and operate in the United Kingdom, France and Switzerland where we incur
expenses and generate billings denominated in those local currencies. As a result, the value of our assets, cash flows and financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions
in foreign markets. In addition, 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 which may fluctuate in value over time.



Our cash, cash equivalents, and short-term investments are subject to market risk.



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. A significant change in the markets in which we are invested could reduce our reported assets, and adversely affect our stock price and results of operations.



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 life sciences 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



31



---

##### Table of Contents

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.



Our stock price may be volatile.



The price of our common stock has been volatile over the past 18 months. Our common stock reached a high of $5.20 per share on May 14, 2004 and traded as low as
$1.13 per share on September 1, 2004. As a result of fluctuations in the price of our common stock, you may be unable to sell your shares at or above the price you paid for them. The trading price of our common stock could be subject to
fluctuations for a number of reasons, including



| |  |  | future announcements concerning us or our competitors;
| | - |  | ------------------------------------------------------



| |  |  | actual or anticipated quarterly variations in operating results;
| | - |  | ----------------------------------------------------------------



| |  |  | changes in analysts earnings projections or recommendations;
| | - |  | -------------------------------------------------------------



| |  |  | announcements of technological innovations;
| | - |  | -------------------------------------------



| |  |  | the introduction of new products;
| | - |  | ---------------------------------



| |  |  | changes in product pricing policies by us or our competitors;
| | - |  | -------------------------------------------------------------



| |  |  | loss of key personnel;
| | - |  | ----------------------



| |  |  | deficiencies in our internal controls;
| | - |  | --------------------------------------



| |  |  | proprietary rights litigation or other litigation; or
| | - |  | -----------------------------------------------------



| |  |  | changes in accounting standards that adversely affect our revenues and earnings.
| | - |  | --------------------------------------------------------------------------------



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



|ITEM 3. | CONTROLS AND PROCEDURES
|------- | -----------------------



Evaluation of Disclosure Controls and Procedures



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



32



---

##### Table of Contents

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 report, and they have concluded that, as of that date, our disclosure controls and procedures were effective.



PART II. OTHER INFORMATION



|ITEM 1. | Legal Proceedings
|------- | -----------------



On December 13, 2002, Wajih Alaiyan, a former employee, filed a complaint against us in the Superior Court for King County, Washington.
Mr. Alaiyan alleged that his employment was wrongfully terminated. On December 5, 2003, the court granted summary judgment in our favor, dismissing the complaint. On June 13, 2005, the Court of Appeals for the State of Washington
issued an unpublished opinion upholding the lower courts decision. On July 12, 2005, Mr. Alaiyan filed a petition with the Supreme Court of Washington seeking review of the Court of Appeals decision. If the petition is granted,
we expect to incur considerable expense in defending this action. If the Court of Appeals decision is modified or reversed, we will likely resume litigation in the lower court, where we expect to continue to vigorously defend ourself against
the former employees claim, which we deny. As a consequence of vigorously defending ourselves, we may incur considerable expense. We are unable to evaluate the likelihood of an adverse outcome.



|ITEM 6. | Exhibits
|------- | --------



| | (a) | See Index to Exhibits.
| | --- | ----------------------



33



---

##### Table of Contents

SIGNATURES



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



November 16, 2005



INSIGHTFUL CORPORATIONBy:

/s/    Jeffrey E. CoombsJeffrey E. CoombsPresident and Chief Executive Officer(Principal Executive Officer)




November 16, 2005



By:

/s/    Richard P. BarberRichard P. BarberChief Financial Officer(Principal Financial and Accounting Officer)




34



---

##### Table of Contents

EXHIBIT INDEX



|              |  |                                                                                                                                                    
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                        
|3.1           |  | Amended and Restated Certificate of Incorporation of the registrant (Exhibit 3.1) (A)                                                              
|              | 
|3.2           |  | Amended and Restated Bylaws of the registrant (Exhibit 3.2) (A)                                                                                    
|              | 
|31.1          |  | Certification of Chief Executive Officer of Insightful Corporation as Required by Section 302 of Sarbanes-Oxley Act of 2002                        
|              | 
|31.2          |  | Certification of Chief Financial Officer of Insightful Corporation as Required by Section 302 of Sarbanes-Oxley Act of 2002                        
|              | 
|32.1          |  | Certification of Financial Statements by Chief Executive Officer Insightful Corporation as Required by Section 906 of Sarbanes-Oxley Act of 2002   
|              | 
|32.2          |  | Certification of Financial Statements by Chief Financial Officer of Insightful Corporation as Required by Section 906 of Sarbanes-Oxley Act of 2002



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



35