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SECURITIES AND EXCHANGE COMMISSIONWashington,
DC 20549

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FORM 10-Q

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

For the Quarterly Period ended September 30, 2004

OR

oTRANSITION 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

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

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

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

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

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

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

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

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

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

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TABLE OF CONTENTS

|                              |         | Page                                                                                                               
|----------------------------- | ------- | -------------------------------------------------------------------------------------------------------------------
|                              |         |                                                                                                                    
|                              |         |                                                                                                                    
|PART I. FINANCIAL INFORMATION |        
|                              |         |                                                                                                                    
|                              | ITEM 1. | Consolidated
  Financial Statements (Unaudited)                                                                    
|                              |         |                                                                                                                    
|                              |         | Condensed
  Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003                             
|                              |         |                                                                                                                    
|                              |         | Condensed
  Consolidated Statements of Operations for the three and nine months ended
  September 30, 2004 and 2003
|                              |         |                                                                                                                    
|                              |         | Condensed Consolidated
  Statements of Cash Flows for the nine months ended September 30, 2004 and
  2003          
|                              |         |                                                                                                                    
|                              |         | Notes to
  Condensed Consolidated Financial Statements                                                             
|                              |         |                                                                                                                    
|                              | ITEM 2. | Managements
  Discussion and Analysis of Financial Condition and Results of Operations                            
|                              |         |                                                                                                                    
|                              | ITEM 3. | Quantitative
  and Qualitative Disclosures about Market Risk                                                       
|                              |         |                                                                                                                    
|                              | ITEM 4. | Controls
  and Procedures                                                                                          
|                              |         |                                                                                                                    
|PART II. OTHER INFORMATION    |        
|                              |         |                                                                                                                    
|                              | ITEM 1. | Legal
  Proceedings                                                                                                
|                              |         |                                                                                                                    
|                              | ITEM 4. | Submission
  of Matters to a Vote of Security Holders                                                              
|                              |         |                                                                                                                    
|                              | ITEM 5. | Other
  Information                                                                                                
|                              |         |                                                                                                                    
|                              | ITEM 6. | Exhibits                                                                                                           
|                              |         |                                                                                                                    
|SIGNATURES                    | 24     

Trademarks

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

1

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL
STATEMENTS

INSIGHTFUL CORPORATION AND
SUBSIDIARIES

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

|                                                                                                                                       |  | September 30,2004 |   | December 31,
  2003 |  
|-------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | - | ------------------- | -
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  | (unaudited)       |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|ASSETS                                                                                                                                 |  |                   |   |                     |  
|Current Assets:                                                                                                                        |  |                   |   |                     |  
|Cash
  and cash equivalents                                                                                                            |  |                   | $ | 8,568               |  
|Trade
  accounts receivable, net                                                                                                       |  |                   |   | 3,468               |  
|Other
  receivables                                                                                                                    |  |                   |   | 448                 |  
|Prepaid
  expenses and other current assets                                                                                            |  |                   |   | 478                 |  
|                                                                                                                                       |  |                   |   |                     |  
|Total
  current assets                                                                                                                 |  |                   |   | 12,962              |  
|                                                                                                                                       |  |                   |   |                     |  
|Property and equipment, net                                                                                                            |  |                   |   | 540                 |  
|                                                                                                                                       |  |                   |   |                     |  
|Purchased technology, net                                                                                                              |  |                   |   | 1,373               |  
|                                                                                                                                       |  |                   |   |                     |  
|Goodwill                                                                                                                               |  |                   |   | 800                 |  
|                                                                                                                                       |  |                   |   |                     |  
|Other assets                                                                                                                           |  |                   |   | 60                  |  
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  |                   | $ | 15,735              |  
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                   |  |                   |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|Current Liabilities:                                                                                                                   |  |                   |   |                     |  
|Current
  portion of long-term debt                                                                                                    |  |                   | $ | 129                 |  
|Accounts
  payable                                                                                                                     |  |                   |   | 1,219               |  
|Accrued
  payroll and payroll-related items                                                                                            |  |                   |   | 1,350               |  
|Accrued
  expenses and other current liabilities                                                                                       |  |                   |   | 561                 |  
|Deferred
  revenue                                                                                                                     |  |                   |   | 5,558               |  
|                                                                                                                                       |  |                   |   |                     |  
|Total
  current liabilities                                                                                                            |  |                   |   | 8,817               |  
|Long-term debt, less
  current portion                                                                                                 |  |                   |   | 64                  |  
|                                                                                                                                       |  |                   |   |                     |  
|Commitments and
  contingencies                                                                                                        |  |                   |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|Stockholders equity:                                                                                                                  |  |                   |   |                     |  
|Preferred
  stock, $0.01 par value                                                                                                    |  |                   |   |                     |  
|Authorized1,000,000
  shares                                                                                                          |  |                   |   |                     |  
|Issued
  and outstandingnone                                                                                                          |  |                   |   | -                   |  
|Common
  stock, $0.01 par value                                                                                                       |  |                   |   |                     |  
|Authorized20,000,000
  shares                                                                                                         |  |                   |   |                     |  
|Issued
  and outstanding12,319,525 and 11,474,444, shares 
               at
  September 30, 2004 and December 31, 2003, respectively |  |                   |   | 123                 |  
|Additional
  paid-in capital                                                                                                           |  |                   |   | 36,177              |  
|Accumulated
  deficit                                                                                                                  |  |                   |   | (29,320             | )
|Other
  accumulated comprehensive loss-cumulative translation adjustment                                                               |  |                   |   | (126                | )
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|Total
  stockholders equity                                                                                                           |  |                   |   | 6,854               |  
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  |                   |   |                     |  
|                                                                                                                                       |  |                   | $ | 15,735              |  
|                                                                                                                                       |  |                   |   |                     |  

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

2

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INSIGHTFUL CORPORATION AND
SUBSIDIARIES

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

|                                                                           |  | Three Months Ended September 30, |   | Nine Months Ended September 30, |  
|-------------------------------------------------------------------------- |  | -------------------------------- | - | ------------------------------- | -
|                                                                           |  |                                  |   |                                 |  
|                                                                           |  | 2004                             |   | 2003                            |  
|                                                                           |  |                                  |   |                                 |  
|Revenues:                                                                  |  |                                  |   |                                 |  
|Software
  licenses                                                        |  |                                  | $ | 2,164                           |  
|Software
  maintenance                                                     |  |                                  |   | 1,626                           |  
|Professional
  services and other                                          |  |                                  |   | 979                             |  
|                                                                           |  |                                  |   |                                 |  
|Total
  revenues                                                           |  |                                  |   | 4,769                           |  
|                                                                           |  |                                  |   |                                 |  
|Cost of revenues:                                                          |  |                                  |   |                                 |  
|Software
  related                                                         |  |                                  |   | 390                             |  
|Professional
  services and other                                          |  |                                  |   | 526                             |  
|                                                                           |  |                                  |   |                                 |  
|Total
  cost of revenues                                                   |  |                                  |   | 916                             |  
|                                                                           |  |                                  |   |                                 |  
|Gross
  profit                                                             |  |                                  |   | 3,853                           |  
|                                                                           |  |                                  |   |                                 |  
|Operating expenses:                                                        |  |                                  |   |                                 |  
|Sales
  and marketing                                                      |  |                                  |   | 1,678                           |  
|Research
  and development                                                 |  |                                  |   | 1,342                           |  
|LessFunded
  research                                                     |  |                                  |   | (650                            | )
|                                                                           |  |                                  |   |                                 |  
|Research
  and development, net                                            |  |                                  |   | 692                             |  
|General
  and administrative                                               |  |                                  |   | 961                             |  
|Restructuring
  charges                                                    |  |                                  |   | -                               |  
|                                                                           |  |                                  |   |                                 |  
|Total
  operating expenses                                                 |  |                                  |   | 3,331                           |  
|                                                                           |  |                                  |   |                                 |  
|Income
  (loss) from operations                                            |  |                                  |   | 522                             |  
|                                                                           |  |                                  |   |                                 |  
|Other income, net                                                          |  |                                  |   | 90                              |  
|                                                                           |  |                                  |   |                                 |  
|Income
  (loss) before income taxes                                        |  |                                  |   | 612                             |  
|                                                                           |  |                                  |   |                                 |  
|                                                                           |  |                                  |   |                                 |  
|Income tax expense                                                         |  |                                  |   | 3                               |  
|                                                                           |  |                                  |   |                                 |  
|Income
  (loss) from continuing operations                                 |  |                                  |   | 609                             |  
|                                                                           |  |                                  |   |                                 |  
|Loss from discontinued
  operations, net of tax                            |  |                                  |   | -                               |  
|                                                                           |  |                                  |   |                                 |  
|Net
  income (loss)                                                        |  |                                  | $ | 609                             |  
|                                                                           |  |                                  |   |                                 |  
|Basic and diluted net
  income (loss) per share  
  continuing operations |  |                                  | $ | 0.05                            |  
|                                                                           |  |                                  |   |                                 |  
|Basic and diluted net loss
  per share  discontinued 
  operations        |  |                                  | $ | -                               |  
|                                                                           |  |                                  |   |                                 |  
|Basic and diluted net
  income (loss) per share                            |  |                                  | $ | 0.05                            |  
|                                                                           |  |                                  |   |                                 |  
|Weighted average common
  shares outstanding                               |  |                                  |   | 12,312                          |  
|                                                                           |  |                                  |   |                                 |  
|Weighted average common shares assuming dilution                           |  |                                  |   | 12,572                          |  
|                                                                           |  |                                  |   |                                 |  

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

3

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INSIGHTFUL CORPORATION AND
SUBSIDIARIES

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

|                                                                                                                                            |  | Nine Months Ended September 30, |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | -
|                                                                                                                                            |  |                                 |  
|                                                                                                                                            |  | 2004                            |  
|                                                                                                                                            |  |                                 |  
|Operating activities:                                                                                                                       |  |                                 |  
|Net
  income (loss)                                                                                                                         |  |                                 | $
|LessLoss
  from discontinued operations                                                                                                    |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Loss
  from continuing operations                                                                                                           |  |                                 |  
|Adjustments
  to reconcile net income (loss) from continuing operations to
          net cash provided by (used
  in) operating activities: |  |                                 |  
|Depreciation,
  amortization and other non-cash charges                                                                                     |  |                                 |  
|Stock-based
  compensation                                                                                                                  |  |                                 |  
|Changes
  in current assets and liabilities:                                                                                                |  |                                 |  
|Trade
  accounts receivable                                                                                                                 |  |                                 |  
|Other
  receivables                                                                                                                         |  |                                 |  
|Prepaid
  expenses and other assets                                                                                                         |  |                                 |  
|Accounts
  payable                                                                                                                          |  |                                 |  
|Accrued
  payroll and payroll-related items                                                                                                 |  |                                 |  
|Accrued
  expenses and other current liabilities                                                                                            |  |                                 |  
|Deferred
  revenue                                                                                                                          |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Net
  cash provided by (used in) operating activities                                                                                       |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Investing activities:                                                                                                                       |  |                                 |  
|Purchases
  of property and equipment                                                                                                       |  |                                 |  
|Purchases
  of other non-current assets                                                                                                     |  |                                 |  
|Purchase
  of technology                                                                                                                    |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Net
  cash used in investing activities                                                                                                     |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Financing activities:                                                                                                                       |  |                                 |  
|Payments
  on debt                                                                                                                          |  |                                 |  
|Proceeds
  from exercise of stock options and employee stock purchase plan                                                                  |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Net
  cash provided by (used in) financing activities                                                                                       |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Effect of exchange rate
  changes on cash and cash equivalents                                                                              |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Net cash used in continuing
  operations                                                                                                    |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Net cash used in
  discontinued operations                                                                                                  |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Net increase (decrease) in
  cash and cash equivalents                                                                                      |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Cash and cash equivalents,
  beginning of period                                                                                            |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Cash and cash equivalents,
  end of period                                                                                                  |  |                                 |  
|                                                                                                                                            |  |                                 |  
|Supplemental disclosure of
  cash flow information:                                                                                         |  |                                 |  
|Cash
  paid for:                                                                                                                            |  |                                 |  
|Interest                                                                                                                                    |  |                                 | $
|Income
  taxes (refund)                                                                                                                     |  |                                 |  
|Supplemental disclosure of
  non-cash investing information  portion of
      purchased technology financed through accounts
  payable     |  |                                 | $

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

4

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

(1) DESCRIPTION OF BUSINESS AND BASIS OF
PRESENTATION

a) Description of Business

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

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

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

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

(b) Unaudited Interim Financial
Information

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

(2) SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation

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

(b) Revenue Recognition

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

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

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

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

5

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

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

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

(c) Stock-Based Compensation

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

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

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

|                                                                             |  | Three Months Ended
  September 30, |   | Nine Months Ended
  September 30, |  
|---------------------------------------------------------------------------- |  | ---------------------------------- | - | --------------------------------- | -
|                                                                             |  |                                    |   |                                   |  
|                                                                             |  | 2004                               |   | 2003                              |  
|                                                                             |  |                                    |   |                                   |  
|Net income (loss) as
  reported                                              |  |                                    | $ | 609                               |  
|Employee stock-based
  compensation, as reported                             |  |                                    |   |                                  |  
|Employee stock-based
  compensation determined
  under the fair value method |  |                                    |   | (63                               | )
|                                                                             |  |                                    |   |                                   |  
|Pro forma net income (loss)                                                  |  |                                    | $ | 546                               |  
|                                                                             |  |                                    |   |                                   |  
|Basic and diluted net
  income (loss) per share as
  reported                |  |                                    | $ | 0.05                              |  
|Pro forma basic and diluted
  net income (loss) loss
  per share             |  |                                    | $ | 0.04                              |  

(d) Reclassification of Amounts

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

(3) PURCHASED TECHNOLOGY

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

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

6

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(4) FINANCING ARRANGEMENTS

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

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

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

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

|                    |  | Before
  December 31, |   | Year Ending December 31, |  |      |  |      |    
|------------------- |  | --------------------- | - | ------------------------ |  | ---- |  | ---- | ---
|                    |  |                       |   |                          |  |      |  |      |    
|                    |  | 2004                  |   | 2005                     |  | 2006 |  | 2007 |    
|                    |  |                       |   |                          |  |      |  |      |    
|Equipment term loan |  |                       | $ | 32                       |  |      |  | $    | 129

(5) NET INCOME (LOSS) PER SHARE

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

|                                                                               |  | Three Months Ended
  September 30, |        | Nine Months Ended
  September 30, | 
|------------------------------------------------------------------------------ |  | ---------------------------------- | ------ | --------------------------------- | 
|                                                                               |  |                                    |        |                                   | 
|                                                                               |  | 2004                               |        | 2003                              | 
|                                                                               |  |                                    |        |                                   | 
|Shares used
  in basic net income (loss) per share computation                 |  |                                    | 12,312 |                                   | 
|Effect of
  dilutive potential common shares resulting from stock
     options |  |                                    | 260    |                                   | 
|                                                                               |  |                                    |        |                                   | 
|Shares used
  in diluted net income (loss) per share computation               |  |                                    | 12,572 |                                   | 
|                                                                               |  |                                    |        |                                   | 

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

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

|                                                                                              |  | Three Months Ended
  September 30, |       | Nine Months Ended
  September 30, | 
|--------------------------------------------------------------------------------------------- |  | ---------------------------------- | ----- | --------------------------------- | 
|                                                                                              |  |                                    |       |                                   | 
|                                                                                              |  | 2004                               |       | 2003                              | 
|                                                                                              |  |                                    |       |                                   | 
|Weighted-average
  stock options excluded from the computation of
  diluted net income (loss) |  |                                    | 1,431 |                                   | 

(6) OTHER COMPREHENSIVE INCOME (LOSS)

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

|                                              |  | Three Months Ended
  September 30, |   | Nine Months Ended
  September 30, |  
|--------------------------------------------- |  | ---------------------------------- | - | --------------------------------- | -
|                                              |  |                                    |   |                                   |  
|                                              |  | 2004                               |   | 2003                              |  
|                                              |  |                                    |   |                                   |  
|Net income (loss)                             |  |                                    | $ | 609                               |  
|Change in cumulative
  translation adjustment |  |                                    |   | (44                               | )
|                                              |  |                                    |   |                                   |  
|Comprehensive income (loss)                   |  |                                    | $ | 565                               |  
|                                              |  |                                    |   |                                   |  

7

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(7) SEGMENT REPORTING

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

|North American Data Analysis    |  | Three Months Ended
  September 30, |   | Nine Months Ended
  September 30, |  
|------------------------------- |  | ---------------------------------- | - | --------------------------------- | -
|                                |  |                                    |   |                                   |  
|                                |  | 2004                               |   | 2003                              |  
|                                |  |                                    |   |                                   |  
|Revenues                        |  |                                    | $ | 2,947                             |  
|Loss from operations            |  |                                    | $ | (57                               | )
|                                |  |                                    |   |                                   |  
|International
  Data Analysis   |  | Three Months Ended
  September 30, |   | Nine Months Ended
  September 30, |  
|                                |  |                                    |   |                                   |  
|                                |  | 2004                               |   | 2003                              |  
|                                |  |                                    |   |                                   |  
|Revenues                        |  |                                    | $ | 1,542                             |  
|Income (loss) from
  operations |  |                                    | $ | 628                               |  
|                                |  |                                    |   |                                   |  
|North
  American Text Analysis  |  | Three Months Ended
  September 30, |   | Nine Months Ended
  September 30, |  
|                                |  |                                    |   |                                   |  
|                                |  | 2004                               |   | 2003                              |  
|                                |  |                                    |   |                                   |  
|Revenues                        |  |                                    | $ | 280                               |  
|Loss from operations            |  |                                    | $ | (49                               | )

(8) BUSINESS RESTRUCTURING

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

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

(9) COMMITMENTS AND CONTINGENCIES

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

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

8

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|ITEM 2. | MANAGEMENTS
  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | ---------------------------------------------------------------------------------------

Forward-Looking Statements

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

| |  | information concerning
  possible or assumed future results of operations, trends in financial results
  and business plans, including those relating to earnings growth and revenue
  growth;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                               
| |  | statements about the level
  of our costs and operating expenses relative to our revenues, and about the
  expected composition of our revenues;                                              
| |   |                                                                                                                                                                                               
| |  | statements about expected
  future trends for sales of our products and services;                                                                                                             
| |   |                                                                                                                                                                                               
| |  | Statements about the
  long-term potential of the data analysis market;                                                                                                                       
| |   |                                                                                                                                                                                               
| |  | statements about our future
  capital requirements and the sufficiency of our cash, cash equivalents,
  investments and available bank borrowings to meet these requirements;                 
| |   |                                                                                                                                                                                               
| |  | information about the
  anticipated release dates of new products;                                                                                                                            
| |   |                                                                                                                                                                                               
| |  | other statements about our
  plans, objectives, expectations and intentions; and                                                                                                              
| |   |                                                                                                                                                                                               
| |  | other statements that are
  not historical facts.                                                                                                                                             

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

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

Description of the Company

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

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

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

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

Products

Data Analysis Products

S-PLUS®

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

9

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Insightful Miner

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

Verticalized Toolkits

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

Server Products

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

Text Analysis Products

InFact®

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

Maintenance and Services

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

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

Critical Accounting Policies and Estimates

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

Revenue Recognition

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

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

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

10

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Sales Returns

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

Bad Debts

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

Impairment of Goodwill and Other Long Lived
Assets

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

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

Contingencies

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

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

Revenues by Type

|                                          |  | Three Months Ended
  September 30, |   | Percent
  Increase |   | Nine Months Ended
  September 30, |      | Percent
  Increase
  (Decrease) |      
|----------------------------------------- |  | ---------------------------------- | - | ------------------ | - | --------------------------------- | ---- | ------------------------------- | -----
|                                          |  |                                    |   |                    |   |                                   |     
|                                          |  | 2004                               |   | 2003               |   |                                   | 2004 |                                 | 2003 
|                                          |  |                                    |   |                    |   |                                   |      |                                 |      
|Revenues
  (in thousands):                |  |                                    |   |                    |   |                                   |      |                                 |      
|Software
  licenses                       |  |                                    | $ | 2,164              |   |                                   |      | $                               | 1,855
|Software
  maintenance                    |  |                                    |   | 1,626              |   |                                   |      |                                 | 1,627
|Professional
  services and other         |  |                                    |   | 979                |   |                                   |      |                                 | 555  
|                                          |  |                                    |   |                    |   |                                   |      |                                 |      
|Total                                     |  |                                    | $ | 4,769              |   |                                   |      | $                               | 4,037
|                                          |  |                                    |   |                    |   |                                   |      |                                 |      
|                                          |  |                                    |   |                    |   |                                   |      |                                 |      
|Revenues by type (as% of total revenues): |  |                                    |   |                    |   |                                   |      |                                 |      
|Software
  licenses                       |  |                                    |   | 45                 | % |                                   |      |                                 | 46   
|Software
  maintenance                    |  |                                    |   | 34                 | % |                                   |      |                                 | 40   
|Professional
  services and other         |  |                                    |   | 21                 | % |                                   |      |                                 | 14   
|                                          |  |                                    |   |                    |   |                                   |      |                                 |      
|Total                                     |  |                                    |   | 100                | % |                                   |      |                                 | 100  
|                                          |  |                                    |   |                    |   |                                   |      |                                 |      

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

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

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

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

11

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Revenues by Segment
and Geography

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

|                                    |  | Three Months Ended
  September 30, |   | Percent
  Increase |   | Nine Months Ended
  September 30, |      | Percent
  Increase |      
|----------------------------------- |  | ---------------------------------- | - | ------------------ | - | --------------------------------- | ---- | ------------------ | -----
|                                    |  |                                    |   |                    |   |                                   |     
|                                    |  | 2004                               |   | 2003               |   |                                   | 2004 |                    | 2003 
|                                    |  |                                    |   |                    |   |                                   |      |                    |      
|Revenues
  (in thousands):          |  |                                    |   |                    |   |                                   |      |                    |      
|North
  American Data Analysis      |  |                                    | $ | 2,947              |   |                                   |      | $                  | 2,722
|International
  Data Analysis       |  |                                    |   | 1,542              |   |                                   |      |                    | 1,177
|North
  American Text Analysis      |  |                                    |   | 280                |   |                                   |      |                    | 138  
|                                    |  |                                    |   |                    |   |                                   |      |                    |      
|Total                               |  |                                    | $ | 4,769              |   |                                   |      | $                  | 4,037
|                                    |  |                                    |   |                    |   |                                   |      |                    |      
|                                    |  |                                    |   |                    |   |                                   |      |                    |      
|Revenues
  (as% of total revenues): |  |                                    |   |                    |   |                                   |      |                    |      
|North
  American Data Analysis      |  |                                    |   | 62                 | % |                                   |      |                    | 68   
|International
  Data Analysis       |  |                                    |   | 32                 | % |                                   |      |                    | 29   
|North
  American Text Analysis      |  |                                    |   | 6                  | % |                                   |      |                    | 3    
|                                    |  |                                    |   |                    |   |                                   |      |                    |      
|Total                               |  |                                    |   | 100                | % |                                   |      |                    | 100  
|                                    |  |                                    |   |                    |   |                                   |      |                    |      

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

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

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

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

Cost of Revenues

|                                              |  | Three Months Ended
  September 30, |   | Percent
  Increase
  (Decrease) |   | Nine Months Ended
  September 30, |      | PercentDecrease |      
|--------------------------------------------- |  | ---------------------------------- | - | ------------------------------- | - | --------------------------------- | ---- | --------------- | -----
|                                              |  |                                    |   |                                 |   |                                   |     
|                                              |  | 2004                               |   | 2003                            |   |                                   | 2004 |                 | 2003 
|                                              |  |                                    |   |                                 |   |                                   |      |                 |      
|Cost of
  revenues (in thousands):            |  |                                    |   |                                 |   |                                   |      |                 |      
|Software
  related                            |  |                                    | $ | 390                             |   |                                   |      | $               | 527  
|Professional
  services and other             |  |                                    |   | 526                             |   |                                   |      |                 | 511  
|                                              |  |                                    |   |                                 |   |                                   |      |                 |      
|Total                                         |  |                                    | $ | 916                             |   |                                   |      | $               | 1,038
|                                              |  |                                    |   |                                 |   |                                   |      |                 |      
|                                              |  |                                    |   |                                 |   |                                   |      |                 |      
|Cost of
  revenues
  (as% of total revenues): |  |                                    |   |                                 |   |                                   |      |                 |      
|Software
  related                            |  |                                    |   | 8                               | % |                                   |      |                 | 13   
|Professional
  services and other             |  |                                    |   | 11                              | % |                                   |      |                 | 13   
|                                              |  |                                    |   |                                 |   |                                   |      |                 |      
|Total                                         |  |                                    |   | 19                              | % |                                   |      |                 | 26   
|                                              |  |                                    |   |                                 |   |                                   |      |                 |      

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

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

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

12

---

---

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

Operating Expenses

Sales
and Marketing

|                                                         |  | Three Months Ended
  September 30, |   | Percent
  Increase |   | Nine Months Ended
  September 30, |      | Percent
  Decrease |      
|-------------------------------------------------------- |  | ---------------------------------- | - | ------------------ | - | --------------------------------- | ---- | ------------------ | -----
|                                                         |  |                                    |   |                    |   |                                   |     
|                                                         |  | 2004                               |   | 2003               |   |                                   | 2004 |                    | 2003 
|                                                         |  |                                    |   |                    |   |                                   |      |                    |      
|Sales and marketing expenses (in thousands)              |  |                                    | $ | 1,678              |   |                                   |      | $                  | 1,671
|Sales and marketing expenses (as percentage of revenues) |  |                                    |   | 35                 | % |                                   |      |                    | 41   

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

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

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

Research
and Development, Net

|                                                        |  | Three Months Ended
  September 30, |   | Percent
  Increase
  (Decrease) |   | Nine Months Ended
  September 30, |      | Percent
  Decrease |       
|------------------------------------------------------- |  | ---------------------------------- | - | ------------------------------- | - | --------------------------------- | ---- | ------------------ | ------
|                                                        |  |                                    |   |                                 |   |                                   |     
|                                                        |  | 2004                               |   | 2003                            |   |                                   | 2004 |                    | 2003  
|                                                        |  |                                    |   |                                 |   |                                   |      |                    |       
|Research and development (in thousands):                |  |                                    |   |                                 |   |                                   |      |                    |       
|Research
  and development                              |  |                                    | $ | 1,342                           |   |                                   |      | $                  | 1,646 
|Less
   Funded research                                |  |                                    |   | (650                            | ) |                                   |      |                    | (1,180
|                                                        |  |                                    |   |                                 |   |                                   |      |                    |       
|Research
  and development, net                         |  |                                    | $ | 692                             |   |                                   |      | $                  | 466   
|                                                        |  |                                    |   |                                 |   |                                   |      |                    |       
|                                                        |  |                                    |   |                                 |   |                                   |      |                    |       
|Research and development (as percentage of
  revenues): |  |                                    |   |                                 |   |                                   |      |                    |       
|Research
  and development                              |  |                                    |   | 28%                             |   |                                   |      |                    | 41%   
|Less
   Funded research                                |  |                                    |   | (13)%                           |   |                                   |      |                    | (29)% 
|                                                        |  |                                    |   |                                 |   |                                   |      |                    |       
|Research
  and development, net                         |  |                                    |   | 15%                             |   |                                   |      |                    | 12%   
|                                                        |  |                                    |   |                                 |   |                                   |      |                    |       

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

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

General
and Administrative

|                                                       |  | Three Months Ended
  September 30, |   | Percent
  Decrease |   | Nine Months Ended
  September 30, |      | Percent
  Increase |     
|------------------------------------------------------ |  | ---------------------------------- | - | ------------------ | - | --------------------------------- | ---- | ------------------ | ----
|                                                       |  |                                    |   |                    |   |                                   |     
|                                                       |  | 2004                               |   | 2003               |   |                                   | 2004 |                    | 2003
|                                                       |  |                                    |   |                    |   |                                   |      |                    |     
|General and administrative (in thousands)              |  |                                    | $ | 961                |   |                                   |      | $                  | 986 
|General and administrative (as percentage of revenues) |  |                                    |   | 20                 | % |                                   |      |                    | 24  

13

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

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

Restructuring
charges

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

Other Income, Net

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

Income Tax Expense

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

Loss from
Discontinued Operations, net of tax

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

Liquidity and Capital Resources

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

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

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

|                                                      |  | Nine Months Ended
  September 30, |  
|----------------------------------------------------- |  | --------------------------------- | -
|                                                      |  |                                   |  
|                                                      |  | 2004                              |  
|                                                      |  |                                   |  
|Net income (loss) from
  continuing operations        |  |                                   | $
|Add: non-cash expenses                                |  |                                   |  
|Deduct: changes in
  operating assets and liabilities |  |                                   |  
|                                                      |  |                                   |  
|Net cash provided by (used
  in) operating activities |  |                                   |  
|                                                      |  |                                   |  

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

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

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

14

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---

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

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

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

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

|                            |  | Before
  December 31, |   | Year Ending December 31, |  |      |   |      | 
|--------------------------- |  | --------------------- | - | ------------------------ |  | ---- | - | ---- | 
|                            |  |                       |   |                          |  |      |   |      | 
|                            |  | 2004                  |   | 2005                     |  | 2006 |   | 2007 | 
|                            |  |                       |   |                          |  |      |   |      | 
|Equipment term loan         |  |                       | $ | 32                       |  |      | $ | 129  | 
|Operating lease obligations |  |                       |   | 165                      |  |      |   | 605  | 
|                            |  |                       |   |                          |  |      |   |      | 
|Total                       |  |                       | $ | 197                      |  |      | $ | 734  | 
|                            |  |                       |   |                          |  |      |   |      | 

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

15

---

---

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

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

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

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

| |  | our primary
  reliance on one product family;                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                               
| |  | our ability
  to penetrate new markets;                                                                                                                       
| |   |                                                                                                                                                               
| |  | market
  acceptance of our products;                                                                                                                          
| |   |                                                                                                                                                               
| |  | our ability
  to compete in the highly competitive statistics, data mining and knowledge
  access markets;                                                    
| |   |                                                                                                                                                               
| |  | our ability
  to obtain government contracts and research grants;                                                                                             
| |   |                                                                                                                                                               
| |  | our ability
  to expand our sales and support infrastructure;                                                                                                 
| |   |                                                                                                                                                               
| |  | our ability
  to maintain our relationships with key partners;                                                                                                
| |   |                                                                                                                                                               
| |  | our ability
  to successfully expand our international operations;                                                                                            
| |   |                                                                                                                                                               
| |  | our ability
  to maintain third-party licenses;                                                                                                               
| |   |                                                                                                                                                               
| |  | general
  economic conditions, which may affect our customers purchasing decisions;                                                                          
| |   |                                                                                                                                                               
| |  | our ability
  to attract and retain key employees or management team members;                                                                                 
| |   |                                                                                                                                                               
| |  | integration
  of our new key management team members;                                                                                                         
| |   |                                                                                                                                                               
| |  | our ability
  to develop, introduce and market new products on a timely basis;                                                                                
| |   |                                                                                                                                                               
| |  | our ability
  to protect our intellectual property rights;                                                                                                    
| |   |                                                                                                                                                               
| |  | unanticipated
  legal costs; and                                                                                                                              
| |   |                                                                                                                                                               
| |  | uncertain
  costs associated with being a public company, such as the cost of being
  compliant with the provisions of The Sarbanes-Oxley Act of 2002, or SOX.

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

| |  | our sales
  cycles are lengthy and variable, typically ranging between two and eight
  months from our initial contact with a potential customer;                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                          
| |  | a
  substantial portion of our sales are completed at the end of the quarter and,
  as a result, a substantial portion of our license revenues are recognized in
  the last days of a quarter;                                                           
| |   |                                                                                                                                                                                                                                                          
| |  | the amount
  of unfulfilled orders for our products is typically small;  and                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                          
| |  | delay of new
  product releases can result in a customers decision to delay execution of a
  contract or, for contracts that include the new release as an element of the
  contract, will result in deferral of revenue recognition until such release.

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

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

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

16

---

---

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

17

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---

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

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

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

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

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

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

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

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

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

| |  | that we
  review all significant processes involved in the financial reporting and
  operating activities of the company for potential segregation-of-duties
  issues; review and test our expense and purchasing approval functions; and,
  as necessary, revise our processes and procedures around internal
  investigations.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                 
| |  | that we
  perform a detailed critique of our financial statement close process,
  domestically as well as internationally including implementing and
  documenting recurring close procedures and assessing our staffing levels.                                                                                                

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

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

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

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

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

18

---

---

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

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

| |  | costs of
  customizing products for foreign countries;                                                                                                                              
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                     
| |  | export and
  import restrictions, tariffs and other trade barriers;                                                                                                                 
| |   |                                                                                                                                                                                     
| |  | the need to
  comply with multiple, conflicting and changing laws and regulations;                                                                                                  
| |   |                                                                                                                                                                                     
| |  | separate
  management information systems and control procedures;                                                                                                                   
| |   |                                                                                                                                                                                     
| |  | reduced
  protection of intellectual property rights and increased liability exposure;
  and                                                                                        
| |   |                                                                                                                                                                                     
| |  | regional
  economic, cultural and political conditions, including the direct and
  indirect effects of terrorist activity and armed conflict in countries in
  which we do business.

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

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

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

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

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

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

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

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

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

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

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

19

---

---

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

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

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

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

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

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

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

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

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

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

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

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

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

| |  | stop or
  delay selling, incorporating or using products that incorporate the
  challenged intellectual property;                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                  
| |  | pay damages;                                                                                                                                                     
| |   |                                                                                                                                                                  
| |  | enter into
  licensing or royalty agreements, which may be unavailable on acceptable
  terms; or                                                                 
| |   |                                                                                                                                                                  
| |  | redesign
  products or services that incorporate infringing technology, which we might
  not be able to do at an acceptable price, in a timely fashion or at all.

20

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

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

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

Our stock price may
be volatile.

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

| |  | future
  announcements concerning us or our competitors;                          
| | - | ----------------------------------------------------------------------------------
| |   |                                                                                   
| |  | actual or
  anticipated quarterly variations in operating results;                
| |   |                                                                                   
| |  | changes in
  analysts earnings projections or recommendations;                   
| |   |                                                                                   
| |  | announcements
  of technological innovations;                                     
| |   |                                                                                   
| |  | the
  introduction of new products;                                               
| |   |                                                                                   
| |  | changes in
  product pricing policies by us or our competitors;                   
| |   |                                                                                   
| |  | loss of key
  personnel;                                                          
| |   |                                                                                   
| |  | deficiencies
  in our internal controls;                                          
| |   |                                                                                   
| |  | proprietary
  rights litigation or other litigation; or                           
| |   |                                                                                   
| |  | changes in
  accounting standards that adversely affect our revenues and earnings.

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

21

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|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
|------- | -----------------------------------------------------------

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

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

|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Disclosure Controls and Procedures

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

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

Internal Controls over Financial Reporting

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

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

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

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

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

Changes in internal controls

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

22

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|PART II. | OTHER INFORMATION
|-------- | -----------------
|         |                  
|ITEM 1.  | Legal Proceedings

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

|ITEM 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

None.

|ITEM 5. | Other Information
|------- | -----------------

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

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

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

(a)     See
Index to Exhibits.

23

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SIGNATURES

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

November 15, 2004

| | INSIGHTFUL CORPORATION
| | ----------------------
| |                       
| |                       
| | By:                   
| |                       
| |                       

November 15, 2004

| | INSIGHTFUL CORPORATION
| | ----------------------
| |                       
| |                       
| | By:                   
| |                       
| |                       

24

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EXHIBIT INDEX

|ExhibitNumber |  | Description
|------------- |  | -----------
|              |  |            
|3.1           |  |            
|              |  |            
|3.2           |  |            
|              |  |            
|3.3           |  |            
|              |  |            
|31.1          |  |            
|              |  |            
|31.2          |  |            
|              |  |            
|32.1          |  |            
|              |  |            
|32.2          |  |            

| | (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.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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