**SECURITIES
      AND EXCHANGE COMMISSION**
      **Washington,
      DC 20549**------------------------





**FORM
10-QSB**





**þ**  **QUARTERLY REPORT UNDER SECTION 13 OR 15(d)**


**OF
THE SECURITIES EXCHANGE ACT OF 1934**





**For
the Quarterly Period ended March 31, 2005**





**OR**





**o**  **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
THE SECURITIES EXCHANGE ACT OF 1934**





**For
the transition period from ___ to ___**





**Commission
      file number 0-020992**____________________**INSIGHTFUL
      CORPORATION**
      **(Exact
      name of registrant as specified in its
charter)**





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





**1700
      Westlake Avenue North, Suite 500, Seattle, Washington
      98109-3044******
      **(Address
      of principal executive offices) (Zip code)****(206)
      283-8802******
      **Registrant’s
      telephone number, including area code**________________________________________





Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. YES þ **** NO o





The
number of shares outstanding of the Registrant’s Common Stock, $0.01 par value,
was 12,426,085 shares as of May 10, 2005.





Transitional
Small Business Disclosure Format (Check one) YES o **** NO þ












**TABLE
OF CONTENTS**


****
    **Page****PART
      I. FINANCIAL INFORMATION**ITEM
      1. Consolidated Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of March 31, 2005 and December
      31, 2004
    2Condensed Consolidated Statements of Operations for the three months
      ended March 31, 2005 and 2004
    3Condensed Consolidated Statements of Cash Flows for the three months
      ended March 31, 2005 and 2004
    4Notes to Condensed Consolidated Financial
      Statements
    5ITEM
      2. Management’s Discussion and Analysis or Plan of
    Operations
    9ITEM
      3. Controls and Procedures
    21**PART
      II. OTHER INFORMATION**ITEM
      1. Legal Proceedings
    22ITEM
      6. Exhibits
    22SIGNATURES
    23


1


**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)**





**March
      31,**
      **2005**
    
    **December
      31,**
      **2004****(unaudited)****ASSETS**Current
      Assets:Cash
      and cash equivalents
    
    $
    9,561
    
    $
    9,650Trade
      accounts receivable, net
    
    
    3,452
    
    
    4,157Other
      receivables
    
    
    680
    
    
    501Prepaid
      expenses and other current assets
    
    
    702
    
    
    453Total
      current assets
    
    
    14,395
    
    
    14,761Property
      and equipment, net
    
    
    906
    
    
    966Purchased
      technology, net
    
    
    1,079
    
    
    1,226Goodwill
    
    
    800
    
    
    800Other
      assets
    
    
    60
    
    
    60$
    17,240
    
    $
    17,813**LIABILITIES
      AND STOCKHOLDERS’ EQUITY**Current
      Liabilities:Current
      portion of long-term debt
    
    $
    129
    
    $
    129Accounts
      payable
    
    
    884
    
    
    1,644Accrued
      payroll-related liabilities
    
    
    1,374
    
    
    1,358Accrued
      expenses and other current liabilities
    
    
    451
    
    
    554Deferred
      revenue
    
    
    6,209
    
    
    6,318Total
      current liabilities
    
    
    9,047
    
    
    10,003Long-term
      debt, less current portion
    
    
    -
    
    
    32Commitments
      and contingenciesStockholders’
      Equity:Preferred
      stock, $0.01 par value-Authorized-1,000,000
      sharesIssued
      and outstanding-none
    
    
    -
    
    
    -Common
      stock, $0.01 par value-Authorized-20,000,000
      sharesIssued
      and outstanding-12,422,885 and 12,393,950, shares
      at
      March 31, 2005 and December 31, 2004, respectively
    
    
    124
    
    
    124Additional
      paid-in capital
    
    
    36,381
    
    
    36,329Accumulated
      deficit
    
    
    (28,049
    )
    
    (28,383
    )Other
      accumulated comprehensive loss-cumulative translation
      adjustment
    
    
    (263
    )
    
    (292
    )Total
      stockholders’ equity
    
    
    8,193
    
    
    7,778$
    17,240
    
    $
    17,813





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




2


****


**INSIGHTFUL
CORPORATION AND SUBSIDIARIES**




**CONDENSED
CONSOLIDATED STATEMENTS OF INCOME**


**(In
thousands, except per share data)**


**(unaudited)**





**Three
      Months Ended March 31**,**2005**
    
    **2004**Revenues:Software
      licenses
    
    $
    2,527
    
    $
    2,168Software
      maintenance
    
    
    1,609
    
    
    1,632Professional
      services and other
    
    
    1,122
    
    
    535Total
      revenues
    
    
    5,258
    
    
    4,335Cost
      of revenues:Software
      related
    
    
    404
    
    
    417Professional
      services and other
    
    
    762
    
    
    536Total
      cost of revenues
    
    
    1,166
    
    
    953Gross
      profit
    
    
    4,092
    
    
    3,382Operating
      expenses:Sales
      and marketing
    
    
    1,865
    
    
    1,493Research
      and development
    
    
    1,252
    
    
    1,409Less-Funded
      research
    
    
    (526
    )
    
    (1,012
    )Research
      and development, net
    
    
    726
    
    
    397General
      and administrative
    
    
    1,074
    
    
    1,197Amortization of
      intangibles
    
    
    -
    
    
    22Total operating expenses
    
    
    3,665
    
    
    3,109Income
      from operations
    
    
    427
    
    
    273Other
      expense, net
    
    
    74
    
    
    37Income
      before income taxes
    
    
    353
    
    
    236Income
      tax expense
    
    
    19
    
    
    11Net
      income
    
    $
    334
    
    $
    225Basic
      and diluted net income per share
    
    $
    0.03
    
    $
    0.02Weighted
      average common shares outstanding
    
    
    12,395
    
    
    11,654Weighted
      average common shares assuming dilution
    
    
    12,933
    
    
    11,921








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




3




**INSIGHTFUL
CORPORATION AND SUBSIDIARIES**




**CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(In
thousands)**


**(unaudited)**


**Three
      Months Ended March 31,****2005**
    
    **2004**Operating
      activities:Net
      income
    
    $
    334
    
    $
    225Adjustments
      to reconcile net income from operations to net cash provided by (used in)
      operating activities:Depreciation,
      amortization and other non-cash charges
    
    
    306
    
    
    349Changes
      in current assets and liabilities:Trade
      and other accounts receivable
    
    
    444
    
    
    145Prepaid
      expenses and other assets
    
    
    (255
    )
    
    (52
    )Accounts
      payable
    
    
    (247
    )
    
    309Accrued
      payroll-related liabilities and other accrued expenses
    
    
    (64
    )
    
    (847
    )Deferred
      revenue
    
    
    (13
    )
    
    251Net
      cash provided by operating activities
    
    
    505
    
    
    380Investing
      activities:Purchases
      of property and equipment
    
    
    (110
    )
    
    (5
    )Payment
      made for purchase of technology
    
    
    (500
    )
    
    (1,265
    )Net
      cash used in investing activities
    
    
    (610
    )
    
    (1,270
    )Financing
      activities:Payments
      on debt
    
    
    (32
    )
    
    (32
    )Proceeds
      from exercise of stock options and employee stock purchase
      plan
    
    
    52
    
    
    992Net
      cash provided by financing activities
    
    
    20
    
    
    960Effect
      of exchange rate changes on cash and cash equivalents
    
    
    (4
    )
    
    7Net
      increase (decrease) in cash and cash equivalents
    
    
    (89
    )
    
    77Cash
      and cash equivalents, beginning of period
    
    
    9,650
    
    
    7,139Cash
      and cash equivalents, end of period
    
    $
    9,561
    
    $
    7,216Supplemental
      disclosure of cash flow information:Cash
      paid for:Interest
    
    $
    4
    
    $
    11Income
      taxes
    
    $
    8
    
    $
    24Supplemental
      disclosure of non-cash investing information - portion ofpurchased
      technology accrued in accounts payable
    
    $
    -
    
    $
    500





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




4









**INSIGHTFUL
CORPORATION AND SUBSIDIARIES**


**NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**(unaudited)**


**March** **31, 2005**


****


**(1)**
    **DESCRIPTION
      OF BUSINESS AND BASIS OF
PRESENTATION**
 
 **a)**
    **Description
      of Business**


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





Insightful’s
products include S-PLUS® and
S-PLUS Server, Insightful MinerTM, InFact® and various verticalized S-PLUS
toolkits such as S+ArrayAnalyzer® and
S+FinMetricsTM .
Insightful’s consulting services and training provide specialized expertise and
processes for the design, development and deployment of analytical solutions.





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





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





**(b)**
    **Unaudited
      Interim Financial Information**
 
 The
accompanying unaudited condensed consolidated financial statements have been
prepared by Insightful pursuant to accounting principles generally accepted in
the United States and the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. The balance sheet at
December 31, 2004 has been derived from audited financial statements at that
date, but does not include all disclosures required by generally accepted
accounting principles for complete financial statements. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto for the year ended December
31, 2004 included in Insightful's Annual Report on Form 10-K. The accompanying
condensed consolidated financial statements reflect all adjustments (consisting
solely of normal, recurring adjustments), which, in the opinion of management,
are necessary for a fair presentation of results for the interim periods
presented. The results of operations for the three month period ended March 31,
2005 are not necessarily indicative of the results to be expected for the entire
fiscal year or future years.


**(2)**
    **SIGNIFICANT
      ACCOUNTING POLICIES**
 
 **(a)**
    **Principles
      of Consolidation**
 
 The
accompanying consolidated financial statements include the accounts of
Insightful and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in
consolidation.





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





Revenue
from fixed-term licenses is recognized on a straight-line basis over the license
term if all other aspects of SOP 97-2 are satisfied. Revenues under arrangements
that include several different software products and services sold together are
allocated based on the residual method in accordance with SOP No. 98-9. Under
the residual method, the fair value of the undelivered non-essential elements is
deferred and subsequently recognized when earned.





Insightful
has established VSOE of fair value for professional services and training
services. In addition, the Company has established VSOE for maintenance related
to most of its products. For software products sold with maintenance where VSOE
for the maintenance element has not been established, such as InFact, all
revenue under the arrangement is recognized over the maintenance term provided
all other revenue recognition criteria have been met. VSOE is based on the price
charged when an element is sold separately or, in case of an element not yet
sold separately, the price established by authorized management, if it is
probable that the price, once established, will not change before market
introduction. 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 t he 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.





5





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





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





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





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





**(c)**
    **Stock-Based
      Compensation**


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





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





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





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**
      **March
      31,****2005**
    
    **2004**Net
      income as reported
    
    $
    334
    
    $
    225Employee
      stock-based compensation, as reported
    
    
    -
    
    
    -Employee
      stock-based compensation determined under the fair value
      method
    
    
    (499
    )
    
    (471
    )Pro
      forma net income (loss)
    
    
    (165
    )
    $
    (246
    )Basic
      and diluted net income (loss) per share as reported
    
    $
    0.03
    
    $
    0.02Pro
      forma basic and diluted net income (loss) loss per share
    
    $
    (0.01
    )
    $
    (0.02
    )


****


**(d)**
    **Reclassification
      of Amounts**
 
 Certain prior year amounts have been reclassified to conform to the current year
presentation.


****


**(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 months ended
March 31, 2005 and 2004, the Company recorded $147,000 and $99,000,
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; the remaining $0.5 million was paid in the first quarter of 2005.


**(4)**
    **FINANCING
      ARRANGEMENTS**
  6





In March
2005, the Company renewed a working capital revolving line of credit and
security agreement with Silicon Valley Bank. The terms provide for up to $3.0
million in borrowing availability through March 25, 2006. This facility is
secured by the Company’s accounts receivable and allows it to borrow up to the
lesser of 75% of its eligible accounts receivable or $3.0 million and bears
interest at the prime rate, which was 5.75% as of March 31, 2005, plus 1%. At
March 31, 2005, no amounts had been borrowed under the line of credit
facility.





At March
31, 2005, the Company also had an outstanding balance on the equipment loan with
Silicon Valley Bank, secured by the underlying assets. The Company borrowed
$450,000 under this facility in 2002 and the remaining outstanding balance was
$129,000 at March 31, 2005. This loan bears interest at the prime rate plus 1%
and is being repaid over a 42-month period, ending in March of 2006.





These
credit facilities contain covenants that limit the Company’s net losses and
restrict the amount of capital expenditures not financed through the equipment
term loan. In addition, the Company is prohibited under these facilities from
paying dividends. The Company was in compliance with these covenants as of March
31, 2005.





Future
maturities of debt as of March 31, 2005 are $97,000 before December 31, 2005 and
$32,000 for the year ending December 31, 2006.


**(5)**
    **NET
      INCOME (LOSS) PER SHARE**
 
 The following is a reconciliation of the number of shares used in the basic and
diluted net income per share computations for the periods presented (in
thousands):




**Three
      Months Ended**
      **March
      31,****2005**
    
    **2004**Shares
      used in basic net income per share computation
    
    
    12,395
    
    
    11,654Effect
      of dilutive potential common shares resulting from stock
      options
    
    
    538
    
    
    267Shares
      used in diluted net income per share computation
    
    
    12,933
    
    
    11,921





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**
      **March
      31,****2005**
    
    **2004**Weighted-average
      stock options excluded from the computation of diluted net
      income
    
    
    603
    
    
    393


**(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 is foreign currency translation adjustments. Total comprehensive income
is as follows (in thousands):





**Three
      Months Ended**
      **March
      31,****2005**
    
    **2004**Net
      income
    
    $
    334
    
    $
    225Change
      in cumulative translation adjustment
    
    
    29
    
    
    46Comprehensive
      income
    
    $
    363
    
    $
    271


**(7)**
    **SEGMENT
      REPORTING**
 
 SFAS No.
131, “Disclosures About Segments of an Enterprise and Related Information,”
establishes standards for reporting information about operating segments in
annual financial statements. It also establishes standards for related
disclosures about products, services, geographical areas and major customers.
Business segment information includes the segments of North American Data
Analysis, International Data Analysis and Text Analysis. The Company measures
segment performance based on their revenues and contribution margin, which is a
measure of profitability that allocates only direct and controllable costs to a
segment. Depreciation expense is not allocated by segment. Assets are not
allocated to segments for internal reporting presentations. Intercompany
transactions have been eliminated from the segment information. Non-operating
income and expenses are not tracked by segment. Segment information is provided
below (in thousands):





7




**North**
      **American
      Data**
      **Analysis**
    
    **International**
      **Data
      Analysis**
    
    **Text
      Analysis**
    
    **Total****Three
      months ended March 31, 2005**Revenues
    
    $
    2,797
    
    
    1,926
    
    
    535
    
    $
    5,258Contribution
      margin
    
    
    1,393
    
    
    651
    
    
    261
    
    
    2,305Unallocated
      costs and expenses
    
    
    
    
    
    
    
    
    
    
    
    (1,878
    )Income
      from operations
    
    
    
    
    
    
    
    
    
    
    $
    427**Three
      months ended March 31, 2004**Revenues
    
    $
    2,771
    
    
    1,400
    
    
    164
    
    $
    4,335Contribution
      margin
    
    
    1,360
    
    
    477
    
    
    41
    
    
    1,878Unallocated
      costs and expenses
    
    
    
    
    
    
    
    
    
    
    
    (1,605
    )Income
      from operations
    
    
    
    
    
    
    
    
    
    
    $
    273


**(8)**
    **BUSINESS
      RESTRUCTURING**


On September 30, 2003, Shawn Javid, President and CEO, resigned from the
company. Termination benefits associated with the resignation of Mr. Javid were
included in restructuring expenses recorded in 2003. During
the three months ended March 31, 2005, the Company paid $52,000 associated with
Mr. Javid’s termination benefits. As of March 31, 2005, $22,000 in termination
benefits remained to be paid. All termination benefits will be paid by June 30,
2005. No additional expenses are expected to be incurred in connection with the
2003 restructuring or Mr. David’s termination.


**(9)**
    **COMMITMENTS
      AND CONTINGENCIES**




In
certain of its licensing agreements, the Company provides intellectual property
infringement indemnifications. These indemnifications are excluded from the
initial recognition and measurement requirements of FASB Interpretation No. 45, *Guarantor's
Accounting and Disclosure Requirements for Guarantees. Including Indirect
Guarantees of Indebtedness of Others* . The
Company's policy is to record any obligation under such indemnification when a
required payment under such indemnification is probable and the amount of the
future loss is estimable. At March 31, 2005, there were no such indemnifications
for which a required payment was deemed to be probable or estimable; therefore,
no accrual has been made for potential losses associated with these
indemnifications.


On
December 13, 2002, Wajih Alaiyan, a former employee, filed a complaint against
us in the Superior Court for King County, Washington. Mr. Alaiyan was formerly
employed by the Company and he alleged that his employment was wrongfully
terminated. On December 5, 2003, the court granted summary judgment in the
Company’s favor, dismissing the complaint. The ex-employee filed an appeal with
the Court of Appeals for the State of Washington, and oral arguments were
presented on November 9, 2004. The Company is awaiting the outcome of the
appeal. If the Company loses the appeal, it will likely resume litigation in the
lower court, where it expects to continue to vigorously defend itself against
the ex-employee’s claim, which the Company denies. The ex-employee seeks an
unspecified amount of damages. The Company is unable to evaluate the likelihood
of an adverse outcome.




8


**ITEM
      2.**
    **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OR PLAN OF
OPERATIONS**
 **
 *The
following discussion and analysis should be read in conjunction with our
Consolidated Financial Statements included elsewhere in this
report.*





**Forward-Looking
Statements**





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





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




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




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




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




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




·
    information
      about the anticipated release dates of new
products;




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




·
    other
      statements that are not historical facts.




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





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





**Description
of the Company**





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





Our
products include S-PLUS® and
S-PLUS Server, Insightful MinerTM, InFact® and various verticalized S-PLUS
toolkits such as S+ArrayAnalyzer® and
S+FinMetricsTM . Our
consulting services and training provide specialized expertise and processes for
the design, development and deployment of analytical solutions.





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





Headquartered
in Seattle, Washington, we also have North American offices in New York City and
North Carolina and international offices in France, Switzerland, and the United
Kingdom, with distributors around the world. At March 31, 2005, we had 111
employees, 88 of which were located in the United States and 23 of which were in
our international locations.





We
originally incorporated in Massachusetts in 1984 as Mathsoft, Inc. and
reincorporated in Delaware in 2001. Our principal executive offices are located
at 1700 Westlake Ave. N. Suite 500, Seattle, Washington 98109, and our telephone
number is (206) 283-8802. Our Internet address is http://www.insightful.com.





**Products**





***Data
Analysis Products*** **


*S-PLUS*® **


9





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





*Insightful
MinerTM*





Insightful
Miner is a scalable data analysis workbench for predictive modeling, data mining
and statistical data analysis. It has a drag-and-drop interface intended to make
it easy to create self-documenting visual workmaps. Insightful Miner provides
data miners, business analysts and data analysis professionals with a suite of
scalable components for data access, management and modeling, and its pipeline
architecture allows the user to process large data sets. Insightful Miner is an
open and extensible tool that offers full integration with the S-PLUS
programming language. Insightful Miner offers deployment capabilities via batch
mode, predictive model markup language (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 life sciences markets to allow users to perform specialized data
analysis. For example, S+FinMetricsTM is designed to provide the financial
services market with comprehensive software for modeling, analyzing and
visualizing financial market data, offering a modern and flexible analytic
environment for reliable and robust predictive econometric modeling.
S+ArrayAnalyzer® is designed to enable pharmaceutical companies to obtain
statistically rigorous information from microarray technology, shortening
time-to-discovery for competitive advantage.





*Server
Products*





Our
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 with standard
database and file formats. With our server products, statistical models and data
visualization capabilities are built and stored in a central server for access
by non-technical users, who can apply these analytical techniques using a Web
browser interface, or dedicated graphical user interfaces written using
Java® technology. Our server products are designed to enable end-users to analyze and
understand technical or business information without requiring expertise in
statistics or statistical tools.





***Text
Analysis Products*** **





*InFact*®





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





***Maintenance
and Support*** **





We
provide product updates and unspecified product upgrades and customer support
services under an annual maintenance agreement for most of our Data Analysis
products and under the annual term based license agreement for InFact. The
initial one-year maintenance contract is bundled into the license fees on most
of our Data Analysis products.





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





***Services*** **





Our
consulting and training organization provides fee-based services, including
providing assistance in developing complex statistical models or data or text
analysis techniques. In addition, they include deployment assistance, project
management, integration with existing customer applications and related services
to our customers. We also offer a series of fee-based training courses to our
customers. Courses can be taken at Insightful 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.




10





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





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





***Sales
Returns***





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





***Bad
Debts***


**


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





***Impairment
of Goodwill and Other Long Lived Assets***


**


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





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





***Contingencies***


**


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





**Results
of Operations for the Three Months Ended March 31, 2005 and
2004**





***Revenues
by Type***


**


**Three
      Months Ended**
      **March
      31,**
    
    **Percent****Increase****2005**
    
    **2004**
    
    **(Decrease)****Revenues
      (in thousands):**Software
      licenses
    
    $
    2,527
    
    $
    2,168
    
    
    17
    %Software
      maintenance
    
    
    1,609
    
    
    1,632
    
    
    (1
    )%Professional
      services and other
    
    
    1,122
    
    
    535
    
    
    110
    %Total
    
    
    5,258
    
    
    4,335
    
    
    21
    %**Revenues
      by type (as % of total revenues):**Software
      licenses
    
    
    48
    %
    
    50
    %Software
      maintenance
    
    
    31
    %
    
    38
    %Professional
      services and other
    
    
    21
    %
    
    12
    %Total
    
    
    100
    %
    
    100
    %





Software
license revenues, consisting of software licenses and subscriptions, increased
for the three months ended March 31, 2005, as compared to the corresponding
period of 2004, due to the increase in sales of data analysis products
internationally where we have added to and improved the effectiveness of our
sales staff. In addition, the increase is due to an increase in license revenues
from our Text Analysis segment.





Software
maintenance revenues for the three months ended March 31, 2005, were comparable
to those for the three months ended March 31, 2004.





Professional
services revenue is generated from consulting and training activities. The
increase in professional services and other revenues for the three months ended
March 31, 2005, as compared to the corresponding period of 2004, 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. In addition, professional services revenue for the
three months ended March 31, 2005 includes $180,000 in revenues generated by our
Text Analysis segment, compared to none in the first quarter of
2004.





11





***Revenues
by Segment***


**


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





**Three
      Months Ended**
      **March
      31,**
    
    **Percent****2005**
    
    **2004**
    
    **Increase****Revenues
      (in thousands):**North
      American Data Analysis
    
    $
    2,797
    
    $
    2,771
    
    
    1
    %International
      Data Analysis
    
    
    1,926
    
    
    1,400
    
    
    38
    %Text
      Analysis
    
    
    535
    
    
    164
    
    
    226
    %Total
    
    
    5,258
    
    
    4,335
    
    
    21
    %**Revenues
      (as % of total revenues):**North
      American Data Analysis
    
    
    53
    %
    
    64
    %International
      Data Analysis
    
    
    37
    %
    
    32
    %Text
      Analysis
    
    
    10
    %
    
    4
    %Total
    
    
    100
    %
    
    100
    %





The
slight increase in North American Data Analysis revenues for the three months
ended March 31, 2005, as compared to the corresponding period of 2004, is due
primarily to an increase in professional services revenues of approximately
$215,000 resulting from our increased emphasis on training and consulting,
offset in part by a decline of $175,000 in software license revenues.





The
increase in International Data Analysis revenues for the three months ended
March 31, 2005, as compared to the corresponding period of 2004, 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 of our European organization in mid-2003, resulting
in the creation of direct sales organizations that focus on building
relationships with large target accounts. This initiative allowed us to expand
our customer base to drive more deployment and enterprise transactions,
incorporating both license sales and services.





The
increase in Text Analysis revenues recognized for the three months ended March
31, 2005, as compared to the corresponding period of 2004, relates to increased
bookings of InFact subscription licenses in the periods preceding the first
quarter of 2005, as compared to bookings in the corresponding period preceding
the first quarter of 2004. Revenues from subscription licenses, including InFact
licenses, are recognized ratably over the subscription period, which is
generally one year. We had no subscription bookings with new customers in our
Text Analysis segment in the first quarter of 2005. Also contributing to the
increase in revenues for the Text Analysis segment in the first quarter of 2005
was the inclusion of $180,000 in professional services revenue, as compared to
none in the corresponding period of 2004. We expect a decrease in Text Analysis
revenues in the second quarter of 2005 when compared to the first quarter of
2005.





***Cost
of Revenues***


**


**Three
      Months Ended**
      **March
      31,**
    
    **Percent****Increase****2005**
    
    **2004**
    
    **(Decrease)****Cost
      of revenues (in thousands):**Software
      related
    
    $
    404
    
    $
    417
    
    
    (3
    )%Professional
      services and other
    
    
    762
    
    
    536
    
    
    42
    %Total
    
    
    1,166
    
    
    953
    
    
    22
    %Cost
      of software related revenues as a % of software related
      revenues
    
    
    10
    %
    
    11
    %Cost
      of professional services and other revenues as a % of professional
      services and other revenues
    
    
    68
    %
    
    100
    %Total
    
    
    22
    %
    
    22
    %





Cost of
software-related revenues consists of royalties for third-party software,
product media, product duplication, manuals and maintenance and technical
support costs, and amortization of the costs of the software code underlying the
"S" programming language purchased from Lucent Technologies Inc. Cost of
software-related revenue decreased slightly for the three months ended
March 31, 2005, as compared to the corresponding periods of 2004, due primarily
to a reduction in maintenance update costs, offset in part by higher
amortization of the “S” programming acquisition cost, which was recorded for a
full quarter for the three months ended March 31, 2005 compared to a partial
quarter in the corresponding period of 2004 due to the timing of the
purchase.





Cost of
professional services and other revenues consists primarily of salaries and
other labor related costs of employees who provide consulting services and
training. The increase in cost of professional services and other revenues for
the three months ended March 31, 2005, as compared to the corresponding period
of 2004, was due primarily to the redeployment of team members from our Text
Analysis group and our research and development team, who were previously
utilized primarily for government grant-funded research, to professional
services engagements. Cost of software related revenues can fluctuate from
quarter to quarter depending on the mix of revenues and depending on whether a
particular quarter includes the cost of a license upgrade to existing
maintenance customers.





The costs
of professional services and other revenues, as a percentage of revenues,
decreased in the three months ended March 31, 2005, as compared to the
corresponding period of 2004, due to higher utilization rates and billable
productivity of our consulting professionals. Cost of professional services and
other revenues as a percentage of revenues can fluctuate from quarter to quarter
based primarily on the billing productivity of our consultants, since these
costs are relatively fixed in the short-term.





***Operating
Expenses***


**


12





*Sales
and Marketing*





**Three
      Months Ended**
      **March
      31,**
    
    **Percent****2005**
    
    **2004**
    
    **Increase**Sales
      and marketing expenses (in thousands)
    
    $
    1,865
    
    $
    1,493
    
    
    25
    %Sales
      and marketing expenses (as percentage of revenues)
    
    
    35
    %
    
    34
    %





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 increase in absolute dollars of sales and
marketing expenses for the three months ended March 31, 2005, as compared to the
corresponding period of 2004, is due primarily to the hiring of additional
salespeople in both the U.S. and Europe and higher expenditures on certain
marketing events and promotional activities. We expect sales and marketing
expenses to increase in future periods as we recruit and hire additional
personnel, including executives, and expand our marketing programs.





*Research
and Development, Net*





**Three
      Months Ended**
      **March
      31,**
    
    **Percent****Increase****2005**
    
    **2004**
    
    **(Decrease)****Research
      and development (in thousands):**Research
      and development
    
    $
    1,252
    
    $
    1,409
    
    
    (11
    )%Less
      - funded research
    
    
    (526
    )
    
    (1,012
    )
    
    (48
    )%Research
      and development, net
    
    $
    726
    
    $
    397
    
    
    83
    %**Research
      and development (as percentage of revenues):**Research
      and development
    
    
    24
    %
    
    32
    %Less
      - funded research
    
    
    (10
    )%
    
    (23
    )%Research
      and development, net
    
    
    14
    %
    
    9
    %





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 in absolute dollars in
the net research and development costs for the three months ended March 31,
2005, as compared to the corresponding period of 2004, primarily reflects the
decline in reimbursements from government research grants resulting in part from
the pursuit of fewer grants, as we continue to focus our research efforts
towards further development of technology more closely aligned with our
commercial product lines. The decrease in gross research and development
expenses is due primarily to a reduction in research personnel as well as the
use of our research and development staff for consulting services. We expect our
research and development expenses to increase in future periods as we add to our
development staffing and continue to narrow our funded research focus.








*General
and Administrative*


**Three
      Months Ended**
      **March
      31,**
    
    **Percent****2005**
    
    **2004**
    
    **(Decrease)**General
      and administrative (in thousands)
    
    $
    1,074
    
    $
    1,197
    
    
    (10
    )%General
      and administrative (as percentage of revenues)
    
    
    20
    %
    
    28
    %





General
and administrative expenses consist primarily of salaries and related costs
associated with finance, accounting, legal, corporate governance, investor
relations and administration. The decline in general and administrative expenses
for the three months ended March 31, 2005, as compared to the corresponding
period of 2004, is primarily related to significant legal costs incurred in the
first quarter of 2004 associated with the acquisition of the “S” programming
language from Lucent Technologies Inc. in January 2004, offset in part by higher
personnel costs and consulting services related to compliance with the
Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley.





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





***Other
Expense, net***





Other
expense, net, consists primarily of foreign exchange transaction gains and
losses, interest income, and interest expense. The
increase in other expense, net, for the three months ended March 31, 2005, as
compared to the corresponding period of 2004, is due primarily to foreign
exchange transactions losses resulting from a
strengthening of the US dollar rate on US denominated intercompany amounts due
from our international subsidiaries to the US parent company. Foreign exchange
transaction losses were $116,000 in the first quarter of 2005 compared to
$45,000 in the corresponding period of 2004. The increase in other expense, net,
was offset partially by a $26,000 increase in interest income resulting from
increased invested cash balances and the related rate of return on those
investments in the corresponding periods.




13


******


***Income
Tax Expense***





Income
tax expense for the three months ended March 31, 2005 was $19,000, compared to
$11,000 for the corresponding period of 2004. The increase in income tax expense
is a result of the increase in operating income in the first quarter of 2005 as
compared to the corresponding period of 2004.





**Liquidity
and Capital Resources**





Cash
and cash equivalents decreased from $9.7 million at December 31, 2004 to $9.6
million at March 31, 2005. Our working capital increased from $4.8 million at
December 31, 2004 to $5.3 million at March 31, 2005.





We
generated $0.5 million in cash from operating activities for the three months
ended March 31, 2005 compared to $0.4 million for the corresponding period of
2004. The increase in operating cash inflows relates primarily to an increase in
profitability.





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





**Three
      Months Ended**
      **March
      31,****2005**
    
    **2004**Net
      income
    
    $
    334
    
    $
    225Add:
      non-cash expenses
    
    
    306
    
    
    349Deduct:
      changes in non-cash operating assets and liabilities
    
    
    (135
    )
    
    (194
    )Net
      cash provided by operating activities
    
    
    505
    
    
    380





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





Investing
activities resulted in net cash outflows of $0.6 million for the three months
ended March 31, 2005 compared to net cash outflows of $1.3 million for the
corresponding period of 2004. The decrease in cash outflows from investing
activities relates primarily to the purchase of the “S” programming language
from Lucent Technologies in the first quarter of 2004, which required a cash
payment of $1.5 million.





Financing
activities resulted in net cash inflows of $20,000 for the three months ended
March 31, 2005 compared to net cash inflows of $960,000 for the three months
ended March 31, 2004. The decrease in cash inflows from financing activities
relates primarily to a decrease in the proceeds received from the exercise of
employee stock options and contributions to our employee stock purchase
plan.





In
March 2005, we renewed a working capital revolving line of credit and security
agreement with Silicon Valley Bank. The terms provide for up to $3.0 million in
borrowing availability through March 25, 2006. This facility is secured by our
accounts receivable and allows us to borrow up to the lesser of 75% of our
eligible accounts receivable or $3.0 million and bears interest at the prime
rate, which was 5.75% as of March 31, 2005, plus 1%. At March 31, 2005, no
amounts had been borrowed under the line of credit facility.





At March
31, 2005, we also had an outstanding balance on the equipment loan with Silicon
Valley Bank, secured by the underlying assets. We borrowed $450,000 under this
facility in 2002 and the remaining outstanding balance was $129,000 at March 31,
2005. This loan bears interest at the prime rate plus 1% and is being repaid
over a 42-month period, ending in March of 2006.





These
credit facilities contain covenants that limit our net losses and restrict the
amount of capital expenditures not financed through the equipment term loan. In
addition, we are prohibited under these facilities from paying dividends. We
were in compliance with these covenants as of March 31, 2005.





At March
31, 2005, our principal unused sources of liquidity consisted of cash and cash
equivalents of $9.6 million and our bank line of credit. Our liquidity needs are
principally for financing of accounts receivable, capital assets, strategic
investments, product development, and flexibility in a dynamic and competitive
operating environment.





**Commitments**





As
of March 31, 2005, our contractual commitments associated with our operating
leases, primarily for our office space in Seattle, Washington, as well as other
domestic and international locations, and equipment financing are as follows (in
thousands):




**Before**
      **December
      31,**
    
    **Year
      Ending December 31,****2005**
    
    **2006**
    
    **2007**
    
    **2008**
    
    **2009**
    
    **Thereafter**
    
    **Total**Equipment
      term loan
    
    $
    97
    
    $
    32
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    129Operating
      lease obligations
    
    
    511
    
    
    656
    
    
    526
    
    
    46
    
    
    40
    
    
    30
    
    
    1,809Total
    
    $
    607
    
    $
    613
    
    $
    451
    
    $
    46
    
    $
    40
    
    $
    30
    
    $
    1,937
  14


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





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





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





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





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





•
    our
      primary reliance on one product family;


•
    our
      ability to penetrate new markets;


•
    market
      awareness and acceptance of our products;


•
    our
      ability to compete in the highly competitive statistics, data mining and
      text analysis 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;


•
    elongated
      sales cycles and potential sales delays;


•
    fluctuations
      in foreign currency exchange rates;


•
    losses
      associated with expected increases in our
expenses;


•
    our
      ability to maintain effective internal financial and managerial systems,
      controls and procedures;


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


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


•
    our
      ability to obtain funding that may be necessary to support the expansion
      of our business;


•
    our
      ability to successfully expand our international
    operations;


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


•
    integration
      of our new key employees, including our senior management team
      members;


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


•
    our
      ability to protect our intellectual property
rights;


•
    our
      ability to maintain third-party licenses;
and


•
    defects
      or errors in our software, which may result in losses of customers or
      revenues.





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





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


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


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


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





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





15


******


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





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





We have
publicly announced a significant new product release for sometime in 2005. If
that release does not meet our expectations or the expectations of our
customers, our reputation may suffer and our operating results will be harmed.





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





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


******


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





One of
our newest products, InFact, targets the text analysis market. This product has
not contributed substantial revenues to date. The market for relationship search
solutions like InFact 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 text
analysis markets, our business will fail.***





Our
S-PLUS product suite targets the statistics and data analysis market. This
market is highly competitive, fragmented and mature. We face competition in the
statistics and data analysis market primarily from large enterprise software
vendors and 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., The Mathworks and Minitab,
Inc. In addition to competition from other statistical software companies, we
face competition from providers of software for specific statistical
applications. In the data mining and text analysis market, we face competition
from many companies, including SAS Institute, SPSS, IBM, NCR, Autonomy, Verity,
Inxight, ClearForest and Iphrase, many of which are much larger than we are.





In
addition, as we develop other new products, or attempt to expand our sales into
new vertical and end-user markets, we may begin competing with companies with
whom we have not previously competed. It is also possible that new competitors
will enter our markets. An increase in competitive pressures in our market or
our failure to compete effectively may result in pricing reductions, reduced
gross margins and loss of market share. Many of our competitors have longer
operating histories, greater name recognition, greater market share, larger
customer bases and significantly greater financial, technical, marketing and
other resources than we do. We could also experience competition from companies
in other sectors of the broader market for business intelligence software, like
providers of on-line analytical processing, 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. During the fiscal years 2001 through
2003, these contracts generated from $4.3 to $4.8 million annually in offsets to
our research and development expenses. During 2004, we began realigning our
research and development efforts to ensure that we only pursue projects that
directly support our business strategy. As a result of this realignment, we have
applied for and received fewer government research contracts, and for the year
ended December 31, 2004, research contracts generated $2.9 million. Further
reductions in these offsets to our research and development expenses are likely
and will negatively affect our operating results. Further, we may not receive
new funded research contracts or any renewals of government-funded projects
currently in process, and we may decide to cancel or reassign certain ongoing
projects that are not aligned with our core business needs. The personnel and
other costs associated with these programs are relatively fixed in the short
run, and a sudden cancellation or non-renewal of a major funding program or
multiple smaller programs would be harmful to our operating results. A
substantial portion of the research grant money we receive is granted to us
based on our status as a small business, the definition of which varies
depending on the individual contract terms. If the number of our employees or
the amount of our revenues ever grows beyond the limits prescribed in any of
these contracts, we will no longer be eligible for such research contracts and
we will have to incur certain research and development expenses without the
benefit of offsets.





Furthermore,
a significant portion of our license revenues come from 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.





***Our
sales cycle is variable, and our limited ability to predict revenues could cause
our operating results to fluctuate, which could cause a decline in our stock
price.***





An
enterprise’s decision to purchase statistics, data mining and text analysis
software and services is discretionary, involves a significant commitment of its
resources and is influenced by its budget cycles. Our sales cycles can be
variable, typically ranging between one and eight months from our initial
contact with a potential customer to the issuance of a purchase order or signing
of a license or services agreement, although the amount of time varies
substantially from customer to customer, making our revenues difficult to
predict in the short term. Occasionally sales require substantially more time,
and sales cycles have shown to be substantially longer for our higher-priced
text analysis product, InFact. In addition, sales delays could cause our
operating results for any given period to fall below the expectations of
securities analysts or investors, which could result in a decrease in our stock
price.





16





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





Until the
fourth quarter of 2003, we had posted net losses for each fiscal quarter since
the fourth quarter of 2001. As of March 31, 2005, we had an accumulated deficit
of over $28 million. We expect our expenses to be higher in 2005 than in 2004,
in part due to our efforts to enhance our information technology resources and
improve our financial and managerial systems. 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.





While we
have shown a trend of growth in revenue and profit in recent quarters, there is
no guarantee that these trends will continue. We 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.





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


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

Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, we will be required to furnish
an internal controls report of management’s assessment of the design and
effectiveness of our internal controls as part of our Annual Report beginning
with the fiscal year ended December 31, 2006. Our auditors will then be required
to attest to, and report on, management’s assessment. In order to issue our
report, our management must document both the design of our internal controls
and the testing processes that support management’s evaluation and conclusion.
This process will likely require us to hire additional personnel and engage
outside advisory services which will result in additional accounting and legal
expenses. In addition, the evaluation and attestation processes required by
Section 404 are new and neither companies nor auditing firms have significant
experience in complying with these requirements. Accordingly, we may encounter
problems or delays in completing the review and evaluation, the implementation
of improvements and the receipt of an attestation by our independent auditors.

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

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


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





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





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





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





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





•
    costs
      of customizing products for foreign
countries;


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


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


•
    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.





17





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 2004. Currency fluctuations resulted in foreign currency
transaction losses of $0.1 million in the three months ended March 31, 2005 and
gains of $0.4 million during the year and quarter ended December 31, 2004.
Future currency exchange rate fluctuations may have an adverse effect on our
results of operations in future periods. Our operating results could be
materially harmed if we enter into license or service agreements providing for
significant amounts of foreign currencies with extended payment terms or
extended implementation timeframes if the values of those currencies fall in
relation to the U.S. dollar over the payment period of the agreement.





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





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





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





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





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





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





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





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





Substantially
all of our executive leadership team has been replaced in the last 15 months.
Since January 2004, we hired a new Chief Executive Officer, Chief Financial
Officer, Vice President of Research and Development and Vice President of North
American Sales. We are also currently in the process of recruiting a senior
marketing executive. 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.





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





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





***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.





18





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





Our
success depends in part on our ability to protect our proprietary rights,
including our patents on InFact technology and our rights in the software code
underlying the “S” programming language that we purchased from Lucent
Technologies Inc. in January 2004. To protect our proprietary rights, we rely
primarily on a combination of patent, copyright, trade secret and trademark
laws, confidentiality agreements with employees and third parties and protective
contractual provisions such as those contained in license agreements with
consultants, vendors and customers, although we have not signed these agreements
in every case. Despite our efforts to protect our proprietary rights,
unauthorized parties may copy aspects of our products and obtain and use
information that we regard as proprietary. 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.





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





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





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





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





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





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





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


•
    pay
      damages;


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


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


******


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





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





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





19





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


**


We sell
products developed in the U.S. worldwide and operate in the United Kingdom,
France and Switzerland where we incur expenses and generate billings denominated
in those local currencies. As a result, the value of our assets, cash flows and
financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. For
example, currency fluctuations resulted in foreign currency transaction losses
of $0.1 million in the three months ended March 31, 2005 and gains of $0.4
million during the year and quarter ended December 31, 2004. In addition,
interest income and expense are sensitive to changes in the general level of
U.S. interest rates, particularly since our investments are in short-term
instruments which may fluctuate in value over time.





***Our
cash and cash equivalents are subject to market risk.***


**


Our
general investing policy is to limit the risk of principal loss and ensure the
safety of invested funds by limiting credit and market risk. 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. A significant change in the markets in which we are invested could
reduce our reported assets and affect our stock price.





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




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





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





***Our
stock price may be volatile.***





The price
of our common stock has been volatile over the past 12 months. Our common stock
reached a high of $5.20 per share on May 14, 2004 and traded as low as $1.13 per
share on September 1, 2004. As a result of fluctuations in the price of our
common stock, you may be unable to sell your shares at or above the price you
paid for them. The trading price of our common stock could be subject to
fluctuations for a number of reasons, including





•
    future
      announcements concerning us or our
competitors;


•
    actual
      or anticipated quarterly variations in operating
  results;


•
    changes
      in analysts’ earnings projections or
recommendations;


•
    announcements
      of technological innovations;


•
    the
      introduction of new products;


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


•
    loss
      of key personnel;


•
    deficiencies
      in our internal controls;


•
    proprietary
      rights litigation or other litigation; or


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





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







**ITEM
      3.**
    **CONTROLS
      AND PROCEDURES**
****
**Evaluation
of Disclosure Controls and Procedures**





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





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.




20
































21





**PART
      II.**
    **OTHER
      INFORMATION**




**ITEM
      1.**
    **Legal
      Proceedings**







On
December 13, 2002, Wajih Alaiyan, a former employee of ours, filed a complaint
against us in the Superior Court for King County, Washington. Mr. Alaiyan was
formerly employed by the Company and he alleged that his employment was
wrongfully terminated. On December 5, 2003, court granted summary judgment in
our favor, dismissing the complaint. The ex-employee filed an appeal with the
Court of Appeals for the State of Washington, and oral arguments were presented
on November 9, 2004. We are awaiting the outcome of the appeal. If we lose the
appeal we will likely resume litigation in the lower court, where we expect to
continue to vigorously defend ourselves against the ex-employee’s claim, which
we deny. The ex-employee seeks an unspecified amount of damages. We are unable
to evaluate the likelihood of an adverse outcome.





****ITEM
      6.**
    **Exhibits****


(a)
    
    See
      Index to Exhibits.




****


22


****


**SIGNATURES**





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





May 10,
2005


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





May 10,
2005


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


23




**EXHIBIT
INDEX**




****Exhibit**Number******
    **Description**31.1
    Certification
      of Chief Executive Officer of Insightful Corporation as Required by
      Section 302 of Sarbanes-Oxley Act of 200231.2
    Certification
      of Chief Financial Officer of Insightful Corporation as Required by
      Section 302 of Sarbanes-Oxley Act of 200232.1
    Certification
      of Financial Statements by Chief Executive Officer Insightful Corporation
      as Required by Section 906 of Sarbanes-Oxley Act of
200232.2
    Certification
      of Financial Statements by Chief Financial Officer of Insightful
      Corporation as Required by Section 906 of Sarbanes-Oxley Act of
      2002