UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
x |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2004
Commission file number 0-020992
INSIGHTFUL CORPORATION
Delaware |
04-2842217 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. employer identification) |
1700 Westlake Ave. N. #500
Seattle, Washington 98109-3044
(206) 283-8802
(Address and telephone number of principal executive offices) (Zip
code)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Securities Exchange Act of 1934). YES o NO x
The aggregate market value of the voting stock held by nonaffiliates of the registrant, based on the closing sale price of the registrant’s common stock on June 30, 2004, as reported on the Nasdaq SmallCap Market, was $22,469,462. The number of shares of common stock, $.01 par value, outstanding as of March 11, 2005 was 12,424,186.
DOCUMENTS INCORPORATED BY REFERENCE IN PART III OF THIS 10-K:
Portions of registrant’s definitive proxy statement to be filed pursuant to Regulation 14A promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, which definitive proxy statement shall be filed within 120 days after the end of the registrant’s fiscal year ended December 31, 2004, are incorporated by reference in Part III of this report.
TABLE OF CONTENTS
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PART I
Forward-Looking Statements
Our disclosure and analysis in this report contain forward-looking statements, which provide our current expectations or forecasts of future events. Forward-looking statements in this report include, without limitation:
| • | information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth; | ||
| • | statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues; | ||
| • | statements about expected future sales trends for our products; | ||
| • | statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments and available bank borrowings to meet these requirements; | ||
| • | information about the anticipated release dates of new products; | ||
| • | other statements about our plans, objectives, expectations and intentions; and | ||
| • | other statements that are not historical facts. |
Words such as “believes,” “anticipates” and “intends” may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the factors described in the section entitled Important Factors That May Affect Our Business, Our Operating Results and Our Stock Price in this report. Other factors besides those described in this report could also affect actual results. You should carefully consider the factors described in the section entitled Important Factors That May Affect Our Business, Our Operating Results and Our Stock Price in evaluating our forward-looking statements.
You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect the occurrence of unanticipated events.
ITEM 1. BUSINESS.
Description of the Company
We provide enterprises with scalable data and text analysis solutions designed to facilitate decision-making by revealing patterns, trends and relationships. We are a supplier of software and services for the statistical analysis, data mining and knowledge access industry segments enabling customers to gain intelligence from numerical data and text.
Our products include S-PLUS®, S-PLUS Server, Insightful Miner™, InFact® and various S-PLUS add-on modules such as S+ArrayAnalyzerTM, and S+FinMetricsTM. Our consulting services provide specialized expertise and proven processes for the design, development and deployment of analytical solutions.
Our customers primarily consist of companies in financial services, pharmaceuticals, biotechnology, telecommunications and manufacturing as well as government and research institutions.
Insightful has three reporting segments: Domestic Data Analysis, International Data Analysis and Text Analysis. For information regarding revenues and losses from operations for each of our last three fiscal years, please refer to our financial statements included in this report.
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Headquartered in Seattle, Washington, we also have North American offices in New York and North Carolina. Our international offices are located in France, Switzerland and the United Kingdom, with distributors around the world. At December 31, 2004, we had 108 employees, 85 of which were located in the United States and 23 of which were in our international locations. For financial information by geography refer to our financial statements included in this report.
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®
S-PLUS is our flagship product for statistical data analysis. The software offers technical professionals a flexible, extensible and productive platform for data analysis and visualization. S-PLUS is based on our object-oriented “S” programming language, which we licensed on an exclusive worldwide basis from Lucent Technologies Inc. until we acquired the rights to “S” in January 2004. S-PLUS offers a wide range of analytic methods for extracting intelligence from large data sets, and allows its users to create customized analytical applications that operate in the Windows® and UNIX® environments.
Insightful Miner™
Insightful Miner is a scalable data analysis workbench for predictive modeling, data mining and statistical data analysis. It has a drag-and-drop interface intended to make it easy to create self-documenting visual workmaps. Insightful Miner provides data miners, business analysts and data analysis professionals with a suite of scalable components for data access, management and modeling, and its pipeline architecture 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+FinMetrics™ is designed to provide the financial services market with comprehensive software for modeling, analyzing and visualizing financial market data, offering a modern and flexible analytic environment for reliable and robust predictive econometric modeling. S+ArrayAnalyzer™ is designed to enable pharmaceutical companies to obtain statistically rigorous information from microarray technology, shortening time-to-discovery for competitive advantage.
Server Products
Insightful’s S-PLUS Server products enable our customers to deploy statistical data analysis throughout an organization, leveraging existing Web-based or client/server technologies using server computers running Windows and UNIX operating systems. Our server products are data warehouse-independent and integrate 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.
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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.
Operations
Marketing and Sales
Our data analysis solutions serve a variety of industries including financial services, pharmaceuticals and biotechnology, telecommunications, manufacturing, government and research. Our data analysis solutions are used in a variety of functions including research, engineering, production, marketing and finance. We focus our statistics and data analysis business on two vertical markets: financial services and life sciences.
We acquire domestic customers for our data analysis products and services through the combination of a domestic telesales organization and an outside sales team. Leads are generated from direct mail, public relations, the Internet, seminars and tradeshows. Our telesales and direct sales forces then qualify and pursue these leads, working in coordination with our consultants.
Internationally, for data analysis we have direct sales force offices in France, Switzerland and the United Kingdom. In other countries, we primarily sell through a network of resellers and distributors, who may work in conjunction with the direct sales force on global accounts.
The Text Analysis segment, which focuses on defense intelligence and life sciences customers, markets its product using a domestic sales team that generates leads primarily through referrals and outbound sales efforts. This segment is currently dependent on a few customers. The loss of any one or more of these customers could have a material adverse effect on the segment.
Manufacturing and Distribution
We utilize third party vendors to replicate our products. This permits us to manage peak volumes customary in the software industry and to avoid high fixed costs associated with daily fluctuations in orders and customer contacts.
We subcontract with third party vendors to replicate all of our S-PLUS product line updates. We warehouse inventory at a regional facility and process domestic orders internally out of our Seattle office. Most international orders are processed and fulfilled by third party vendors located in the United Kingdom that also provide warehousing and fulfillment services.
Funded Research
We receive funding from U.S. federal agencies for work performed under government grants. Research projects are primarily performed under cost reimbursement arrangements, which provide funding on a time and materials basis based on agency approved labor, overhead and profit rates. The terms of these arrangements generally require us to submit both progress and final reports. Research projects are focused primarily on extending the frontiers of data analysis for numeric, textual signal and image data. Funding is generally received through cash requests or installment payments. These amounts are recognized either as the work is performed under time and material contracts, or on a percentage of completion basis for fixed bid contracts, and are recorded as an offset against our total research and development costs. Funded research recognized in operations was approximately $2,949,000 in 2004, $4,307,000 in 2003, and $4,674,000 in 2002.
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Product Development
Our product development organization is responsible for software development, product documentation and quality assurance. The organization’s priorities are to continue technical innovation for power and performance and to respond to market feedback by continuing to design products that will generate future revenues.
Our development team consists of specialists in software engineering, quality assurance, mathematics, statistics, computer science, engineering and documentation, user interface design and advanced Microsoft Windows, UNIX and Internet technologies.
Gross research and development costs charged to operations were approximately $5,240,000 in 2004, $6,469,000 in 2003, and $7,918,000 in 2002.
Competition
Our S-PLUS product targets statisticians and data managers in the statistics market. This market is competitive, fragmented and mature. We face competition in the statistics market primarily from large enterprise software vendors and our potential customers’ information technology departments who may create custom-made applications instead of using Insightful software. These departments may seek to develop data analysis solutions utilizing R, a free statistics 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, Inc. and Minitab, Inc. In addition to competition from other statistical software companies, we also face competition from providers of software for specific statistical applications.
In the data mining and text analysis markets, we face competition from many companies, including SAS Institute, SPSS, IBM, NCR, Autonomy, Verity, Inxight, ClearForest and Iphrase, many of which are much larger than we are.
Intellectual Property Rights and Licenses
Our software is proprietary and we attempt to protect it with copyrights, patents, trade secret laws and internal nondisclosure safeguards, as well as restrictions on copying, disclosure and transferability that are incorporated into our software license agreements. 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, 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. In addition, we have entered into nondisclosure and inventions agreements with all of our employees. However, judicial enforcement of these agreements may be uncertain. We hold three issued patent on InFact and have several other patent applications pending on both InFact and our data analysis products.
In January 2004 we acquired the copyrights to the software code underlying the “S” programming language from Lucent, Technologies Inc.
Due to the rapid pace of technological change in the software industry, we believe that patent, trade secret and copyright protection are less significant to our competitive position than factors such as the knowledge, ability and experience of our personnel, new product development, frequent product enhancements, name recognition and ongoing reliable product maintenance and support.
Insightful, Insightful Corporation, the Insightful logo, S-PLUS, Insightful Miner, S+FinMetrics and S+ArrayAnalyzer are trademarks or registered trademarks of Insightful Corporation in the United States and other countries. Microsoft, Windows and Windows NT are either trademarks or registered trademarks of Microsoft Corporation in the United States and/or other countries. Java is a trademark or registered trademarks of Sun Microsystems, Inc. in the United States or other countries. UNIX is a registered trademark of The Open Group in the United States or other countries. All product names mentioned herein may be trademarks or registered trademarks of their respective companies.
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Important Factors That May Affect Our Business, Our Operating Results and Our Stock Price
In addition to the other information contained in this 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; |
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| • | 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.
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.
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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. Over the previous three fiscal years, these contracts have 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.
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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.
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 December 31, 2004, 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 for our internal controls and the testing processes that support management’s evaluation and conclusion. This process will likely require us to hire additional personnel and engage
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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 expect to be 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; |
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| • | reduced protection of intellectual property rights and increased liability exposure; and | ||
| • | regional economic, cultural and political conditions, including the direct and indirect effects of terrorist activity and armed conflict in countries in which we do business. |
Our foreign subsidiaries operate primarily in local currencies, and their results are translated into U.S. dollars. We do not currently engage in currency hedging activities, but we may do so in the future. Changes in the value of the U.S. dollar relative to foreign currencies increased both our European revenues and expenses in 2003 and 2004. Currency fluctuations resulted in foreign currency transaction 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 twelve 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
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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.
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 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
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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 reputational damage.
Software products as complex as ours frequently contain errors or defects, especially when first introduced or when new versions are released. Our customers are particularly sensitive to such defects and errors because of the importance of accuracy in software used in analyzing data. We have had to delay commercial release of past versions of our products until software problems were corrected, and in some cases have provided product updates to correct errors in released products. Our new products or releases may not be free from errors after commercial shipments have begun. Any errors that are discovered after commercial release could result in loss of revenues or delay in market acceptance, diversion of development resources, damage to our reputation, increased service and warranty costs or claims against us.
In addition, the operation of our products could be compromised as a result of errors in the third-party software we incorporate into our software. It may be difficult for us to correct errors in third-party software because that software is not in our control.
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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,
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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 2. PROPERTIES.
Our headquarters and principal administrative, finance, selling and marketing operations are located in approximately 27,000 square feet of leased office space in Seattle, Washington under a lease that expires in 2007. In North America, we also lease office space in New York and North Carolina. Our international offices are located in France, Switzerland and the United Kingdom. Our Domestic Data Analysis and Text Analysis segments share the Seattle leased office space and we conduct business related to both our Domestic and International Data Analysis segments from the remaining offices.
ITEM 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
No matters were submitted for a vote of our stockholders during the fourth quarter of the year ended December 31, 2004.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Information
Our common stock is quoted on the Nasdaq SmallCap Market under the symbol IFUL. The following table presents quarterly information on the price range of the common stock. This information indicates the high and low sales prices for our common stock for each full quarterly period within the two most recent fiscal years.
| High |
Low |
|||||||
Fiscal Year Ended December 31, 2003: |
||||||||
First Quarter |
$ | 1.55 | $ | 0.93 | ||||
Second Quarter |
$ | 1.50 | $ | 0.97 | ||||
Third Quarter |
$ | 2.37 | $ | 1.21 | ||||
Fourth Quarter |
$ | 2.50 | $ | 1.75 | ||||
Fiscal Year Ended December 31, 2004: |
||||||||
First Quarter |
$ | 4.90 | $ | 2.00 | ||||
Second Quarter |
$ | 5.20 | $ | 2.03 | ||||
Third Quarter |
$ | 2.32 | $ | 1.13 | ||||
Fourth Quarter |
$ | 3.38 | $ | 1.82 | ||||
Holders
As of March 11, 2005, the number of stockholders of record of Common Stock was 280. This figure does not include the number of stockholders whose shares are held of record by a broker or clearing agency, but does include each such brokerage house or clearing agency as a single holder of record.
Dividends
We have never paid any cash dividends on our Common Stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. In addition, the terms of our credit facility with Silicon Valley Bank prohibit us from paying dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information regarding our existing compensation plans and individual compensation arrangements pursuant to which our equity securities may be issued to employees, directors, consultants, advisors or other persons in exchange for consideration in the form of services.
| Plan Category |