The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect the Company's reported and expected financial results. Note that our preparation of this Annual Report on Form 10-K requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Revenue Recognition

The Company derives revenue from the sale of its software products, professional consulting, and support and maintenance services. We recognize license revenue when persuasive evidence of an agreement exists, the product has been delivered or services have been provided, the fee is fixed or determinable, and collection of the fee is probable. From time to time we enter into extended payment programs with creditworthy customers. We recognize revenue related to extended payment programs when payment becomes due to the Company. In making our decision to recognize revenue we must make a determination of the credit worthiness of our customer. This determination involves management judgment and while management believes that it can make reliable judgments, there is no guarantee that the revenue recognized will be collected. The credit worthiness of customers is further analyzed in the section below entitled "Accounts Receivable".

We recognize revenue under multiple-element arrangements using the residual method when vendor-specific objective evidence ("VSOE") of fair value exists for all of the undelivered elements under the arrangement. We have established sufficient VSOE for the value of our consulting, training, and other services, based on the price charged when these elements are sold separately. VSOE of the fair value of maintenance services may also be determined based on a substantive renewal clause, if any, within a customer contract. Accordingly, software license revenues are recognized under the residual method in arrangements in which software is licensed with maintenance, consulting, training or other services. Our products and the industries in which we compete are not static and the determination of VSOE involves judgment. Management believes that we will continue to be able to use the residual method for recognizing license revenue under multiple-element arrangements. If, for any reason, we are unable to continue to use the residual method, the timing of revenue recognition could be affected and, consequently, the trends that we are currently experiencing.

Our professional services include custom font design, consulting services, development, and training. We recognize professional services revenue under software development contracts as services are provided for per diem contracts or by using the percentage-of-completion method of accounting for long-term fixed price contracts. Provisions for any estimated losses on contracts in progress are made in the period in which such losses become probable. We had no long-term contracts in progress as of December 31, 2008.

We recognize revenue from end user product sales upon delivery of the software to the end user, net of estimated returns and allowances, if collection is probable. We estimate returns and allowances based on historical rates and as of December 31, 2008, we did not have a reserve. Reserves reduce revenue recognized, as necessary, at the time the related revenue is recorded. We periodically adjust estimates for returns based upon historical rates of return. While management believes that it can make reliable estimates, it is possible that these estimates will change in the future or that actual amounts could vary materially from our estimates.

We generally warrant that our products will function substantially in accordance with the documentation provided to customers for 90 days following initial delivery. As of December 31, 2008, we had not incurred any material expense related to warranty claims. We estimate reserves based on historical rates and, accordingly, have not recorded a warranty reserve. While management believes that we can make reliable estimates, it is possible that these estimates will change in the future or that actual amounts could vary materially from our estimates.

Stock-based Compensation

We adopted the provisions of Statement of Financial Accounting Standards No. 123R ("SFAS 123R") during the first quarter of fiscal 2006, and have accounted for stock-based compensation in accordance with SFAS 123R since that time. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

We currently use the Black-Scholes option pricing model to determine the fair value of stock options and awards. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

We estimate the expected term of options granted by calculating the average term from our historical stock option exercise experience. We estimate the volatility of our common stock by historical volatility. We base the risk-free interest rate that we use in the option pricing model on zero-coupon yields implied from U.S. Treasury issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All share based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and net income per share.

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics not present in our option grants and awards. Existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in our financial statements. There currently is no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values.

The application of these principles using guidance from SFAS 123R may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimate of stock-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.

Impairment of Long-Lived Assets

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company tested recorded goodwill for impairment. We have determined that we do not have separate reporting units and thus goodwill is tested for impairment based upon an enterprise wide valuation. We conducted impairment testing as of December 31, 2008 and determined that the fair value of the enterprise was greater than its carrying value. Although none of the goodwill was impaired, there can be no assurance that, upon completion of a future review, a material impairment charge will not be required.

Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from customers and maintain a provision for estimated credit losses based on our historical experience and any specific customer collection issues that we identify. While such credit losses have historically been within our expectations and appropriate reserves have been established, we cannot guarantee that we will continue to experience the same credit loss rates that we have experienced in the past.

Income Taxes

As part of the process of preparing consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that we will recover our deferred tax assets from future taxable income and, to the extent we believe recovery unlikely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. Determination of our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets requires significant management judgment. We have fully reserved against our tax assets due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward and foreign tax credits, before they expire. We base our valuation allowance on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. The determination of the valuation allowance requires us to make estimates, which we cannot guarantee will prove to be accurate.

Bitstream is a software development company focused on bringing unique software products to a wide variety of markets. Our core software products include award-winning fonts and font rendering technologies, mobile browsing technologies and variable data publishing and Web-to-print technologies.

Fonts and font rendering technologies. Bitstream is a leading developer of font technology solutions that enable developers to display high-quality text in almost any language for almost any device or application. We work with partners from around the world to provide complete text composition and font rendering solutions for consumer electronics devices, mobile handsets, set-top boxes, digital TVs, printers, graphics and software applications, and embedded systems. Our solutions include Bitstream Panorama™ for text composition and Font Fusion® for font rendering. Bitstream font technology supports all international languages. With our technology, developers can render any scalable industry-standard and compact font format. Developers rely on Bitstream for complete font solutions, including a certified Simplified Mainland Chinese font, MobileFonts™, the Tiresias Screenfont, the Closed Captioned TV (CCTV) Font Set, the TV Font Pack, delta-hinted screen fonts, and compact stroke-based Asian fonts. Bitstream also delivers high-quality font solutions for developers, ad agencies, graphic designers, desktop publishers, corporations, small businesses, and home office users. Our world-renowned library includes over 1,000 high-quality fonts in OpenType, TrueType, and PostScript Type 1 formats for Windows, Macintosh, Unix, and Linux. We also sell our fonts and fonts from other foundries and designers on MyFonts.com SM, a showcase of the world's fonts available from one easy-to-use website. MyFonts.com provides the largest collection of fonts ever assembled for on-line delivery, and offers easy ways to find and purchase fonts on-line. MyFonts.com also offers unique typographic resources for research and reference, including WhatTheFont SM, a unique font identifier that accepts image files of fonts uploaded by users, analyzes the images, and then displays the fonts on the MyFonts.com site that most closely match the font shapes captured in the image.

Mobile browsing technologies. ThunderHawk provides a fast, easy to use full HTML desktop-like browsing experience. Built with Bitstream core mobile technology, ThunderHawk offers a feature-rich mobile browsing experience that enables users to find and read information quickly.

ThunderHawk™ Client/Server Technology offers powerful, user-friendly benefits in a small package to mobile operators and device manufacturers. It minimizes resource requirements on the handset and supports a vast range of mass-market and higher end phones, with extremely fast page load speeds and low over-the-air data sizes. When a subscriber uses ThunderHawk to access the Web, the ThunderHawk client residing on the handset communicates with a server cloud. The cloud receives a connection from the client, and requests an HTML Web page from the Internet over a fast data connection. Upon receiving the requested page, a server renders the content on-the-fly and compresses the graphics. A server sends the requested HTML page in a compressed compact transport format to the subscriber's handset, reducing the data size to approximately one-twenty-third, on small magnification setting, of the size of the page on the desktop. This results in extremely fast loading and display of Website content for a truly superior user experience. The client technology is available as a J2ME client that runs on a majority of the phones currently on the market or as a platform-agnostic C++ SDK, that can be ported to any environment including Windows Mobile, BREW and Symbian OS, enabling a feature-rich, full desktop-style HTML browsing experience on nearly any mobile device.

BOLT, a consumer-facing browser built on ThunderHawk Java Client/Server technology. Offering a browser directly to consumers allows for rapid testing of new features (such as streaming video and RSS support) to improve, and generate interest in, our OEM and mobile operator-facing browsing technologies.

Variable data publishing, Web-to-print, and multi-channel communications technologies. The Pageflex® product line from Bitstream is the technology of choice for web-to-print applications and sophisticated personalized communications based on customer information. We pioneered flexible variable data software in 1997 and have been a technology innovator in the variable output and web-to-print document customization

arena ever since. Pageflex provides unparalleled design control with powerful graphic design features created specifically for variable publishing. The platform produces rich, creative, award-winning document designs that look like they were given the individual attention of a graphic designer but were, in reality, created on-the-fly with Pageflex variable publishing technology. Printer service providers, marketing service providers, corporate marketers, and publishers use Pageflex products to ensure design integrity and brand control while empowering local users to customize and personalize print collateral, email campaigns, and 1-to-1 marketing Web sites. Pageflex Persona™ is desktop software that produces personalized print and email documents using data from a database. Pageflex Storefront is a turnkey solution for producing web portals for document customization and online purchasing of print documents. Pageflex Server provides an enterprise solution for high-volume document customization driven by a database or requests from a web site. Pageflex Campaign Manager lets companies develop personal conversations with their customers in print, email, and online. Pageflex products enable companies worldwide to streamline their document production processes, communicate more personally with their customers, and control their brand and market messaging while enabling their remote employees, franchises, and consumers to use a self-serve model to order customized communications.

The following table sets forth the percentage of revenue represented by certain items reflected in the Company's Statements of Operations Data for the periods presented:

                                                     Years Ended December 31,
                                                  2008         2007         2006
    Revenue
    Software licenses                               78.6 %       81.4 %       83.5 %
    Services                                        21.4         18.6         16.5

    Total revenue                                  100.0        100.0        100.0
    Cost of revenue
    Software licenses                               29.3         29.4         29.7
    Services                                        10.0          7.9          7.7

    Total cost of revenue                           39.3         37.3         37.4

    Gross profit                                    60.7         62.7         62.6

    Operating expenses:
    Marketing and selling                           18.3         16.7         17.0
    Research and development                        21.6         20.1         21.7
    General and administrative                      11.3         11.4         11.6

    Total operating expenses                        51.2         48.2         50.3

    Operating income                                 9.5         14.6         12.3
    Interest and other income, net                   0.7          2.4          1.3
    Legal fee reimbursement                           -            -           2.3

    Provision for (benefit from) income taxes        0.4          0.1         (0.1 )

    Net income (loss)                                9.8 %       16.9 %       16.0 %

     YEAR ENDED DECEMBER 31, 2008 COMPARED TO YEAR ENDED DECEMBER 31, 2007

                     (in thousands, except percent amounts)

Gross Profit:



                                               Years Ended December 31,
                                      % of                   % of              Change
                            2008     Revenue       2007     Revenue      Dollars      Percent
  Revenue
  Software licenses       $ 18,868      78.6 %   $ 19,229      81.4 %   $    (361 )      (1.9 )%
  Services                   5,140      21.4        4,389      18.6           751        17.1

  Total revenue             24,008     100.0       23,618     100.0           390         1.7
  Cost of Revenue
  Software licenses          7,018      37.2        6,939      36.1            79         1.1
  Services                   2,408      46.8        1,863      42.4           545        29.3

  Total cost of revenue      9,426      39.3        8,802      37.3           624         7.1

  Gross Profit            $ 14,582      60.7 %   $ 14,816      62.7 %   $    (234 )      (1.6 )%

The decrease in revenue from software licenses for the year ended December 31, 2008 as compared to the year ended December 31, 2007 was attributable to decreases in licenses from our publishing products, partially offset by increases in our font and font technology products. License revenue from direct sales, which includes e-commerce sales, decreased $530, or 4.1% to $12,527 for the year ended December 31, 2008 as compared to $13,057 for the year ended December 31, 2007. License revenue from resellers decreased $197, or 13.4% to $1,278 for the year ended December 31, 2008, as compared to $1,475 for the year ended December 31, 2007. License revenue from OEMs and ISVs increased $366, or 7.8% to $5,063 for the year ended December 31, 2008, as compared to $4,697 for the year ended December 31, 2007. The net decrease in direct and reseller revenue was due to decreases in the volume and variety of fonts and publishing products licensed throughout 2008. The increase in OEM and ISV revenue was due to an increase in new licenses, as well as license renewals and royalties received under existing license agreements because of increases in reported unit shipments by certain OEM customers. We are affected by the global economic downturn, as are our customers including various OEMs and ISVs who report product royalties on shipments of their products, and we are not able to determine at this time how these economic concerns will impact our license revenue during 2009.

The increase in revenue from services was primarily due to increases in maintenance and support contracts associated with our publishing and font technology product lines. Service revenue from direct sales increased $550, or 16.6%, to $3,867 for the year ended December 31, 2008 as compared to $3,317 for the year ended December 31, 2007. Service revenue from resellers increased $159, or 24.3%, to $812 for the year ended December 31, 2008 as compared to $653 for the year ended December 31, 2007. Service revenue from OEMs and ISVs increased $42, or 10.0%, to $461 for the year ended December 31, 2008 as compared to $419 for the year ended December 31, 2007. These services vary with the requirements of customers for custom design and development for our embedded products. The increase in service revenue for the year ended December 31, 2008 of $751, or 17.1% as compared to the year ended December 31, 2007 was primarily driven by increases in our customer base and the number of customers contracting for support services. We are affected by the global economic downturn and we are not able to determine at this time how these economic concerns will impact our service revenue during 2009.

We recognize license revenue from direct sales and licensing agreements of our products and products from third parties including e-commerce sales made via our websites, licensing agreements with OEMs and ISVs, and from the resale of our products through various resellers. We recognize reseller revenue if collection is probable, upon notification from the reseller that it has sold the product or, if for a physical product, upon delivery of the

software. E-commerce sales include revenue from the licensing of Bitstream fonts and font technology, licensing of mobile browsing products, licensing of fonts and font technology developed by third parties and from fees received from referring customers to other sites for which we have referral agreements. Referral income for the years ended December 31, 2008 and 2007 was $55 and $31, respectively. There are minimal costs associated with referral revenue, and such costs primarily represent the time to load copies of the fonts provided by each participating foundry to the MyFonts.com database. We expense those costs as incurred.

The increase in cost of license revenue for the year ended December 31, 2008 as compared to the year ended December 31, 2007 was primarily due to increased direct costs, including royalty and credit card processing expenses of $75, or 1.1%, to $6,798 for the year ended December 31, 2008 as compared to $6,723 for the year ended December 31, 2007, from increased sales of third party products including e-commerce sales. We expect the cost of licenses as a percentage of sales for 2009 will approximate that of 2008, though the quarterly results may vary based upon the mix of products sold during any particular quarter.

The increases in cost of services revenue for the year ended December 31, 2008, as compared to the year ended December 31, 2007 was primarily due to a $563 increase in costs attributable to customer consulting resources and support personnel and an increase of $79 in facilities and equipment expenses, including depreciation, partially offset by an increase in the internal allocation of resources charged to research and development projects of $97 for the year ended December 31, 2008. We expect the cost of services for 2009 to approximate the amount of 2008 costs.

Cost of revenue includes royalties and fees paid to third parties for the development of, or license of rights to, technology and/or unique typeface designs, costs incurred in the fulfillment of custom orders, costs incurred in providing customer support, maintenance, and training, and costs associated with the duplication, packaging and shipping of products. These costs include depreciation and amortization.

Operating Expenses:



                                                  Years Ended December 31,
                                          % of                   % of             Change
                                2008     Revenue       2007     Revenue      Dollars    Percent
 Marketing and selling        $  4,389      18.3 %   $  3,949      16.7 %   $     440      11.1 %
 Research and development        5,181      21.6        4,739      20.1           442       9.3
 General and administrative      2,713      11.3        2,686      11.4            27       1.0

 Total operating expenses     $ 12,283      51.2 %   $ 11,374      48.2 %   $     909       8.0 %

Marketing and selling ("M&S") expense consists primarily of salaries and . . .