The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto.

Bitstream Inc. was incorporated in the State of Delaware in 1981. Bitstream Inc. (together with its subsidiaries, "Bitstream" or the "Company") is a software development company focused on bringing unique software products to a wide variety of markets. Today, our core software products include award-winning fonts and font rendering technologies, mobile browsing and messaging technologies and variable data publishing and Web-to-print technologies.

We maintain our executive offices at 245 First Street, 17th Floor, Cambridge, Massachusetts 02142-1270. Our telephone number is (617) 497-6222 and we maintain websites at www.bitstream.com, www.myfonts.com, and www.pageflex.com. Investors may obtain copies of our filings with the Securities and Exchange Commission (the "SEC") free of charge from our website at www.bitstream.com or from the SEC's website at www.sec.gov.

We incorporate herein by reference the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operation - Critical Accounting Policies" contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and filed with the SEC on March 31, 2009. No changes have been made to those policies since December 31, 2008.

Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These forward-looking statements generally are identified by the words "believes," "project," "expects," "anticipates," "estimates," "intends," "strategy," "plan," "may," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, without limitation, market acceptance of our products, competition and the timely introduction of new products. Additional information concerning certain risks and uncertainties that would cause actual results to differ materially from those projected or suggested in the forward-looking statements is contained in our filings with the SEC, including those risks and uncertainties discussed under the section entitled "Forward Looking Statements" contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 filed with the SEC on March 31, 2009. The forward-looking statements contained herein represent our judgment as of the date of this report, and we caution readers not to place undue reliance on such statements. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

 RESULTS OF OPERATIONS (in thousands, except percentages and per share amounts)

Revenue and Gross Profit:



                                 Three Months Ended March 31,
                                       % of                  % of              Change
                             2009     Revenue      2008     Revenue     Dollars      Percent
    Revenue
    Software licenses       $ 3,765      75.3 %   $ 5,126      80.5 %   $ (1,361 )     (26.6 )%
    Services                  1,236      24.7       1,243      19.5           (7 )      (0.6 )

    Total revenue             5,001     100.0       6,369     100.0       (1,368 )     (21.5 )

    Cost of Revenue

    Software licenses         1,565      41.6       2,014      39.3         (449 )     (22.3 )
    Services                    583      47.2         581      46.7            2         0.3

    Total cost of revenue     2,148      43.0       2,595      40.7         (447 )     (17.2 )


    Gross Profit            $ 2,853      57.0 %   $ 3,774      59.3 %   $   (921 )     (24.4 )%

License revenue from direct sales, which includes e-commerce sales, decreased $661, or 19.8%, to $2,681 for the three months ended March 31, 2009 as compared to $3,342 for the three months ended March 31, 2008. License revenue from resellers increased $30, or 11.2%, to $297 for the three months ended March 31, 2009 as compared to $267 for the three months ended March 31, 2008. License revenue from OEMs and ISVs decreased $730, or 48.1%, to $787 for the three months ended March 31, 2009 as compared to $1,517 for the three months ended March 31, 2008.

License revenue varies between quarters due to the timing of license agreements. Revenue for the three months ended March 31, 2009 decreased across all of our product lines due to delays in purchasing decisions by customers and decreases in royalties from consumer-based shipments by OEMs and ISVs during the quarter. We believe these decreases can be attributed primarily to the economic conditions affecting consumers during this period. If general economic conditions do not improve, license revenue for the year ending December 31, 2009 may continue to be lower than the level of license revenue achieved for the same periods in 2008.

The decrease in revenue from services was due to a decrease in consulting and training services of $82, or 31.6% to $177 for the three months ended March, 31 2009 as compared to $259 for the three months ended March 31, 2008. This decrease was partially offset by increases in revenue related to support contracts primarily driven by increases in our customer base and customer demand for publishing support services, of $75, or 7.6%, to $1,059 for the three months ended March 31, 2009 as compared to $984 for the three months ended March 31, 2008. We believe that our overall services revenue during 2009 will approximate the level attained in 2008 but if general economic conditions do not improve, service revenue for the year ending December 31, 2009 may continue to be lower than the level of service revenue achieved for the same periods in 2008.

We recognize license revenue from direct sales and from licensing our products and third party products including e-commerce sales made via our websites, from 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 the ThunderHawk browser, 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 three months ended March 31, 2009 and 2008 was $11 and $6, 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 decrease in cost of license revenue for the three-month period ended March 31, 2009 as compared to the three-month period ended March 31, 2008 was primarily due to a $448 decrease in direct costs, including royalty costs, associated with decreased sales of third party products for the three months ended March 31, 2009. We expect the cost of license revenue as a percentage of license revenue for the fiscal year ending December 31, 2009 to approximate the percentage for the year ended December 31,2008, although the results may vary based upon the mix of products sold during the remainder of the year.

Cost of services revenue for the three months ended March 31, 2009 approximated that for the three months ended March 31, 2008 as the personnel and services infrastructure remained materially unchanged. Total cost of services increased slightly as a percentage of services revenue for the three months ended March 31, 2009 as compared to the same period in 2008 due to the decrease in OEM and ISV consulting services discussed above. For the remainder of 2009, we expect our cost of services as a percentage of service revenue to approximate the percentages for 2008 but if economic conditions do not improve in 2009 these percentages may be higher without infrastructure changes being made.

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 product.

Operating Expenses:



                                   Three Months Ended March 31,
                                         % of                  % of              Change
                               2009     Revenue      2008     Revenue      Dollars      Percent
 Marketing and selling        $ 1,033      20.7 %   $ 1,135      17.8 %   $    (102 )      (9.0 )%
 Research and development       1,214      24.3       1,392      21.9          (178 )     (12.8 )
 General and administrative       772      15.4         647      10.2           125        19.3

 Total operating expenses     $ 3,019      60.4 %   $ 3,174      49.8 %   $    (155 )      (4.9 )%

Marketing and selling ("M&S") expense consists primarily of salaries and benefits, commissions, travel expense and facilities costs related to sales and marketing personnel, as well as marketing program-related costs including trade shows and advertising. The decrease in M&S expense for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 was primarily the result of a $50 decrease in salaries & benefits, a $40 decrease in professional services, and a $25 decrease in advertising and marketing activities including tradeshow participation; partially offset by a $12 increase in facilities and equipment costs. We expect our M&S expenses to continue at a similar level during the remainder of 2009.

Research and development ("R&D") expense consists primarily of salary and benefits costs, contracted third-party development costs, and facility costs related to software developers and management. The decrease in R&D expense for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 was primarily the result of decreases in salaries and benefits and the use of third party contractors of $198 partially offset by an increase in facilities and equipment costs of approximately $18. We expect our development efforts to continue at a similar level during the remainder of 2009.

General and administrative ("G&A") expense consists primarily of salaries, benefits, and other related costs including travel and facility expenses for finance, human resource, legal and executive personnel, legal and accounting professional services, provision for bad debts and director and officer insurance. The increase in G&A for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 is primarily due to an increase in bad debt expense of $159 attributable to an increase in the allowance for doubtful accounts and an increase in professional fees of $14, partially offset by decreases in administrative salaries and benefit costs of $39 and in corporate insurance costs of $8. We expect G&A expense to continue at a similar level during the remainder of 2009.

Other Income, Net:



                                                Three Months Ended March 31,
                                                       % of                 % of              Change
                                            2009      Revenue      2008    Revenue      Dollars      Percent
Interest and other income, net             $   19          0.4 %   $  96       1.5 %   $     (77 )     (80.2 )%

Other income includes interest income earned on cash and money market instruments and foreign currency transaction gains. Transaction gains for the three months ended March 31, 2009 and 2008 were $14, and $ 0, respectively. Net interest income has decreased as compared to the same periods in the prior year due to a lower rate of interest earned on our cash and money market instruments.

Provision for Income Taxes:



                                                 Three Months Ended March 31,
                                                       % of                 % of              Change
                                            2009      Revenue      2008    Revenue      Dollars      Percent
Provision for (benefit from) income taxes   $   6          0.1 %   $  37       0.6 %   $     (31 )     (83.8 )%

The Company's income tax provisions for the three months ended March 31, 2009 and 2008 are primarily attributable to state income taxes in the U.S. and taxes related to foreign jurisdictions. Federal and state tax provisions for those periods included amounts in relation to the Company's income generated in the U.S., reduced by previously unused net operating loss (NOL) carry forwards and tax credits that were recorded on the balance sheet with a full valuation allowance. As of March 31, 2009, a full valuation allowance was recorded against the Company's net deferred tax assets in the U.S. At December 31, 2008, the Company had U.S. federal and state net operating loss ("NOL") carryforwards of $12,626 and $59, respectively, of which the benefit of approximately $7,532 and $59, respectively, when realized, will be recorded as a credit to additional paid in capital. The Company's NOL carry-forwards begin to expire in 2020 for federal purposes. The Company also had U.S. federal and state research and development credit ("R&D Credit") carryforwards of $932 and $331, respectively. These R&D credit carryforwards begin to expire in 2009 for federal purposes and 2016 for state purposes. As of December 31, 2008, we have foreign tax credit carryforwards of $380. These foreign tax credit carryforwards begin to expire in 2012.

We continued to provide a full valuation allowance for our net deferred tax assets at September 30, 2008, as we believe it is more likely than not that the future tax benefits from accumulated net operating losses and deferred taxes will not be realized. We continue to assess the need for the valuation allowance at each balance sheet date based on all available evidence. However, it is possible that the "more likely than not" criterion could be met in future periods, which could result in the reversal of a significant portion or all of the valuation allowance, which, at that time, would be recorded as a tax benefit in the consolidated statement of operations.

Foreign taxes include foreign withholding taxes which vary with OEM license royalties from customers in countries who are a party to tax conventions with the United States including Korea, Israel and Poland, as well as, foreign taxes paid by Bitstream India Pvt. Ltd., our subsidiary, in India.

LIQUIDITY AND CAPITAL RESOURCES (in thousands, except share and per share amounts)

The Company has funded its operations primarily through the public sale of equity securities, cash flows from operations, cash received from the sale of our MediaBank and InterSep OPI product lines to Inso Providence Corporation in August of 1998, and cash received from the sale of our investment in DiamondSoft to Extensis in July of 2003. As of March 31, 2009, we had net working capital of $14,771 versus $14,257 at December 31, 2008, an increase of $514 or 4%.

Our operating activities generated cash during the three months ended March 31, 2009 and 2008 of $491 and $750, respectively. Cash from operating activities was generated primarily from the collections of receivables which decreased by $752 for the three months ended March 31, 2009 partially offset by a net increase in payables and accruals during the same period. Cash from operating activities was generated for the three months ended March 31, 2008 primarily due to our net income before adjustment for non-cash expenses of $659. We used cash of $8 and $60 for the three months ended March 31, 2009 and 2008, respectively, for the purpose of acquiring additional property and equipment and intangible assets. Our financing activities for the three months ended March 31, 2009 provided cash of $411 from the exercise of stock options, while our financing activities for the three months ended March 31, 2008 used cash of $1,769 to repurchase shares of our common stock which was partially offset by $114 in proceeds from the exercise of stock options. Our cash balance also increased by $1 from the effect of foreign currency exchange rates applied to the balances and activities of our subsidiary, Bitstream India Pvt. Ltd, whose functional currency is the Indian Rupee.

As of March 31, 2009, we had no material commitments for capital expenditures.

In August 2003, we entered into a six-year lease agreement and moved our corporate offices. Our current lease expires August 31, 2009 and we are currently reviewing our options for renewing the current lease or obtaining other suitable office space. We understand that sufficient office space is currently available in our geographic area and that, given general economic conditions, we will be able to secure the amount of space we need to conduct our operations at reasonable market rates.

We believe our current cash and cash equivalent balances will be sufficient to meet our operating and capital requirements for at least the next 12 months. There can be no assurance, however, that we will not require additional financing in the future. If we were required to obtain additional financing in the future, there can be no assurance that sources of capital would be available on terms favorable to us, if at all.

We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is primarily based on a dollar amount per unit shipped or a percentage of the underlying revenue. Royalty expense is recorded as cost of license revenue on our Consolidated Statement of Operations.

Off-Balance Sheet Arrangements

We enter into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal, but we can provide no assurance that payments will not be required under these agreements in the future.

On January 1, 2009, we adopted FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities." FSP EITF 03-6-1 clarifies that share-based payment awards that entitle their holders to receive nonforfeitable dividends before vesting should be considered participating securities. As participating securities, these instruments should be included in the calculation of basic earnings per share. FSP EITF 03-6-1 is effective in 2009. The adoption of EITF 03-6-1 has not had a material impact on our consolidated financial statements.

On January 1, 2009, we adopted FASB Staff Position (FSP) 157-2. "Effective date of FASB No. 157, FSP 157-2 delayed the effective date of SFAS 157, Fair Value Measurements" ("SFAS 157") for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. The adoption of FSP 157-2 on January 1, 2009 did not have a material impact on our consolidated financial statements.

On January 1, 2009, SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS No. 141R") became effective for us. This statement significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in process research and development, and restructuring costs. In addition, under this statement, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income tax expense. SFAS 141R may have a material impact on our consolidated financial statements if or when we enter into a business combination.

On January 1, 2009, SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements", an amendment of ARB No. 51 became effective for us. This statement changes the accounting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions with minority interest holders. As of March 31, 2009, the Company did not have any minority interests.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments". This FSP amends SFAS 107, "Disclosure about Fair Value of Financial Instruments", to require disclosures about fair value of financial instruments in interim as well as annual financial statements. This FSP also amends APB 28, "Interim Financial Reporting", to require those disclosures in all interim financial statements. This standard is effective for periods ending after June 15, 2009. We are currently evaluating the impact that this standard may have on our financial statements.

In April 2009, the FASB issued FSP FAS 115-2 and FSP FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments", which amends the other-than-temporary impairment guidance for debt and equity securities. This standard is effective for periods ending after June 15, 2009. We currently anticipate that the adoption of FSP FAS 115-2 and FSP FAS 124-2 will not have an impact on our consolidated financial statements.