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 technologies and variable data publishing and Web-to-print technologies.

We will maintain our executive offices at 245 First Street, 17th Floor, Cambridge, Massachusetts 02142-1270 through the end of our current lease term of August 31, 2009 at which point we will move our executive offices to 500 Nickerson Road, Marlborough, Massachusetts 01752-4695. Our telephone number is
(617) 497-6222 and will remain so after the move. 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 June 30,
                                     % of                    % of               Change
                           2009     Revenue        2008     Revenue      Dollars       Percent
 Revenue
 Software licenses       $  4,084      77.8 %    $  5,215      80.0 %    $ (1,131 )      (21.7 )%
 Services                   1,165      22.2         1,303      20.0          (138 )      (10.6 )

 Total revenue              5,249     100.0         6,518     100.0        (1,269 )      (19.5 )

 Cost of Revenue
 Software licenses          1,602      39.2         1,845      35.4          (243 )      (13.2 )
 Services                     539      46.3           603      46.3           (64 )      (10.6 )

 Total cost of revenue      2,141      40.8         2,448      37.6          (307 )      (12.5 )


 Gross Profit            $  3,108      59.2 %    $  4,070      62.4 %    $   (962 )      (23.6 )%

 Revenue and Gross Profit:

                                 Six Months Ended June 30,
                                     % of                    % of               Change
                           2009     Revenue        2008     Revenue      Dollars       Percent
 Revenue
 Software licenses       $  7,849      76.6 %    $ 10,341      80.2 %    $ (2,492 )      (24.1 )%
 Services                   2,401      23.4         2,546      19.8          (145 )       (5.7 )

 Total revenue             10,250     100.0        12,887     100.0        (2,637 )      (20.5 )

 Cost of Revenue
 Software licenses          3,167      40.3         3,859      37.3          (692 )      (17.9 )
 Services                   1,122      46.7         1,184      46.5           (62 )       (5.2 )

 Total cost of revenue      4,289      41.8         5,043      39.1          (754 )      (15.0 )


 Gross Profit            $  5,961      58.2 %    $  7,844      60.9 %    $ (1,883 )      (24.0 )%

License revenue from direct sales, which includes e-commerce sales, decreased $644, or 19.3%, to $2,695 for the three months ended June 30, 2009 as compared to $3,339 for the three months ended June 30, 2008. License revenue from resellers decreased $380, or 73.1%, to $140 for the three months ended June 30, 2009 as compared to $520 for the three months ended June 30, 2008. License revenue from OEMs and ISVs decreased $107, or 7.9%, to $1,249 for the three months ended June 30, 2009 as compared to $1,356 for the three months ended June 30, 2008. License revenue from direct sales, which includes e-commerce sales, decreased $1,305, or 19.5%, to $5,376 for the six months ended June 30, 2009 as compared to $6,681 for the six months ended June 30, 2008. License revenue from resellers decreased $350, or 44.5%, to $437 for the six months ended June 30, 2009 as compared to $787 for the six months ended June 30, 2008. License revenue from OEMs and ISVs decreased $837, or 29.1%, to $2,036 for the six months ended June 30, 2009 as compared to $2,873 for the six months ended June 30, 2008.

License revenue varies between quarters due to the timing of license agreements. Revenue for the three and six month periods ended June 30, 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 respective periods. We believe these decreases can be attributed primarily to the economic conditions generally affecting consumers during this period. If general economic conditions do not improve, license revenue for the year ending December 31, 2009 will continue to be lower than the levels achieved for the corresponding periods in 2008.

The decrease in revenue from services for the three months ended June 30, 2009 was due to a decrease in consulting and training services of $111, or 40.1% to $166 as compared to $277 for the three months ended June 30, 2008, as well as, a decrease in revenue related to support contracts of $27, or 2.6%, to $999 for the three months ended June 30, 2009 as compared to $1,026 for the three months ended June 30, 2008. The decrease in revenue from services for the six months ended June 30 2009 was due to a decrease in consulting and training services of $193, or 36.0% to $343 as compared to $536 for the six months ended June 30, 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 $47, or 2.3%, to $2,058 for the six months ended June 30, 2009 as compared to $2,011 for the six months ended June 30, 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 our 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 June 30, 2009 and 2008 was $11 and $17, respectively. Referral income for the six months ended June 30, 2009 and 2008 was $22 and $23, 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 and six month periods ended June 30, 2009 as compared to the same periods ended June 30, 2008 was primarily due to decreases of $249 and $697, for the three and six month periods, respectively, in direct costs, including royalty costs, associated with decreased sales of third party products. 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.

The decrease in cost of services revenue for the three and six month periods ended June 30, 2009 as compared to the same periods ended June 30, 2008 was primarily due to an increase in the internal deployment of custom design personnel onto research and development projects during the second quarter of 2009 of $61 which decreased costs of services for the three and six month periods. 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 June 30,
                                                     % of                   % of                Change
                                           2009     Revenue       2008     Revenue       Dollars       Percent
Marketing and selling                     $   874      16.7 %    $ 1,244      19.1 %    $    (370 )      (29.7 )%
Research and development                    1,193      22.7        1,322      20.3           (129 )       (9.8 )
General and administrative                    683      13.0          712      10.9            (29 )       (4.1 )

Total operating expenses                  $ 2,750      52.4 %    $ 3,278      50.3 %    $    (528 )      (16.1 )%

Operating Expenses:



                                                 Six Months Ended June 30,
                                                     % of                   % of                Change
                                           2009     Revenue       2008     Revenue       Dollars       Percent
Marketing and selling                     $ 1,907      18.6 %    $ 2,379      18.5 %    $    (472 )      (19.8 )%
Research and development                    2,407      23.5        2,714      21.1           (307 )      (11.3 )
General and administrative                  1,455      14.2        1,359      10.5             96          7.1

Total operating expenses                  $ 5,769      56.3 %    $ 6,452      50.1 %    $    (683 )      (10.6 )%

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 June 30, 2009 as compared to the three months ended June 30, 2008 was primarily the result of decreases in payroll costs and advertising and marketing activities. Payroll costs decreased primarily due to decreases of $47 in commissions and bonuses from decreased commissionable sales and bonuses and a one-time bonus reversal of $33 during the three months ended June 30, 2009. Advertising and marketing activities decreased $268 primarily due to a $200 decrease in tradeshow costs from the non-recurrence of the Drupa tradeshow during 2009. Drupa is held once every four years and was last held during the second quarter of 2008 in Düsseldorf, Germany. The decrease in M&S expense for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008 was primarily the result of a $53 decrease in professional marketing agency services and decreases in payroll costs and advertising and marketing activities. Payroll costs decreased primarily due to decreases of $86 in commissions and bonuses from decreased commissionable sales and bonuses and a one-time bonus reversal of $33 during the three months ended June 30, 2009. Advertising and marketing activities decreased $311 including a $200 decrease in tradeshow costs from the non-recurrence of the Drupa tradeshow during 2009. Drupa is held once every four years and was last held during the second quarter of 2008 in Düsseldorf, Germany. We expect our M&S expenses to increase above the level recorded for the six months ended June 30, 2009 with increases in trade show expenses and salaries including commissions during the remainder of 2009 but to remain below the level recorded for the year ended December 31, 2008.

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 June 30, 2009 as compared to the three months ended June 30, 2008 was primarily the result of decreases in salaries and benefits and the use of third party contractors of $196 partially offset by an increase in the utilization of custom design and consulting personnel on R&D projects of approximately $61. The decrease in R&D expense for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008 was primarily the result of decreases in salaries and benefits and the use of third party contractors of $395 partially offset by an increase in the utilization of custom design and consulting personnel on R&D projects of approximately $70. The decrease in R&D payroll costs for the three and six month periods ended June 30, 2009 as compared to the same periods ended June 30, 2008 is primarily due to decreases in bonus accruals during 2009 reflecting the Company's decreased performance caused primarily by the current economic environment. We expect our development efforts to increase during the remainder of 2009 and to approximate the level recorded during the third and fourth quarters of 2008.

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 decrease in G&A for the three months ended June 30, 2009 as compared to the three months ended June 30, 2008 is primarily due to decreases in administrative payroll costs of $51 and a decrease in bad debt expense of $12, partially offset by an increase in public reporting and filing related costs of $34. The increase in G&A for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008 is primarily due to an increase in bad debt expense of $147 attributable to an increase in the allowance for doubtful accounts and an increase in professional fees of $38, partially offset by decreases in administrative payroll costs of $94. The decrease in administrative payroll costs for the three and six month periods ended June 30, 2009 as compared to the same periods ended June 30, 2008 is due to decreases in bonus accruals during 2009 reflecting the Company's decreased performance caused primarily by the current economic environment. We expect G&A expense to increase slightly during the remainder of 2009.

Other Income, Net:

Six Months Ended June 30, % of % of Change 2009 Revenue 2008 Revenue Dollars Percent Interest and other income, net $ 35 0.3 % $ 130 1.0 % $ (95 ) (73.1 )%

Other income includes interest income earned on cash and money market instruments and foreign currency transaction gains. Transaction gains for the three months ended June 30, 2009 and 2008 were $13, and $ 0, respectively. Transaction gains for the six months ended June 30, 2009 and 2008 were $27, 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 June 30,
                                         % of                 % of              Change
                                2009    Revenue      2008    Revenue       Dollars    Percent
  Provision for income taxes   $   55       1.0 %    $  13       0.2 %    $      42     323.1 %


                                     Six Months Ended June 30,
                                         % of                 % of              Change
                                2009    Revenue      2008    Revenue       Dollars    Percent
  Provision for income taxes   $   61       0.6 %    $  50       0.4 %    $      11      22.0 %

The Company's income tax provisions for the three and six month periods ended June 30, 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 June 30, 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 June 30, 2009, 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 June 30, 2009, we had net working capital of $15,218 versus $14,257 at December 31, 2008, an increase of $961 or 6.7%.

Our operating activities generated cash during the six months ended June, 2009 and 2008 of $529 and $1,221, respectively. Cash from operating activities was generated primarily from our net income after consideration for non-cash expenses which increased cash for the six months ended June 30, 2009 and 2008 by $722 and 1,985, respectively. These increases were partially offset by changes in assets and liabilities during the same periods. We used cash of $27 and $141 for the six months ended June 30, 2009 and 2008, respectively, for the purpose of acquiring additional property and equipment and intangible assets. Our financing activities for the six months ended June 30, 2009 provided cash of $411 from the exercise of stock options, while our financing activities for the six months ended June 30, 2008 used cash of $4,119 to repurchase shares of our common stock which was partially offset by $558 in proceeds from the exercise of stock options. Our cash balance also decreased by $8 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.

We conduct our operations in leased facilities. The current lease for our corporate offices expires August 31, 2009. In June 2009, we entered into a ten-year lease agreement for 27 square feet of office space with the right of first refusal on an additional four square feet and will move our corporate offices during August 2009. This lease agreement will commence during August 2009 and obligates us to make minimum lease payments plus our pro-rata share of future real estate tax increases and certain operating expense increases above the base year. The lease payments begin after three free months of rent and increase approximately 2% per annum. The total commitment under the lease is approximately $5,390, net of a tenant allowance of $411. We record rent expense on a straight-line basis, which takes into account the free rent period, the tenant allowance received at the outset of the lease, and annual incremental increases to the lease payments. This lease agreement also required us to obtain a Letter of Credit in the amount of $136 through October 31, 2019, which we collateralized with a certificate of deposit classified as a long-term restricted asset on our Balance Sheet.

In July 2008, Bitstream India Pvt. Ltd., our wholly-owned subsidiary, entered into a 33 month lease agreement in Nodia India. This lease agreement commenced May 1, 2008 and obligated us to make monthly payments including service taxes. Our total financial commitment during the 33 month lease period is approximately $132 U.S. dollars.

The future minimum annual lease payments, as of June 30, 2009, under our leased facilities are as follows:

                            Operating leases:
                            2009, remainder     $   186
                            2010                    543
                            2011                    525
                            2012                    522
                            2013                    536
                            2014                    550
                            2015                    564
                            2016                    577
                            2017                    591
                            2018                    605
                            2019                    359

                                                $ 5,558

As of June 30, 2009, we had no material commitments for capital expenditures. During July 2009 we entered into a commitment to purchase approximately $314 in furniture and fixtures related to our corporate office move which will be covered by the tenant allowance provided by our new lease and for which we anticipate being fully reimbursed. The tenant allowance will be amortized over the term of the lease and included in our lease expense.

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 . . .