UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2009March 31, 2010

OR

For the transition period from            to            

Commission File Number: 0-21541

BITSTREAM INC.

(Exact name of registrant as specified in its charter)

500 Nickerson Road, Marlborough, Massachusetts 01752-4695

(Address of principal executive offices and zip code)

(617) 497-6222

(Registrant’s telephone number, including area code)

Indicate by checkmark 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 (the “Exchange Act”) 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  ¨

Indicate by checkmark whether the registrant has submitted electronically and posted on its Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On November 11, 2009,May 7, 2010, there were 9,919,17210,010,307 shares of Class A Common Stock, par value $0.01 per share issued and outstanding, and no shares of Class B Common Stock, par value $0.01 per share, issued or outstanding.

INDEX

PART I — FINANCIAL INFORMATION

BITSTREAM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

(Unaudited)

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

BITSTREAM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

(Unaudited)

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

BITSTREAM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(Unaudited)

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

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)Operations and Significant Accounting Policies

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, ourOur 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, and multi-channel communications technologies.

We areThe Company is subject to risks common to technology-based companies, including dependence on key personnel, rapid technological change, competition from alternative product offerings and larger companies, and challenges to the development and marketing of commercial products and services. We haveThe Company has also experienced net losses in prior years and as of September 30, 2009,March 31, 2010 have an accumulated deficit of approximately $16.6$17 million.

(a) Use of Estimates

The accompanying unaudited condensed consolidated financial statements reflect the application of certain accounting policies as described in this note and elsewhere in the accompanying condensed consolidated financial statements and notes. The preparation of the accompanying condensed consolidated financial statements requires the use of certain estimates by us in determining our assets, liabilities, revenues and expenses. Significant estimates in these financial statements include revenue recognition, share-based compensation, income taxes and the valuation of deferred tax assets, and the allowance for doubtful accounts receivable. Actual results may differ from these estimates.

(b) Basis of Presentation

Our unaudited condensed consolidated financial statements presented herein, without audit, have been prepared pursuant to the rules of the Securities and Exchange Commission (the “SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnote disclosures required by generally accepted accounting principles (“GAAP”). The balance sheet information as of December 31, 20082009 has been derived from our audited consolidated financial statements but does not include all disclosures required by GAAP. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 20082009 included in our Annual Report on Form 10-K, which was filed with the SEC on March 31, 2009.2010. The condensed consolidated balance sheet as of September 30, 2009,March 31, 2010, the condensed consolidated statements of operations for the three months ended March 31, 2010 and nine month periods ended September 30, 2009, and 2008, and the condensed consolidated statement of cash flows for the ninethree months ended September 30,March 31, 2010 and 2009, and 2008, and the notes to each are unaudited, but in the opinion of management include all adjustments necessary for a fair presentation of the condensed consolidated financial position, results of operations, and cash flows of the Company for these interim periods. The results of operations for the ninethree months ended September 30, 2009March 31, 2010 may not necessarily be indicative of the results to be expected for the year ending December 31, 2009.2010.

WeCertain prior year amounts have been reclassified to conform with the current year’s presentation.

The Company evaluated subsequent events through November 16, 2009, the date of financial statement issuance, to determine whether or not any such events required disclosure in this Form 10-Q. See note 8, for our subsequent event disclosure.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - STATEMENTS—(Continued)

(c) Property and Equipment (in thousands)

Property and equipment are stated at cost, less accumulated depreciation and amortization. Property and equipment consistconsists of the following:following (in thousands):

Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets as follows:

Depreciation expense for the three months ended September 30,March 31, 2010 and 2009 was $69 and 2008 was $66 and $74, respectively. Depreciation expense for the nine months ended September 30, 2009 and 2008 was $208 and $225,$72, respectively.

During the three and nine months ended September 30, 2009,March 31, 2010, we disposed of $419$8 of property and equipment with accumulated depreciation of $414$7 resulting in a loss on disposal of $5.$1. The assets were disposed of in connection with the move of our corporate offices and were no longer in service.

(d) Off-Balance Sheet Risk and Concentration of Credit Risk (in thousands)

Financial instruments that potentially expose usthe Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments in marketable securities, and trade accounts receivable, and investments. We placereceivable. The Company places a majority of ourits cash investments and other investmentscash equivalents in one highly-rated financial institution and holds its marketable securities in excess of federally insured limits. We havea custodial account at another highly-rated financial institution. The Company had not experienced significant losses related to receivables from any individual customers or groups of customers in any specific industry or by geographic area.area prior to January 2009. During 2009, the Company established reserves for certain customers affected by the economic downturn which began during the third quarter of 2008 and increased our allowance for bad debts from $32 at December 21, 2008 to $283 at December 31, 2009. During the three months ended March 31, 2010 the Company wrote-off approximately $214 of the reserved accounts. The Company has evaluated its receivable balance at March 31, 2010 and determined that the allowance for bad debts of $44 is adequate. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by us to be inherent in our accounts receivable. At September 30, 2009, one customer accounted for 11% of our accounts receivable. At DecemberMarch 31, 2008, two2010, three customers accounted for 17%14%, 13% and 11%10% of our accounts receivable, respectively. No single customerAt December 31, 2009, two customers accounted for 10% or more27% and 24% of our revenue for the three and nine month periods ended September 30, 2009 or 2008.accounts receivable, respectively. We do not have any off-balance sheet risks as of September 30, 2009March 31, 2010 or December 31, 2008,2009, respectively. For the three months ended March 31, 2010 and 2009, no single customer accounted for 10% or greater of our revenue.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - STATEMENT—(Continued)

(e) Goodwill and Other Intangible Assets (in thousands)

We do not amortizeGoodwill resulted from the acquisitions of Type Solutions, Inc. and Alaras Corporation and was $727 at March 31, 2010 and December 31, 2009.

The Comapny follows the accounting and reporting requirements for goodwill orand other intangible assets as required by authoritative guidance. Under this guidance, goodwill and indefinite-lived intangible assets rather we review themare not amortized, but are required to be reviewed annually for impairment, or more frequently if impairment indicators arise. We haveThe Company has determined that we doit does not have separate reporting units and thus goodwill is combined and tested for impairment based upon an enterprise wide valuation. The Company has not recorded any impairment charges related to goodwill since the time of the change to the authoritative guidance which called for goodwill to be reviewed for impairment rather than amortized, based on the results of its impairment tests. Separable intangible assets that have finite lives are amortized over their useful lives.

The components of ourthe Company’s amortized intangible assets follow:

Amortization expense for finite-lived intangible assets for the three months ended September 30,March 31, 2010 and 2009 and 2008 was $7 and $10, respectively. Amortization expense for finite-lived intangible assets for the nine months ended September 30, 2009 and 2008 was $21 and $29, respectively.$7. Estimated amortization for the five succeeding years follows:

(f) Comprehensive IncomeLoss (in thousands)

Comprehensive incomeloss consists of net income,loss and adjustments to stockholders’ equity for foreign currency translation adjustments.adjustments and unrealized losses from investments in marketable securities classified as available-for-sale. For the purposes of comprehensive incomeloss disclosures, the Company does not record tax provisions or benefits for the net changes in the foreign currency translation adjustment, as the Company intendswe intend to permanently reinvest undistributed earnings in its foreign subsidiaries in accordance with the applicable accounting guidance. For the purposes of comprehensive loss disclosures, the Company also does not record tax provisions or benefits for unrealized gains or losses on investments in marketable securities as we have recorded a full valuation allowance against our deferred tax asset and are not currently recording a tax liability.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - STATEMENTS—(Continued)

The components of comprehensive incomeloss are as follows (in thousands):

Accumulated other comprehensive loss consisted of the following:

(g) Recently Issued Accounting Standards

In June 2009, the Financial Accounting Standards Board (FASB) issued the FASB Accounting Standards Codification (Codification). The Codification will become the single source for all authoritative GAAP recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. The Codification does not change GAAP and will notCompany describes below recent pronouncements that have an affecthad or may have a significant effect on our financial position,statements. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to our financial condition, results of operations, or liquidity.disclosures.

In May 2009, the FASB issued authoritative guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance also requires entities to disclose the date through which subsequent events were evaluated as well as the rationale for why that date was selected and is effective for interim and annual periods ending after June 15, 2009. This guidance requires that public entities evaluate subsequent events through the date that the financial statements are issued. We adopted this guidance effective with our quarterly period ended June 30, 2009 and the adoption did not have a material impact on our condensed consolidated financial statements.

(h) Fair Value of Financial Instruments (in thousands)

Effective January 1, 2008, we implemented authoritative guidance for our financial assets and liabilities that are remeasured and reported atThe fair value at each reporting period, and non-financial assets and liabilities that are remeasured and reported atmeasurement rules establish a fair value at least annually.

We electedhierarchy which requires an entity to defer until January 1, 2009maximize the implementationuse of this authoritative guidance as it relates to our non-financial assetsobservable inputs and non-financial liabilities that are recognized and disclosed atminimize the use of unobservable inputs when measuring fair value in the financial statements on a nonrecurring basis. We adopted this authoritative guidance for all nonfinancial assets andvalue.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - STATEMENTS—(Continued)

nonfinancial liabilities measured atUnder authoritative guidance fair value on a non-recurring basis. Examples include goodwill, intangibles, and other long-lived assets. The adoption of this guidance did not have a material impact on our consolidated financial statements.

This guidance defines fair valueis defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We have certain financial assets and liabilities recorded atThis guidance also establishes a fair value (principally cash equivalentshierarchy that requires an entity to maximize the use of observable inputs, where available, and investments)minimize the use of unobservable inputs when measuring fair value. This guidance describes three levels of inputs that have been classified as Level 1, 2 or 3 withinmay be used to measure fair value:

At December 31, 2009, the fair value hierarchy. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points for the asset or liability.

At September 30, 2009 ourCompany’s financial assets and liabilities that were measured at fair value on a recurring basis included money market funds of $10 short-term investments in certificates of deposit of $114, and a restricted investment - long-term of $136, consisting of a certificate of deposit with an original maturity of greater than twelve months from the date of the balance sheet, which were Level 1 financial assets. The Company did not have any non-financial assets or liabilities that were measured or disclosed at fair value on a recurring basis at December 31, 2009 or March 31, 2010. As required by authoritative guidance, assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. The adoption of this guidance for non-financial assets and liabilities did not have a material impact on our consolidated financial position, results of operations or cash flows.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Assets and liabilities of the Company measured at fair value on a recurring basis as of March 31, 2010, are summarized as follows:

Cash equivalents are short-term, highly liquid investments with original maturity dates of three months or less at the date of acquisition. Cash equivalents are carried at cost plus accrued interest, which approximates fair value. The carrying amounts reflectedCompany’s investments in the consolidated balance sheets for restricted cash, accountsmarketable securities, corporate and government bonds, are classified as available-for-sale and are recorded at fair value with any unrealized gain or loss recorded as an element of stockholders’ equity. Purchased interest in included in interest receivable and reported as other current assets accounts payable,in our condensed consolidated balance sheet. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accrued expensesaccretion (loss) of discounts to maturity. Such amortization and accretion is included in interest income and other, current liabilities approximatenet of expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income and other, net of expense. The fair values due to their short-term maturities.value of investments in marketable securities is determined based on quoted market prices at the reporting date for those instruments.

Cash Equivalents

Cash equivalents of $1,981 consisting of money market funds are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets.

Short-term investments - Certificates of Deposit

Short-term investments - Certificates of Deposit of $114 are classified as Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets.

Restricted investment - long-term

Restricted investment - long-term consisting of Certificates of Deposit of $136 are classified as Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets.

Long-term investments

Long-term investments of $5,970 consisting of federal government and government agency bonds and corporate bonds are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets.

(i) Foreign Currency Translation and transactions (in thousands)

The financial statements of our foreign subsidiaries are translated in accordance with authoritative guidance for foreign currency translation. The functional currency for our foreign subsidiaries is the applicable local currency. For financial reporting purposes, assets and liabilities of subsidiaries outside the United States of America are translated into U.S. dollars using year-endperiod-end exchange rates. Revenue and expense accounts are translated at the monthly average rates in effect during the year.period. The effects of foreign currency translation adjustmentstranslations are included in accumulated other comprehensive incomeloss as a component of stockholders’ equity.

Transaction gains (losses) for the three months ended September 30,March 31, 2010 and 2009 were $2 and 2008 were $18, and $ 0, respectively and for the nine months ended September 30, 2009 and 2008 were $45, and $ 0,$14, respectively. Transaction gains were recorded as interest and other income, net in the condensed consolidated statements of operations.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(2) Cash, Cash Equivalents and Investments in Marketable Securities (in thousands)

Cash equivalents are short-term, highly liquid investments with original maturity dates of three months or less at the date of acquisition. Cash equivalents are carried at cost plus accrued interest, which approximates fair value. Our investments in marketable securities, corporate and government bonds, are classified as available-for-sale and are recorded at fair value with any unrealized gain or loss recorded as an element of stockholders’ equity. Purchased interest is included in interest receivable and reported as other current assets in our condensed consolidated balance sheet. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion (loss) of discounts to maturity. Such amortization and accretion is included in interest income and other, net. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income and other, net. The fair value of investments in marketable securities is determined based on quoted market prices for those instruments at the reporting date. As of March 31, 2010 and December 31, 2009, aggregate cash and cash equivalents and investments in marketable securities consisted of:

March 31, 2010:

(3) Income Per Share (in thousands)

Basic earnings or loss per share is determined by dividing the net income or loss by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflect the effect of the conversion of potentially dilutive securities, such as stock options, warrants, and restricted shares, based on the treasury stock method. In computing diluted earnings per share, common stock equivalents are not considered in periods in which a net loss is reported, as the inclusion of the common stock equivalents would be antidilutive.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

A reconciliation of As a result there is no difference between the Company’s basic and diluted loss per share for the three month periods ended March 31, 2010 and 2009.

If the Company had reported a profit for these periods, the potential common shares would have increased the weighted average shares outstanding by 677 and 405 shares for basicthe three months ended March 31, 2010 and diluted earnings per share is as follows:

2009, respectively. In addition, there were unvested restricted shares and options outstanding to purchase 439389 and 698693 shares for the threeat March 31, 2010 and nine month periods ended September 30, 2009, respectively, and there were unvested restricted shares and options outstanding to purchase 596 shares for the three and nine month periods ended September 30, 2008, that were not included in the potential common share computations because their exercise prices were greater than the average market price of ourthe Company’s common stock. These common stock duringequivalents are antidilutive even when a profit is reported in the applicable period.numerator.

BITSTREAM INC. AND SUBSIDIARIES

(3)NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(4) Equity-Based Compensation Expense (in thousands)

We currently estimateThe Company accounts for stock-based compensation in accordance with authoritative guidance, under which, stock-based compensation cost is measured at the grant date based on the fair value of share-based awardsthe award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

The Company currently estimates the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of share-based awardsstock options include the exercise price of the award, the expected option term, the expected volatility of ourits stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and ourits expected annual dividend yield. We doThe Company does not anticipate paying any cash dividends in the foreseeable future and therefore useuses an expected dividend yield of zero in the option valuation model. We areThe Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We useThe Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. We believeThe Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. These amounts, and the amounts applicable to future quarters, are also subject to future quarterly adjustments based upon a variety of factors, which include, but are not limited to, the issuance of new share-based awards. The following table summarizes the weighted average assumptions we utilized for grants of share-based awardsoptions.

No stock options were granted during the three and nine months ended September 30, 2009March 31, 2010 and 2008:

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

2009. During the three months ended March 31, 2010 we made a restricted stock award of 25,000 shares, which was valued at its intrinsic value, the fair market value at the grant date.

All share-based awardsoptions granted have a contractual ten-year term. All options granted in 2010 vest in equal installments on the first, second, third, and fourth year anniversaryanniversaries over a four-yearfour year period of continuous employee service. All restricted shares grantedstock awards made prior to January 1, 2010 vest in equal installments on the first, second, third, fourth and fifth year anniversaryanniversaries over a five-yearfive year period of continuous employee service. All restricted stock awards made subsequent to January 1, 2010 vest in 20 equal installments on the quarterly anniversaries from the date of grant over a five-year period. The risk-free interest rate utilized is based upon published U.S. Treasury yield curves at the date of the grant for the expected option term. Expected stock price volatility is based upon the historical volatility of our common stock price over the expected term of the option. We use historical exercise, forfeiture, and cancellation information to determine expected term and forfeiture rates.

OurThe Company’s results for the three months ended September 30,March 31, 2010 and 2009 include $227 and 2008 include $216 and $197, respectively, and for the nine months ended September 30, 2009 and 2008 include $616 and $540,$194, respectively, of share-based compensation within the applicable expense classification where we reportit reports the share-based award holders’ compensation expense.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table presents share-based compensation expense included in ourthe Company’s condensed consolidated statement of operations:

(4)(5) Commitments and Contingencies, (in thousands)

Lease commitments

We conduct ourThe Company conducts its operations in leased facilities. The previous lease for our corporate offices expired August 31, 2009. That lease requires that we maintain a Letter of Credit for $150 through October 31, 2009 which is classified as current restricted cash on our Balance Sheet. In June 2009, we entered into a ten-year lease agreement for 27 thousand square feet of office space with the right of first refusal on an additional 4 thousand square feet in a building located in Marlborough, Massachusetts. Our currentThis lease agreement commenced September 1, 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 beginbegan after three (3) free months of rent and increase by approximately 2% per annum. The totalremaining commitment under the lease at March 31, 2010 is approximately $5,390, net of a tenant allowance of $411. We record$5,226. The Company records rent expense on a straight-line basis, taking into consideration the free rent period, the tenant allowance received at the outset of the lease, and annual incremental increases to the lease payments. OurThe Company’s current lease agreement also required usrequires it to obtainmaintain a Letter of Credit in the amount of $136 to be in place through October 31, 2019, which wethe Company collateralized with a certificate of deposit classified as a long-term restricted asset on our Balance Sheet.the condensed consolidated balance sheet.

In July 2008, Bitstream India Pvt. Ltd., our wholly-owned subsidiary, entered into a 33 month33-month lease agreement in Nodia, India. This lease agreement commenced May 1, 2008 and obligates usthe Company to make monthly payments including service taxes. Our total financialThe remaining commitment during the 33 month lease periodat March 31, 2010 is approximately $132$52 U.S. dollars.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

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

Royalties

We haveThe Company has 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 under our cost of software license revenue on ourthe condensed consolidated Statementstatement of Operations.operations.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

IndemnificationGuarantees

We enterThe Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, we indemnify, holdthe Company indemnifies, holds harmless, and agreeagrees 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 ourits products. The term of these indemnification agreements is generally perpetual 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 haveThe Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of our liability under these agreements is minimal.

Legal Actions

From time to time, we arethe Company is subject to legal proceedings and claims in the ordinary course of business, including claims of infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. We makeIn accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. This provision is reviewed at least quarterly. As of September 30, 2009,March 31, 2010, no liability was recorded. Litigation is inherently unpredictable and it is possible that ourthe Company’s financial position, cash flows, or results of operations could be materially affected in any particular period by the occurrence or resolution of any such contingencies or the costs involved in seeking the resolution of any such contingencies.

(5)(6) Income Taxes (in thousands)

We accountThe Company accounts for income taxes under the asset and liability method and determine ourin accordance with authoritative guidance, under which a deferred tax asset or liability is determined based on the difference between the financial statement and the tax basis of assets and liabilities, as measured by enacted tax rates in effect when these differences are expected to reverse.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

The Company’s income tax provisions for the three and nine months ended September 30,March 31, 2010 and 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 September 30, 2009,March 31, 2010, a full valuation allowance was recorded against the Company’s net deferred tax assets in the U.S. At December 31, 2008,2009, the Company had U.S. federal and state net operating loss (“NOL”) carryforwards of $12,626$11,332 and $59,$289, respectively, of which the benefit of approximately $7,532$8,272 and $59,$289, respectively, when realized, will be recorded as a credit to additional paid in capital. The Company’sCompany's NOL carry-forwards begin to expire in 2020 for federal purposes. TheAt December 31, 2009, the Company also had U.S. federal and state research and development credit (“R&D Credit”) carryforwards of $932$1,011 and $331,$366, respectively. These R&D credit carryforwards begin to expire in 20092010 for federal purposes and 2016 for state purposes. As of December 31, 2008,2009, we had foreign tax credit carryforwards of $380.$490. These foreign tax credit carryforwards begin to expire in 2012.

WeThe Company continued to provide a full valuation allowance for our net deferred tax assets at September 30, 2009,March 31, 2010, as we believeit believes it is more likely than not that the future tax benefits from accumulated net operating losses and deferred taxes will not be realized. We continueThe Company continues 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.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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. The following is a summary of the components of the provision for income taxes:

In June 2006, the FASB issued authoritative guidance on accounting for uncertain income taxes which clarifiesclarifying the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’scompany's financial statements. WeThe Company adopted this guidance on January 1, 2007. The2007, the implementation of which did not have a material impact on ourthe Company’s consolidated financial statements, results of operations or cash flows. At the adoption date of January 1, 2007, and also at December 30, 2007,31, 2009, and DecemberMarch 31, 2008, we2010, the Company had no unrecognized tax benefits. We have not conducted a study of our research and development credit carryforwards. Such a study may result in an adjustment to our research and development credit carryforwards; however, until a study is completed and any adjustment is known, no amounts are being presented as an uncertain tax position. A full valuation allowance has been provided against our research and development credits and, if an adjustment is required, this adjustment would be offset by an adjustment to the valuation allowance. Thus, there would be no impact to the consolidated balance sheet or statement of operations if an adjustment were required.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

We recognizeThe Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2009, weMarch 31, 2010, the Company had no accrued interest or penalties related to uncertain tax positions. The tax years 20042005 through 20082009 remain open to examination by the major taxing jurisdictions to which we are subject. We haveThe Company has determined that it is more likely than not that the deferred tax assets will not be realized, therefore, a valuation allowance has reduced the deferred tax assets to zero.

(6)BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(7) Geographical Reporting (in thousands)

We reportThe Company reports revenue and income under one reportable segment. OurIts management assesses operating results on an aggregate basis to make decisions about the allocation of resources. Revenue by geography is based on the billing address of the customer. The following tables set forth revenue and long-lived assets by geographic area.

Long-lived tangible assets by geographic area are as follows:

(8) Subsequent Events

On May 17, 2010, the Company agreed to acquire the assets of Press-sense Ltd. for $6.5 million in cash. Based in Israel, Press-sense is a leading developer of business flow automation systems. The purchase is expected to be completed during our quarter ended June 30, 2010. The purchase price allocation has not been completed, but a significant portion of the purchase price is expected to be allocated to acquired intangible assets and goodwill.

PART I, ITEM 2. MANAGEMENT’SMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

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

OVERVIEW

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 maintain our executive offices at 500 Nickerson Road, Marlborough, Massachusetts 01752-4695. Our telephone number is (617) 497-6222. 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.

CRITICAL ACCOUNTING POLICIES

We incorporate herein by referenceThe Company has identified the section entitled “Management’spolicies 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 Operation — Critical Accounting Policies” contained inOperations where such policies affect the Company’s reported and expected financial results. Note that our Annualpreparation of this Quarterly Report on Form 10-K10-Q 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

We derive revenue from the license of our software products, and from consulting, hosting, and support and maintenance services. Primarily, we recognize 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.

Multiple-element arrangements:

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. Under the residual method, the arrangement consideration is first allocated to undelivered elements based on vendor-specific objective evidence of the fair value for each element and the residual amount is allocated to the delivered elements. Arrangement consideration allocated to undelivered elements is deferred and recognized as revenue when the elements are delivered, if all other revenue recognition criteria are met. We have established sufficient vendor-specific objective evidence for the fiscal yearvalue 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 revenue is recognized under the residual method in arrangements in which software is licensed with maintenance, consulting, training or other services.

License Revenue (in thousands):

We receive and recognize licensing fees and royalty revenue from: (1) Original Equipment Manufacturer (“OEM”) and Independent Software Vendor (“ISV”) customers for font rendering and page composition technologies; (2) direct and indirect licenses of software publishing applications for the creation, enhancement, management, transport, viewing and printing of electronic information; (3) direct sales of custom design and consulting services to end users such as graphic artists, desktop publishers, corporations and resellers; and (4) sales of fonts and publishing applications to foreign customers primarily through distributors and resellers.

Certain OEM and ISV customers pay royalties only upon the sublicensing of our products to end-users. Revenue in such transactions is recognized in the period when sublicenses to end users are reported to us by our OEM or ISV customers. Revenue from guaranteed minimum royalty licenses is recognized upon delivery of the software license when no further obligations of the Company exist. In certain guaranteed minimum royalty licenses, we will enter into extended payment programs with creditworthy customers. Revenue related to extended payment programs is recognized when payment becomes due to the Company.

We recognize license revenue from the resale of our products through various resellers. Resellers may sell our products in either an electronic format or CD format. Revenue is recognized if collection is probable, upon notification from the reseller that it has sold the product, or for a CD product, upon delivery of the software.

Revenue from end user product sales is recognized upon delivery of the software, net of estimated returns and allowances, and when collection is probable. Revenue related to extended payment programs is recognized when payment becomes due to the Company. End user sales include e-commerce revenue generated from our websites from the licensing of Bitstream fonts, subscription licenses for our browser, licensing of fonts 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, 2010 and 2009 was $9 and $11, respectively. There are minimal costs associated with the referral program, and primarily represent the time to load copies of the fonts provided by each participating foundry for addition to the MyFonts.com database. We expense those costs as incurred.

Service Revenue:

Professional services include custom design and 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 are made in the period in which such losses become probable.

We recognize revenue from support and maintenance agreements ratably over the term of the agreement.

Deferred revenue includes unearned software support and maintenance revenue, advance billings under contracts; and advanced billings for unrecognized revenue from licenses.

Cost of revenue from software licenses consists primarily of royalties paid to third party developers and foundries whose products we sell, and costs to distribute the product, including the cost of the media on which it is delivered. Cost of revenue from services consists primarily of costs associated with customer support, consulting and custom product development services.

We generally warrant that our products will function substantially in accordance with documentation provided to customers for approximately 90 days following initial delivery. We have not incurred any material expenses related to warranty claims.

Stock-based Compensation

We account for stock-based compensation in accordance with authoritative guidance and have 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 authoritative guidance 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 authoritative guidance, we 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, 20082009 and filed withdetermined that the SECfair 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 increased these reserves throughout 2009, and subsequently wrote-off several accounts during the three months ended March 31, 2009. No changes2010, as the downturn in the global economy has affected our customers and made collections from certain customers difficult. We cannot guarantee that our credit loss rates won’t continue to worsen or that we will experience the similar credit loss rates that we have been madeexperienced 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.

Cash and Cash Equivalents and Marketable Securities

Cash equivalents are short-term, highly liquid investments with original maturity dates of three months or less at the date of acquisition. Cash equivalents are carried at cost plus accrued interest, which approximates fair value. Our investments in marketable securities, corporate and government bonds, are classified as available-for-sale and are recorded at fair value with any unrealized gain or loss recorded as an element of stockholders’ equity. Purchased interest in included in interest receivable and reported as other current assets in our condensed consolidated balance sheet. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion (loss) of discounts to maturity. Such amortization and accretion is included in interest income and other, net of expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income and other, net of expense. The fair value of investments in marketable securities is determined based on quoted market prices at the reporting date for those policies since December 31, 2008.instruments. Assumptions used require significant judgments by management. Changes in the assumptions could result in materially different estimates of fair values, resulting in additional credits and charges presented in the consolidated financial statements.

FORWARD LOOKING STATEMENTS

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, 20082009 filed with the SEC on March 31, 2009.2010. 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)

RevenueNon-GAAP measures, (in thousands)

We use non-GAAP information internally to evaluate our operating performance and Gross Profit:believe these non-GAAP measures are useful to investors as they provide additional insight into the underlying operating results. Our non-GAAP net income excludes the effect of stock-based compensation expense. These non-GAAP measures are not in accordance with GAAP, should not be considered an alternative for measures prepared in accordance with GAAP, and may have limitations in that they do not reflect all of Bitstream’s results of operations as determined in accordance with GAAP. These non-GAAP measures should only be used to evaluate Bitstream’s results of operations in conjunction with the corresponding GAAP measures. The presentation of non-GAAP information is not meant to be considered superior to, in isolation from, or as a substitute for results prepared in accordance with GAAP. A reconciliation of GAAP to non-GAAP results is set forth in the table below:

Diluted net income per share is based on 9,953 diluted weighted average shares outstanding for the three months ended March 31, 2010. For the three months ended March 31, 2009, diluted net income per share is based on 10,128 fully-diluted weighted average shares outstanding and the diluted net loss per share is based on 9,723 diluted weighted average shares outstanding.

Revenue and Gross Profit:

LicenseThe increase in revenue from software licenses was attributable to an increase in direct sales which includes e-commerce sales, decreased $280,of $559 or 8.9%,20.9% to $2,855$3,240 for the three months ended September 30, 2009March 31, 2010 as compared to $3,135$2,681 three months ended March 31, 2009, due to an increase in sales of fonts from our e-commerce site. This increase was due to both the volume and variety of fonts sold. Software license revenue from resellers decreased $199, or 67.0% to $98 for the three months ended September 30, 2008. License revenue from resellers decreased $96, or 28.6%,March 31, 2010, as compared to $240$297 for the three months ended September 30, 2009 as comparedMarch 31, 2009. Software license revenue from Original Equipment Manufacturers (“OEMs”) and Independent Software Vendors (“ISVs”) decreased $108, or 13.7% to $336$679 for the three months ended September 30, 2008. License revenue from OEMs and ISVs increased $666, or 88.7%,March 31, 2010, as compared to $1,417$787 for the three months ended September 30, 2009March 31, 2009. The decrease in reseller revenue and direct sales, excluding e-commerce sales, was due to decreases in the volume and variety of fonts and publishing products licensed during the three months ended March 31, 2010. The decrease in OEM and ISV revenue was due to a decrease in new licenses, as comparedwell as license renewals and royalties received under existing license agreements because of decreases in reported unit shipments by certain OEM customers. We were affected by the global economic downturn, as were our customers, including various OEMs and ISVs who report product royalties on shipments of their products. We are not able to $751determine at this time how these economic conditions will impact our license revenue during the remainder of 2010.

Revenue from services decreased 3.6% for the three months ended September 30, 2008. LicenseMarch 31, 2010 as compared to the three months ended March 31, 2009 due to decreases in consulting, custom design and training services of $24 and a decrease in maintenance and support contract revenue of $20 associated with our publishing and font technology product lines. Service revenue from direct sales which includes e-commerce sales, decreased $1,585,$52, or 16.1%5.4%, to $8,231$915 for the ninethree months ended September 30, 2009March 31, 2010 as compared to $9,816$967 for the ninethree months ended September 30, 2008. LicenseMarch 31, 2009. Service revenue from resellers decreased $446,increased $26, or 39.7%14.5%, to $677$205 for the ninethree months ended September 30, 2009March 31, 2010 as compared to $1,123$179 for the ninethree months ended September 30, 2008. LicenseMarch 31, 2009. Service revenue from OEMs and ISVs decreased $171,$19, or 4.7%21.1%, to $3,453 for the nine months ended September 30, 2009 as compared to $3,624 for the nine months ended September 30, 2008.

License revenue varies between quarters due to the timing of license agreements. With the exception of new OEM license revenue$71 for the three months ended September 30, 2009, revenue for the three and nine month periods ended September 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. License revenue from OEMs increased during the three months ended September 30, 2009 andMarch 31, 2010 as compared to the same period for the prior year due to the signing of several new licenses in a particularly strong September. We believe that the decreases we have experienced can be attributed primarily to the economic conditions affecting consumers and that our license revenue may continue to be similarly affected until general economic conditions improve.

The decrease in revenue from services$90 for the three months ended September 30, 2009 was due to a decrease in consultingMarch 31, 2009. Consulting, graphic design and training services vary with specific requirements of $106, or 46.8%customers and may be affected more by economic concerns as customers may delay design changes, custom development and training. We are affected by the global economic downturn and we are not able to $121 as compared to $227 for the three months ended September 30, 2008, as well as, a decrease in revenue related to support contracts of $5, or 0.5%, to $1,028 for the three months ended September 30, 2009 as compared to $1,033 for the three months ended September 30, 2008. The decrease in revenue from services for the nine months ended September 30 2009 was due to a decrease in consulting and training services of $299, or 39.2% to $464 as compared to $763 for the nine months ended September 30, 2008. This decrease was partially offset by increases in revenue related to support contracts primarily driven by increases indetermine at this time how these economic concerns will impact our customer base and customer demand for publishing support services, of $42, or 1.4%, to $3,086 for the nine months ended September 30, 2009 as compared to $3,044 for the nine months ended September 30, 2008. We believe that our overall servicesservice revenue during 2009 will approximate the level attained in 2008 but if general economic conditions do not improve, service revenue for the quarter ending December 31, 2009 may continue to be lower than the levelremainder of service revenue achieved for the same period in 2008.2010.

We recognize license revenue from direct sales and from licensing agreements of our products and products from third party productsparties 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,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 three months ended September 30,

March 31, 2010 and 2009 and 2008 was $9 and $17, respectively. Referral income for the nine months ended September 30, 2009 and 2008 was $31 and $40,$11, 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 three months ended September 30, 2009 and the decrease in cost of license revenue for the nine months ended September 30, 2009March 31, 2010 as compared to the same periodsthree months ended September 30, 2008March 31, 2009 was primarily due to an increase of $62 and decrease of $635, for the three and nine month periods, respectively, inincreased direct costs, including royalty costs, associated withand credit card processing expenses of $579, or 38.6%, to $2,078 for the three months ended March 31, 2010 as compared to $1,499 for the three months ended March 31, 2009, resulting from increased sales of third party products which vary with theincluding e-commerce sales. We also incurred increased support infrastructure costs for our e-commerce and browsing product mix sold and the royalty rate paid on those products. Welines. Due to anticipated e-commerce revenue growth, we expect thethat cost of license revenuelicenses as a percentagepercent of licensesales for 2010 will continue at a level above that reflected in our 2009 financial statements, until such time as revenue forfrom sales of our type, publishing and browsing technologies begins to increase relative to the fiscal year ending December 31, 2009 to approximate the percentage for the year ended December 31, 2008, although theincrease in e-commerce revenue, though quarterly results may vary based upon the mix of products sold during the remainder of the year.any particular quarter.

The decrease in cost of services revenue for the three and nine month periodsmonths ended September 30, 2009March 31, 2010, as compared to the same periodsthree months ended September 30, 2008March 31, 2009 was primarily due to a transferdecreases in customer support and consulting services costs of $71 and $46, respectively. The decrease in consulting services costs associated withwas due to an increase in the internal deploymentallocation of custom design personnel ontoresources charged to research and development projects during the second and third quarters of 2009 of $61 and $37, respectively, and a reductionresulting in personnel and related salary and benefitlower costs of $50services expense. Our costs of services infrastructure is expected to remain relatively constant during the third quarter of 2009. During the remainder of 2009,2010 and we expect our cost ofvariable costs to increase as the demand for these services increases and we expect our costs as a percentage of service revenue to increase to approximate the percentages for 2008 but if economic conditions do not improve, our cost of services as a percentage of service revenue may increase unless we make certain infrastructure changes.level attained during 2009.

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.products. These costs include depreciation and amortization.

Operating Expenses: