UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2010March 31, 2011

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). (the Registrant is not yet required to submit Interactive Data)    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 NovemberMay 10, 2010,2011, there were 10,190,63710,359,356 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.

INDEXINDEX

PART I—I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

All references to “Bitstream,” “we,” “us,” “our,” or “Company” refer to Bitstream Inc. and its subsidiaries. Except as otherwise noted, all reported dollar amounts are in thousands.

(1) Operations and Significant Accounting Policies

The Company is a software development company focused on bringing uniqueinnovative and proprietary software products to a wide variety of markets. Our core software products include award-winning fonts and font rendering technologies, mobile browsing and messaging technologies, variable data publishing and web-to-print technologies, and multi-channel communications technologies. The Company operates in one business segment and we conduct our operations through Bitstream Inc. and two foreign subsidiaries; Bitstream India Pvt. Ltd. and Bitstream Israel LTD.

The 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. The Company has also experienced net losses in the current year, as well as prior years, and as of September 30, 2010March 31, 2011 has an accumulated deficit of approximately $18.7$21 million. For a complete discussion of our business risks, see the “Risk Factors” under Part I, Item 1A. beginning on page 18 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.2010.

(a) Use of Estimates

The accompanying 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, the valuation ofacquired intangible assets and goodwill, 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 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, 20092010 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, 20092010 included in our Annual Report on Form 10-K, which was filed with the SEC on March 31, 2010.2011. The condensed consolidated balance sheet as of September 30, 2010,March 31, 2011, the condensed consolidated statements of operations for the three and nine months ended September 30,March 31, 2011 and 2010, and 2009, and the condensed consolidated statementstatements of cash flows for the ninethree months ended September 30,March 31, 2011 and 2010, and 2009, 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, 2010March 31, 2011 may not necessarily be indicative of the results to be expected for the year ending December 31, 2010.2011.

Certain prior year amounts have been reclassified to conform with the current year’s presentation. The Company evaluated subsequent events through November 15, 2010May 13, 2011 to determine whether or not any such events required disclosure in this Form 10-Q, and determined that no such10-Q. See Note 10 for our subsequent event has occurred.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 consists of the following:

Depreciation expense for the three months ended September 30,March 31, 2011 and 2010 was $64 and 2009 was $80 and $66, respectively. Depreciation expense for the nine months ended September 30, 2010 and 2009 was $213 and $208,$69, respectively.

During the three and nine months ended September 30, 2010,March 31, 2011, we disposed of $52 and $65$21 of fully depreciated property and equipment with accumulated depreciation of $52 and $64 resulting in a loss on disposal of $1 for the nine months ended September 30, 2010. The assets werewhich was no longer in service.

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

Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments in marketable securities, and trade accounts receivable. The Company places a majority of its cash and cash equivalents in one highly-rated financial institution and holds its marketable securities in a 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 prior to January 2009. During 2009, we established reserves for certain customers affected by the economic downturn and increased our allowance for doubtful accounts from $32 at December 31, 2008 to $283 at December 31, 2009. During the three and nine month periods ended September 30, 2010 the Company wrote-off approximately $1 and $230, respectively, of the reserved accounts. The Company evaluated its accounts receivable balance at September 30, 2010March 31, 2011 and determined that its allowance for bad debts of $25$30 was 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,March 31, 2011, one customer accounted for 17% of our accounts receivable. At December 31, 2010, two customers accounted for 51%23% and 15%16% of our accounts receivable, respectively. At December 31, 2009, two customers accounted for 27% and 24% of our accounts receivable, respectively.receivable. We do not have any off-balance sheet risks as of September 30, 2010March 31, 2011 or December 31, 2009. One customer accounted for 10% of our revenue for the three month period ended September 30, 2010. For the three months ended September 30,March 31, 2011 and 2010, and for the three and nine month periods ended September 30, 2009, no single customer accounted for 10% or more of our revenue.

BITSTREAM INC. AND SUBSIDIARIES

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

(e) Comprehensive Income (Loss)Loss, in thousands

Comprehensive income (loss)loss consists of net income (loss)loss and adjustments to stockholders’ equity for historical foreign currency translation adjustments and unrealized gainslosses from investments in marketable securities classified as available-for-sale. For the purposes of comprehensive income (loss)loss disclosures, the Company does not record tax provisions or benefits for the net changes in the foreign currency translation adjustment, as it intends to permanently reinvest undistributed earnings in its foreign subsidiaries in accordance with the applicable accounting guidance. For 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 haveit has recorded a full valuation allowance against ourits deferred tax assetsasset and areis not currently recording a tax liability.

The components of comprehensive income (loss)loss are as follows:

Accumulated other comprehensive income (loss) consisted of the following:

(f) Recently Issued Accounting Standards

The Company reviews and evaluates recent pronouncements that have had or may have a significant effect on ourits financial statements. The Company has not included a discussion of recent pronouncements below as none are anticipated to have an impact on or are unrelated to ourits financial condition, results of operations, or disclosures.

BITSTREAM INC. AND SUBSIDIARIES

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

(g) Fair Value of Financial InstrumentsHierarchy, in thousands

The accounting standards codification for fair value measurement rules establishmeasurements specifies a hierarchy for disclosure of fair value measurement. The classification of assets and liabilities within the hierarchy which requires an entityis based on whether the inputs to maximize the use ofvaluation methodology used for measurement are observable or unobservable. Observable inputs and minimize the use ofreflect market-derived or market-based information obtained from independent sources, while unobservable inputs when measuring fair value.

Under authoritative guidance fair value isreflect our estimates about market data. The three levels are 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. This guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value.

This guidance describes three levels of inputs that may be used to measure fair value:follows:

At December 31, 2009,This hierarchy requires the Company’s financial assetsuse of observable market data when available. We maintain policies and liabilities that were measured at fairprocedures to value on a recurring basis included money market funds of $10, short-term investmentsinstruments using the best and most relevant data available. Further, we used internal sources and considered external sources to assist us in certificates of deposit of $114, and a restricted investment long-term of $136, which were Level 1 financial assets. 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)

valuing certain instruments.

Assets and liabilities of the Company measured at fair value on a recurring basis are summarized as follows as of September 30, 2010:March 31, 2011:

See Note 2 for further disclosure regarding our cash, cash equivalents, and marketable securities.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(h) Foreign Currency Remeasurement and Transactions, in thousands

The functional currency for the Company’s foreign subsidiaries is the U.S. Dollar. For financial reporting purposes, assets and liabilities of subsidiaries outside the United States of America denominated in other currencies are remeasured into U.S. dollars using period-end and historical exchange rates. Revenue and expense accounts are remeasured at the monthly average rates in effect during the period. The effects of the remeasurement of the balances of our Israel and India subsidiaries are included as gains (losses) and reported as Interest and other income, net in the condensed and consolidated statements of operations.

Transaction gains (losses) for the three months ended March 31, 2011 and 2010 were $(36) and $2, respectively. Transaction gains (losses) were recorded as Interest and other income, net in the condensed consolidated statements of operations.

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 Company’s 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 of discounts to maturity. Such amortization and accretion is included in interest and other income, 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 and other income, net of expense. The fair value of investments in marketable securities is determined based on quoted market prices at the reporting date for those instruments.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(h) Foreign Currency Translation and Transactions

Transaction gains (losses) for the three months ended September 30, 2010 and 2009 were $(25) and $18, respectively, and for the nine months ended September 30, 2010 and 2009 were $(29) and $45, respectively. Transaction gains were recorded as interest and other income, net in the condensed consolidated statements of operations.

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

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 of discounts to maturity. Such amortization and accretion is included in interest and other income, 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 and other income, net. As of September 30, 2010 and DecemberMarch 31, 2009, aggregate2011, cash and cash equivalents included bank deposits and investments in marketable securities consisted of:money market instruments. As of March 31, 2011 and December 31, 2010 cash equivalents were $301 and $169, respectively.

BITSTREAM INC. AND SUBSIDIARIES

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

As of March 31, 2011 and December 31, 2010, aggregate investments in marketable securities consisted of:

(3) Acquisition

On June 3, 2010, the Company completed the acquisition of certain of the assets of Press-sensePress-Sense Ltd. (“Press-sense”Press-Sense”) pursuant to terms of a Purchase and Sale Agreement dated May 31, 2010 by and among the Company, Bitstream Israel Ltd., a wholly-owned subsidiary of the Company organized under the Laws of the State of Israel and the court appointed Special Manager of Press-sensePress-Sense Ltd., an Israeli company in temporary liquidation under the supervision of the District Court of Haifa. The purchase price of $6,528, including $28 of VAT, was paid in cash. Assets purchased include all Press-sensePress-Sense software and know-how and related intellectual property rights (both source code and object code), some fixed and tangible assets, and all trademarks, transferable licenses and customer data. No liabilities were acquired in the transaction.

The results of operations of the Press-sensePress-Sense assets have been included in the condensed consolidated financial statements since June 3, 2010. Press-sense was a developer of print industry business flow automation systems. The Press-sense business will complement and expand Bitstream’s Pageflex product line of enterprise brand management and web-to-print solutions to create one of the most robust end-to-end offerings of business management tools available in the marketing and print industries. By fully automating the creation, production, and back-office processes for document orders, Bitstream will provide the tools to enable its customers to maximize production efficiency, monitor and reduce costs, and increase profits.

The acquisition was accounted for using the purchase method of accounting in accordance with appropriate standards. The allocation of the purchase price is preliminary and is subject to adjustment. The Company expects to finalize the purchase accounting in the period ending December 31, 2010. The following table summarizes the preliminary allocation of the purchase price of $6,528:

Goodwill was recognized for the excess purchase price over the fair value of the assets acquired. Goodwill is primarily attributable to the expected growth from synergies related to the integration of Press-sensePress-Sense assets acquired with the Company’s Pageflex publishingautomated marketing communication and print production software. Goodwill from the acquisition of Press-sensePress-Sense Ltd. assets will be included within the Company’s one reporting unit and will be included in the Company’s enterprise-level annual review for impairment. Goodwill is deductible for tax purposes.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

The following table reflects the fair value of the acquired identifiable intangible assets and related estimates of useful lives:

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table presents the pro forma results of the historical condensed consolidated statements of operations of the Company and Press-sensePress-Sense Ltd. for the three months ended March 31, 2011 and nine month periods ended September 30, 2010, and September 30, 2009, giving effect to the merger as if it occurred on January 1, 2010 and 2009:2010:

The pro forma net loss and loss per share for each period presented primarily includes adjustments for amortization of intangibles, depreciation, interest income, and income taxes. This pro forma information does not purport to indicate the results that would have actually been obtained had the acquisition been completed on the assumed date, or which may be realized in the future.

(4) Goodwill & Other Intangible Assets

Goodwill

Goodwill resulted from the acquisitions of Type Solutions, Inc. and Alaras Corporation, both acquired in 1998, as well as the purchase of certain assets from Press-sensePress-Sense Ltd. on June 3, 2010. Goodwill was $3,537 and $727$3,526 at September 30, 2010March 31, 2011 and December 31, 2009, respectively. The change in the carrying amount of goodwill for the nine months ended September 30, 2010 is as follows:2010.

The Company follows the accounting and reporting requirements for goodwill and other intangible assets as required by authoritative standards. Under these standards, goodwill is not amortized, but is required to be reviewed annually for impairment, or more frequently if impairment indicators arise. The Company has determined that it does not have separate reporting units and thus goodwill is 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 based on the results of impairment tests rather than amortized.

BITSTREAM INC. AND SUBSIDIARIES

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

Other Intangible Assets

The carrying amounts of other intangible assets were $3,561$3,379 and $78$3,479 as of September 30, 2010March 31, 2011 and December 31, 2009,2010, respectively. Intangible assets acquired in a business combination are recorded under the purchase method of accounting at their estimated fair values at the date of acquisition. The Company amortizes other intangible assets over their estimated useful lives on a straight-line basis. Marketing-related intangibles have useful lives of fivefour to eight years. Technology-based intangible assets have useful lives of five to twelve years. The weighted average useful life of other intangible assets is 9 years. The components of the Company’s amortized intangible assets follow:are as follows:

Amortization expense for marketing-related intangible assets included in marketing and selling expense for the three months ended September 30,March 31, 2011 and 2010 and 2009 was $48 and $0, respectively. Amortization expense for technology-related intangible assets included as cost of revenue for the three months ended September 30,March 31, 2011 and 2010 and 2009 was $47 and $0, respectively. Amortization expense for intangible assets included as general and administrative expense for the three months ended September 30,March 31, 2011 and 2010 was $9 and 2009 was $7. Amortization expense for marketing-related intangible assets included in marketing and selling expense for the nine months ended September 30, 2010 and 2009 was $64 and $0, respectively. Amortization expense for technology related intangible assets included as cost of revenue for the nine months ended September 30, 2010 and 2009 was $63 and $0, respectively. Amortization expense for intangible assets included in general and administrative expense for the nine months ended September 30, 2010 and 2009 was $22 and $21,$7, respectively. Estimated amortization for succeeding years is as follows:

BITSTREAM INC. AND SUBSIDIARIES

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

( 5) Income Per Share

Basic incomeearnings or loss per share is determined by dividing net income or loss by the weighted average number of shares of common stock outstanding during the period.period, excluding unvested restricted shares of 204 and 145 for the three month periods ended March 31, 2011 and 2010. 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. A reconciliation of basic and diluted weighted average shares outstanding for basic and diluted earnings per share is as follows:

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. As a result there is no difference between the Company’s basic and diluted loss per share for the three and nine month periods ended September 30,March 31, 2011 or 2010. The Company’s basic and diluted weighted average shares outstanding are as follows:

If the Company had reported a profit for the three and nine month periods ended September 30,March 31, 2011 and 2010, the potential common shares would have increased the weighted average shares outstanding by 549413 and 631 shares,677, respectively. In addition, there were unvested restricted sharesstock and options outstanding to purchase 636523 and 490389 shares respectively,of common stock for the three and nine month periods ended September 30,March 31, 2011 and 2010, and 439 and 698 shares for the three and nine month periods ended September 30, 2009, respectively, that were not included in the potential commoncalculation of diluted net income per share computations becauseas their exercise prices were greater than the market price of the Company’s common stock. These common stock equivalents are antidilutive even when a profit is reported in the numerator.effect would be antidilutive.

(6) Equity-Based Compensation Expense

The Company accounts for stock-based compensation in accordance with authoritative guidance, and has elected the modified prospective method, under which stock basedstock-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.period, net of estimated forfeitures.

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 stock options include the exercise price of the award, the expected option term, the expected volatility of its stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and its expected annual dividend yield. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. The Company is required to estimateestimates forfeitures at the time of grant and reviserevises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and recordrecords stock-based compensation expense only for those awards that are expected to vest. The 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 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.

BITSTREAM INC. AND SUBSIDIARIES

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

The following table summarizes the weighted average assumptions we utilized for grants of share-based awardsNo stock options were granted during the three and nine months ended September 30,March 31, 2011 and 2010. We granted restricted stock awards of 10.5 and 25 during the three months ended March 31, 2011 and 2010, and 2009:respectively, which were valued at the fair market value at the grant date.

All options granted have a contractual ten-year term. All options granted prior to January 1, 2006 vested in equal installments on the first, second, and third year anniversaries over a three year period of continuous employee service. All options granted subsequent to January 1, 2006 vest in equal installments on the first, second, third, and fourth year anniversaries over a four year period of continuous employee service. All restricted stock awards made prior to January 1, 2010 vest in equal installments on the first, second, third, fourth and fifth year anniversaries over a five year period of continuous employee service. All restricted stock awards made subsequent to January 1, 2010 vest in 20twenty 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.

The Company’s results for the three months ended September 30,March 31, 2011 and 2010 include $221 and 2009 include $293 and $216,$227, respectively, and for the nine months ended September 30, 2010 and 2009 include $778 and $616, of share-based compensation within the applicable expense classification where it reports the share-based award holders’ compensation expense.

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

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(7) Commitments and Contingencies,

Lease commitments

The Company conducts its operations in leased facilities. In June 2009, the Company entered into a ten-year lease agreement for 27,00027 thousand square feet of office space with the right of first refusal on an additional 4,0004 thousand square feet in a building located in Marlborough, Massachusetts. This 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 began after three (3) rent-freefree months of rent and increase by approximately 2% per annum. The remaining commitment under the lease at September 30, 2010March 31, 2011 is approximately $4,979.$4,728. 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. The Company’s current lease agreement also requires it to maintain a Letter of Credit in the amount of $136 through October 31, 2019, which the Company collateralized with a certificate of deposit classified as a long-term restricted asset on the condensed consolidated balance sheet.sheets.

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

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 obligates the Company to make monthly payments including service taxes. In January 2011, Bitstream India Pvt. Ltd., exercised the option to renew the lease agreement for an additional twenty-seven (27) months. The remaining commitment at September 30, 2010March 31, 2011 is approximately $28.$136 U.S. dollars.

In January 2011, Bitstream Israel Ltd., our wholly-owned subsidiary, entered into a thirty-six (36) month lease agreement in Caesarea, Israel. This lease agreement commences April 15, 2011 and obligates us to make semi-annual payments including service taxes. The remaining commitment at March 31, 2011 is approximately $320 U.S. dollars. This lease agreement also required us to obtain a bank guarantee in the amount of approximately $54 U.S. dollars to be in place through May 14, 2014. The bank guarantee is classified as restricted cash on our condensed consolidated balance sheets.

Royalties

The 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 the condensed consolidated statement of operations.

Indemnification AgreementsGuarantees

The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees 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, copyright or other intellectual property infringement claim by any third party with respect to itsthe Company’s 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. The 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 these agreements is minimal.

Legal Actions

From time to time, the 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, and claims involving commercial, employment and other matters. In 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, 2010,March 31, 2011, there are no material pending legal proceedings to which we are a party, and no liability was recorded. Litigation is inherently unpredictable and it is possible that the Company’s financial position, cash flows, or results of operations could be materially affected in any particular period by the resolution of any such contingencies or the costs involved in seeking the resolution of any such contingencies.

BITSTREAM INC. AND SUBSIDIARIES

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

(8) Income Taxes

The Company accounts for income taxes under the liability method in 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.

The following is a summary of the components of the provision for and (benefit from) income taxes:

Foreign taxes include foreign withholding taxes from 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 and by Bitstream Israel Ltd. our subsidiary in Israel. Federal income tax is related to the deferred tax liability from the amortization of Goodwill for tax purposes. Federal and state tax provisions for the three and nine month periods ended September 30, 2009 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.

At December 31, 2009,2010, the Company had U.S. federal and state net operating loss (“NOL”)NOL carryforwards of $11,332$14,716 and $289,$3,567, respectively, of which the benefit of approximately $8,272$9,030 and $289,$973, respectively, when realized, will be recorded as a credit to additional paid-in capital. The Company’s NOL carryforwards begin to expire in 2020 for federal purposes and in 2011 for state purposes. At December 31, 2009, theThe Company also had U.S. federal and state research and development credit (“R&D Credit”) carryforwards of $1,011$1,088 and $366,$409, respectively. These R&D credit carryforwards begin to expire in 20102011 for federal purposes and 2016 for state purposes. As of December 31, 2009,2010, we hadhave foreign tax credit carryforwards of $490.$726. These foreign tax credit carryforwards begin to expire in 2012.

The Company continued to provide a full valuation allowance for its net deferred tax assets at September 30, 2010,March 31, 2011, as it believes it is more likely than not that the future tax benefits from accumulated net operating losses and deferred taxes will not be realized. The 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 condensed consolidated statement of operations.

BITSTREAM INC. AND SUBSIDIARIES

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

In June 2006, the FASB issued authoritative guidance clarifying 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’s financial statements. The Company adopted this guidance on January 1, 2007, the implementation of which did not have a material impact on the Company’s consolidated financial statements, results of operations or cash flows. At the adoption date of January 1, 2007, and also at December 31, 20092010 and September 30, 2010,March 31, 2011, the Company had no unrecognized tax benefits.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2010,March 31, 2011, the Company had no accrued interest or penalties related to uncertain tax positions. The Company’s 20052006 through 20092010 tax years remain open to examination by the majormaterial taxing jurisdictions to which it is subject. The 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.

(9) Geographical Reporting

The Company reports revenue and income under one reportable segment. Company 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: