<PAGE>   1


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark one)
              [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                   OF THE SECURITIES EXCHANGE ACT OF 1934 
               For the quarterly period ended September 30, 1998

                                       or

              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
            For the transition period from __________ to ___________


                         COMMISSION FILE NUMBER: 0-21541

                                 BITSTREAM INC.
             -----------------------------------------------------          
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                         <C>
                DELAWARE                              04-2744890
    -------------------------------         ------------------------------------
    (State or other jurisdiction of         (I.R.S. Employer Identification No.)
     incorporation or organization)         


             215 FIRST STREET
        CAMBRIDGE, MASSACHUSETTS                          02142
----------------------------------------                ---------
(Address of principal executive offices)                (Zip Code)
</TABLE>

                                 (617) 497-6222
              ----------------------------------------------------
              (Registrant's telephone number, including area code)

                                 Not Applicable
--------------------------------------------------------------------------------
     (Former name, former address and former fiscal year, if changed since
                                  last report)

    Indicate by check mark 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 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 [ ]

    On November 12, 1998 there were 6,866,621 shares of Class A Common Stock,
par value $0.01 per share, and no shares of Class B Common Stock, par value
$0.01 per share, outstanding.



<PAGE>   2


                                      INDEX

<TABLE>
<CAPTION>
                                                                                   PAGE
                                                                                  NUMBERS
                                                                                  -------
<S>                                                                                 <C>
PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

     CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1997       3

     CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS AND NINE
            MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 ..........................       4

     CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
            SEPTEMBER 30, 1998 AND 1997 .......................................       5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ....................................       6

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS .............................................      10

PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS ....................................................      14

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS ............................      14

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES ......................................      14

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..................      14

ITEM 5.  OTHER INFORMATION ....................................................      15

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K .....................................      15

               SIGNATURES .....................................................      15
</TABLE>

                                       2
<PAGE>   3


                         PART I -- FINANCIAL STATEMENTS

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

                         BITSTREAM INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                            SEPTEMBER 30,      DECEMBER 31,
                                                                                 1998              1997
                                                                            ------------       ------------
<S>                                                                         <C>                <C>
                                ASSETS
Current assets:
   Cash and cash equivalents                                                $ 15,701,000       $  6,364,000
   Accounts receivable, net of allowance for doubtful accounts
      of $1,088,000 in 1998 and $391,000 in 1997                               1,844,000          3,694,000
    Current portion of long-term accounts receivable, net of allowance
      for doubtful accounts of $100,000 in 1998 and $127,000 in 1997             571,000          1,855,000
   Deferred income taxes                                                         868,000            868,000
   Other current assets                                                          525,000            684,000
                                                                            ------------       ------------
       Total current assets                                                   19,509,000         13,465,000
                                                                            ------------       ------------
Property and equipment, net                                                      920,000          1,399,000
                                                                            ------------       ------------
Other assets:
   Long-term accounts receivable, net of current portion                           9,000             39,000
   Goodwill, net of amortization                                                 292,000          1,948,000
   Investment in DiamondSoft, Inc.                                               448,000               --
   Other assets                                                                  180,000            158,000
                                                                            ------------       ------------
        Total other assets                                                       929,000          2,145,000
                                                                            ------------       ------------
        Total assets                                                        $ 21,358,000       $ 17,009,000
                                                                            ============       ============

                 LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Current maturities of capital lease obligations                          $     27,000       $     28,000
   Accounts payable                                                              397,000            753,000
   Accrued expenses                                                            3,185,000          3,472,000
                                                                            ------------       ------------
       Total current liabilities                                               3,609,000          4,253,000
                                                                            ------------       ------------
Capital lease obligations, less current maturities                                35,000             54,000
                                                                            ------------       ------------
Other long-term liabilities                                                       21,000             19,000
                                                                            ------------       ------------
       Total long-term liabilities                                                56,000             73,000
Stockholders' equity:
   Common stock                                                                   68,000             65,000
   Additional paid-in capital                                                 30,514,000         29,940,000
   Accumulated deficit                                                       (12,850,000)       (17,283,000)
   Cumulative translation adjustment                                             (39,000)           (39,000)
                                                                            ------------       ------------
       Total stockholders' equity                                             17,693,000         12,683,000
                                                                            ------------       ------------
       Total liabilities and stockholders' equity                           $ 21,358,000       $ 17,009,000
                                                                            ============       ============
</TABLE>


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

                                       3
<PAGE>   4


                         BITSTREAM INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>



                                                              THREE MONTHS ENDED                  NINE MONTHS ENDED
                                                                 SEPTEMBER 30,                       SEPTEMBER 30,
                                                        ------------------------------       -------------------------------
                                                            1998              1997               1998               1997
                                                        ------------       -----------       ------------       ------------
<S>                                                     <C>                <C>               <C>                <C>         
   Revenues                                             $  1,135,000       $ 3,659,000       $  7,280,000       $  9,344,000
   Cost of revenues                                          236,000           275,000          1,120,000          1,049,000
                                                        ------------       -----------       ------------       ------------

       Gross Profit                                          899,000         3,384,000          6,160,000          8,295,000
                                                        ------------       -----------       ------------       ------------
OPERATING EXPENSES:
   Selling and marketing                                   1,659,000         2,061,000          4,843,000          4,880,000
   Research and development                                  997,000           841,000          3,621,000          1,998,000
   General and administrative                                527,000           495,000          1,141,000          1,484,000
   Severance and other non-recurring compensation          1,000,000              --            2,647,000          1,371,000
   Acquired in-process research and development                 --                --                 --            4,930,000
                                                        ------------       -----------       ------------       ------------      
       Total operating expenses                            4,183,000         3,397,000         12,252,000         14,663,000
                                                        ------------       -----------       ------------       ------------

   Gain on sale of assets                                 10,317,000              --           10,317,000               --
                                                        ------------       -----------       ------------       ------------

       Income (loss) from operations                       7,033,000           (13,000)         4,225,000         (6,368,000)
                                                        ------------       -----------       ------------       ------------
OTHER INCOME (EXPENSE):
    Loss on investment in DiamondSoft, Inc. 
                                                              (2,000)             --              (52,000)              --
    Other income, net                                        135,000           116,000            305,000            458,000
                                                        ------------       -----------       ------------       ------------

       Total other income                                    133,000           116,000            253,000            458,000
                                                        ------------       -----------       ------------       ------------
       Income (loss) before provision for (benefit
       from) income taxes                                  7,166,000           103,000          4,478,000
                                                                                                                  (5,910,000)
       Provision for (benefit from) income taxes             (23,000)           57,000             45,000            198,000
                                                        ------------       -----------       ------------       ------------

       Net income (loss)                                $  7,189,000       $    46,000       $  4,433,000       $ (6,108,000)
                                                        ============       ===========       ============       ============
Net income (loss) per share:
       Basic                                            $       1.06       $      0.01       $       0.66       $      (0.98)
                                                        ============       ===========       ============       ============

       Diluted                                          $       0.96       $      0.01       $       0.59       $      (0.98)
                                                        ============       ===========       ============       ============
Weighted average shares outstanding:
       Basic                                               6,764,842         7,773,690          6,254,063          6,688,810
                                                        ============       ===========       ============       ============
       Diluted                                             7,451,764         8,976,694          7,524,860          6,254,063
                                                        ============       ===========       ============       ============
</TABLE>



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


                                       4
<PAGE>   5
                         BITSTREAM INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                       NINE MONTHS ENDED
                                                                                         SEPTEMBER 30,
                                                                                 -------------------------------
                                                                                     1998               1997
                                                                                 ------------       ------------
<S>                                                                             <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                              $  4,433,000       $ (6,108,000)
  Adjustments to reconcile net income (loss) to net cash provided by
     (used in) operating activities:
     Gain on sale of certain assets sold to Inso Providence Corporation           (10,317,000)                --
     Acquired in-process research and development                                          --          4,930,000
     Depreciation and amortization                                                    841,000            452,000
     Compensation on grant of stock options                                           334,000                 --
     Loss on investment of DiamondSoft, Inc.                                           52,000                 --
     Changes in assets and liabilities:
       Accounts receivable                                                          3,135,000         (1,566,000)
       Long-term accounts receivable                                                   30,000             61,000
       Other current assets                                                           159,000            169,000
       Accounts payable                                                              (356,000)          (170,000)
       Accrued expenses                                                                83,000          1,527,000
                                                                                 ------------       ------------
       Net cash used in operating activities                                       (1,606,000)          (705,000)
                                                                                 ------------       ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment                                                (190,000)          (538,000)
  Acquisition of businesses                                                                --         (4,141,000)
  Cash proceeds from sale of certain assets to Inso Providence Corporation         11,430,000                 --
  Investment in DiamondSoft, Inc.                                                    (500,000)                --
  Change in other assets                                                              (22,000)            81,000
  Change in other long term liabilities                                                 2,000             18,000
                                                                                 ------------       ------------
       Net cash provided by (used in) investing activities                         10,720,000         (4,580,000)
                                                                                 ------------       ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Payments of capital lease obligations                                               (20,000)           (31,000)
  Payments of IPO offering expenses                                                        --            (68,000)
  Proceeds from the exercise of stock options and warrants                            243,000             61,000
                                                                                 ------------       ------------
        Net cash provided by (used in) financing activities                           223,000            (38,000)
                                                                                 ------------       ------------
Net increase (decrease) in cash and cash equivalents                                9,337,000         (5,323,000)
Cash and cash equivalents, beginning of period                                      6,364,000         11,718,000
                                                                                 ------------       ------------
Cash and cash equivalents, end of period                                         $ 15,701,000       $  6,395,000
                                                                                 ============       ============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid for interest                                                         $      5,000              7,000
                                                                                 ============       ============
  Cash paid for income taxes                                                     $     21,000             30,000
                                                                                 ============       ============
IN CONNECTION WITH THE ACQUISITION OF BUSINESSES (SEE NOTE 6) THE FOLLOWING
NON-CASH TRANSACTIONS OCCURRED:
  Fair value of assets acquired                                                            --       $  7,959,000
  Liabilities assumed                                                                      --           (914,000)
  Issuance of common stock                                                                 --         (1,608,000)
  Issuance of options to purchase common stock                                             --         (1,296,000)
                                                                                 ------------       ------------
  Cash paid for acquisition and acquisition costs                                          --       $  4,141,000
                                                                                 ============       ============
</TABLE>


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

                                       5
<PAGE>   6

                         BITSTREAM INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 1998

(1) BASIS OF PRESENTATION

    The consolidated financial statements of Bitstream Inc. (the "Company" or
"Bitstream") 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. The balance
sheet information at December 31, 1997 has been derived from the Company's
audited consolidated financial statements. These statements should be read in
conjunction with the financial statements and notes thereto for the period ended
December 31, 1997 included in the Company's Annual Report on Form 10-K which was
filed by the Company with the SEC on March 31, 1998.

    The balance sheet as of September 30, 1998, the statements of operations for
the three and nine months ended September 30, 1998 and 1997, the statements of
cash flows for the nine months ended September 30, 1998 and 1997, and the notes
to each thereof are unaudited, but in the opinion of management include all
adjustments necessary for a fair presentation of the consolidated financial
position, results of operations, and cash flows of the Company and its
subsidiaries for these interim periods.

    The results of operations for the three and nine months ended September 30,
1998 may not necessarily be indicative of the results to be expected for any
future interim period or for the year ending December 31, 1998.

     The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries: Bitstream World Trade, Inc. (a
Delaware corporation), a holding company for Bitstream, BV (a Dutch
corporation); Bitstream S.A.R.L. (a French corporation); Bitstream BV France (a
French corporation); Mainstream Software Solutions (an English corporation) and
Archetype, Inc. (a Delaware corporation). All material intercompany transactions
and balances have been eliminated in consolidation.

(2) NET INCOME (LOSS) PER SHARE

     The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 128, Earnings Per Share. SFAS No. 128 established standards for computing
and presenting earnings per share and applies to entities with publicly held
common stock or potential common stock. The Company has applied the provisions
of SFAS No. 128 and SEC Staff Accounting Bulletin (SAB) No. 98 retroactively to
all periods presented.

    Basic net income (loss) per share is computed by dividing net income (loss)
by the weighted average number of common shares outstanding during the period.
Diluted net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of common and common equivalent shares outstanding
during the period using the treasury stock method. In computing Diluted earnings
per share, common equivalent shares are not considered dilutive in periods which
a net loss is reported because such common equivalent shares are antidilutive.


                                       6
<PAGE>   7


The following is a reconciliation of shares outstanding for basic and diluted
earnings per share:

<TABLE>
<CAPTION>
                                                                 THREE MONTHS ENDED            NINE MONTHS ENDED
                                                                    SEPTEMBER 30,                SEPTEMBER 30,
                                                             ------------------------      ------------------------
                                                                1998           1997           1998           1997
                                                             ---------      ---------      ---------      ---------
<S>                                                          <C>            <C>            <C>            <C>      
Weighted average shares outstanding                          6,764,842      7,773,690      6,688,810      6,254,063
    Dilutive effect of options                                 427,026        891,360        544,005             --
    Dilutive effect of warrants                                259,896        311,644        292,045             --
                                                             ---------      ---------      ---------      ---------
Shares outstanding for diluted income (loss) per share:      7,451,764      8,976,694      7,524,860      6,254,063
                                                             =========      =========      =========      =========

Options and warrants excluded as they are antidilutive       1,710,698      1,644,223      1,561,570      2,847,227
                                                             =========      =========      =========      =========
</TABLE>

    Diluted net loss per share for the nine months ended September 30, 1997 is
the same as basic net loss per share as the inclusion of the potential common
stock equivalents would be antidilutive.


(3) CONCENTRATION OF CREDIT RISK

    The Company has no significant off-balance-sheet concentration of credit
risk such as foreign exchange contracts, option contracts or other foreign
hedging arrangements.

    For the three months ended September 30, 1998, one customer represented
25.9% of revenues. For the three months ended September 30, 1997, one customer
represented 13.7% of revenues. For the nine months ended September 30, 1998 and
1997, no customer represented greater than 10% of revenues.

(4) COMPREHENSIVE INCOME (LOSS)

     The Company  adopted SFAS No. 130,  Reporting  Comprehensive  Income,
effective  January 1, 1998. SFAS No. 130 establishes  standards for the
reporting and display of  comprehensive  income and its  components in a full
set of general purpose financial statements.  The components of the Company's
comprehensive income are as follows:


<TABLE>
<CAPTION>
                                            THREE MONTHS ENDED                NINE MONTHS ENDED
                                              SEPTEMBER 30,                     SEPTEMBER 30,
                                       --------------------------       -----------------------------
                                           1998            1997            1998              1997
                                       -----------       --------       -----------       -----------
<S>                                    <C>               <C>            <C>               <C>         
Net income (loss)                      $ 7,189,000       $ 46,000       $ 4,433,000       $(6,108,000)
Cumulative translation adjustment          (39,000)       (40,000)          (39,000)          (40,000)
                                       -----------       --------       -----------       -----------
Total comprehensive income (loss)      $ 7,150,000       $  6,000       $ 4,394,000       $(6,148,000)
                                       ===========       ========       ===========       ===========
</TABLE>
                                                               

(5) RECENTLY ISSUED ACCOUNTING STANDARDS

     In July 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 131, Disclosures About Segments of an Enterprise and Related Information.
SFAS No. 131 requires certain financial and supplementary information to be
disclosed on an annual and interim basis for each reportable segment of an
enterprise. Reportable segments, as defined by this statement, correspond to the
way management organizes units and evaluates performance internally, and may be
based upon products, geography, legal entity, management structure or a
combination of these methods. SFAS No. 131 is effective for fiscal years
beginning after December 15, 1997, and interim period reporting is not required
until interim periods beginning after December 15, 1998. The Company believes
that the adoption of SFAS No. 131 will not have a material impact on its
financial results or financial position.


                                       7
<PAGE>   8


(6) ACQUISITIONS

     MAINSTREAM SOFTWARE SOLUTIONS, LTD.

     In January 1997, the Company purchased substantially all of the assets of
Mainstream Software Solutions Ltd., a corporation organized under the laws of
England primarily engaged in the business of marketing, selling, distributing
and supporting the Company's type products in the United Kingdom, for
approximately $505,000. As a result, the Company directly distributes its own
products in the United Kingdom. The acquisition was accounted for as a purchase
and resulted in approximately $450,000 of goodwill.

     ARCHETYPE, INC.

     In April 1997, the Company acquired Archetype, Inc. ("Archetype"), a
Delaware corporation primarily engaged in the business of developing and
marketing server-based information management computer software for the graphic
arts industry, pursuant to an Agreement and Plan of Merger, dated March 27, 1997
among the Company, Archetype, and Archetype Acquisition Corporation, a newly
organized wholly owned subsidiary of the Company. Archetype's products include:
MediaBank(TM), a digital asset management product that allows for the
cataloging, archiving, and management of electronic images, text and documents;
InterSep(TM) OPI and InterSep Output Manager, advanced open prepress interface
and print management products for raster image processors and servers; and
NuDoc(TM), an advanced document composition technology.

     In connection with the Merger, Archetype stockholders received an aggregate
of approximately $1.3 million in cash and 510,000 shares of the Company's Class
A Common Stock in exchange for their shares of Archetype capital stock. In
addition, the Company satisfied approximately $1.8 million of obligations and
indebtedness owed by Archetype, and issued options and warrants (the "Options")
to purchase approximately 605,000 shares of the Company's Class A Common Stock,
in order to induce the former Archetype employees and other persons receiving
such Options to become employees of, or perform certain services for, the
Company and/or to replace certain outstanding options and warrants issued by
Archetype. Of these options, 405,000 have an exercise price of $.90 per share
and were issued under the Company's 1996 Stock Plan and the remaining 200,000
have an exercise price of $3.94 per share and were issued under the Company's
1997 Stock Plan.

     The Merger was accounted for as a purchase, and accordingly, the initial
purchase price and acquisition costs aggregating approximately $7.5 million has
been allocated to the assets acquired as described below. The aggregate purchase
price of $7,454,000 consisted of the following:

<TABLE>
<CAPTION>

          DESCRIPTION                                      AMOUNT
          -----------                                    -----------
<S>                                                      <C>        
          Common stock and stock options.........        $ 2,904,000
          Cash paid to shareholders and for the       
              retirement of certain obligations..          3,056,000
          Assumed liabilities....................          1,094,000
          Acquisition costs......................            400,000
                                                         -----------
          Total purchase price...................        $ 7,454,000
                                                         ===========
</TABLE>

     The purchase price allocations represent the fair values of assets acquired
determined by an independent appraisal. The appraisal incorporated established
valuation procedures and techniques in determining the fair value of each asset.
The purchase price has been allocated as follows:

<TABLE>
<CAPTION>

          DESCRIPTION                                       AMOUNT
          ------------                                   -----------
<S>                                                      <C>      
          Current assets.......................          $   431,000
          Property, plant and equipment........              207,000
          Other assets.........................               54,000
          In-process research and development..            4,930,000
          Other acquired intangible assets.....            1,832,000
                                                         -----------
          Total assets acquired................          $ 7,454,000
                                                         ===========
</TABLE>

                                       8
<PAGE>   9


     The amount allocated to in-process research and development related to
projects that had not yet reached technological feasibility and that, until
completion of the development, had no alternative future use. These projects
will require substantial high risk development and testing by the Company prior
to reaching technological feasibility. Accordingly, the Company charged the
purchase price to operations in the year ended December 31, 1997.

     Based on the unaudited data, the following table presents selected
financial information for Bitstream and Archetype on a pro forma basis for the
nine months ended September 30, 1997, assuming the companies had been combined
since the beginning of 1997.

<TABLE>
<CAPTION>
                                                    NINE MONTHS
                                                       ENDED
                                                 SEPTEMBER 30, 1997
                                                 ------------------
<S>                                                <C>         
Revenues.....................................      $ 10,406,000
                                                   ------------
Net loss.....................................        (6,751,000)
                                                   ------------
Basic and diluted net loss per share......         $      (1.00)
                                                   ============
</TABLE>


     The pro forma results are not necessarily indicative of future operations
or the actual results that would have occurred had the acquisition been made on
January 1, 1997.

(7) SALE OF ASSETS

     Pursuant to an Asset Purchase Agreement dated August 28, 1998, the Company
sold substantially all of the assets relating to its MediaBank and InterSep OPI
product lines, previously a part of Bitstream's Archetype Applications Division,
to Inso Providence Corporation of Boston, Massachusetts for net cash proceeds of
$11,430,000.

     Reflected in income from operations for the three and nine months ended
September 30, 1998 is a gain of $10,317,000 from this sale. The components of
the gain are as follows:

<TABLE>
<CAPTION>

DESCRIPTION                                                   AMOUNT
------------                                               ------------
<S>                                                         <C>        
Net Cash proceeds......................................     $11,430,000
Net book value of assets sold..........................      (1,485,000)
Liabilities assumed by buyer ..........................         472,000
Transaction costs......................................        (100,000)
                                                           ------------
     Total gain on sale................................    $ 10,317,000
                                                           ============
</TABLE>


(8)  INVESTMENTS

     On March 13, 1998, the Company made a $500,000 equity investment in
 DiamondSoft, Inc. ("DiamondSoft"), a California corporation primarily engaged
 in the business of developing, marketing and distributing software tools to a
 variety of professional markets. This equity investment involved the purchase
 of 250,000 shares of DiamondSoft's Series A Convertible Preferred Stock at a
 price of $2.00 per share representing a 25% ownership interest. In addition,
 pursuant to a letter agreement with DiamondSoft dated March 17, 1998, the
 Company will market DiamondSoft's FontReserve software to hardware and software
 developers and DiamondSoft will license the Company's Font Navigator software
 to retailers and corporate users.

                                       9

<PAGE>   10


(9)  SEVERANCE AND OTHER NON-RECURRING CHARGES

     Included in operating expenses for the three and nine months ended
September 30, 1998 are $1,000,000 and $2,647,000, respectively, of severance and
other non-recurring compensation expenses incurred in connection with certain
arrangements between the Company and certain former employees and executives.
Operating expenses for the nine months ended September 30, 1997 reflect
$1,371,000 for severance and other non-recurring compensation expenses incurred
in connection with the acquisition of Archetype and certain arrangements between
the Company and certain former executives.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

    Bitstream Inc. develops, markets, and supports software technologies and
applications for the graphics communications industry. The Company primarily
licenses its products, including text imaging and page layout technologies, to
original equipment manufacturers ("OEMs") and independent software vendors
("ISVs") for inclusion in their output devices, embedded systems, applications,
Internet authoring tools, World Wide Web browsers and other products.

     The Company's products and technologies consist of: (i) NuDoc(TM), an
advanced document composition technology; (ii) type products, such as libraries
of type designs (fonts) and custom type products; (iii) enabling technologies,
which deliver typographic capabilities to hardware output devices and software
applications; (iv) TrueDoc(R), a portable type technology providing for the
efficient distribution of text, with fidelity, in a highly compact format; and
(v) PageFlex(TM), and XML-based application for the dynamic publishing of
customized documents.

     Bitstream was founded in 1981 as a digital type supplier to computer
hardware and software developers. The Company's library of type products is used
by OEMs, ISVs and end users around the world in the creation of electronic
documents. The Company was also an early developer of typographic enabling
software for hardware and software developers. Its font processor products are
used to provide type scaling functionality to operating systems, network servers
and a wide variety of computer printers and other output devices. The Company
has focused its product development and marketing efforts on technology
solutions that address the font-related issues of document creation and
portability in the Internet and corporate intranets.

     The Company derives revenues principally from the following sources: (i)
licensing fees and royalty payments paid by OEM and ISV customers for text
imaging and page layout technologies; (ii) direct and indirect sales of software
publishing applications for the creation, enhancement, management, transport,
viewing and printing of electronic information; (iii) direct sales of custom and
other type products to end users such as graphic artists, desktop publishers and
corporations; and (iv) sales of type products to foreign customers primarily
through distributors. Royalty payments due from OEM and ISV customers, who
generally pay specified minimums or fixed fees for the right to include the
Company's products as a component of a larger product for a specified time
period or volume limit, are generally recognized as revenue at the time the
software is delivered to the OEM or ISV customer. If the royalty payments are to
be received over a period of time greater than one year, the amount recognized
is discounted to the present value of the future minimum payments. Certain OEM
and ISV customers pay royalties only upon the sublicensing of the Company's
products to end users. Royalties due from these OEM and ISV customers are
recognized when such sublicenses are reported to the Company by the OEM or ISV
customer. Revenues from sales to end users and foreign distributors are
generally recognized at the time the software products are delivered to the
customer.

     Cost of revenues is comprised of direct costs of licenses and royalties, as
well as direct costs of product sales to end users. Included in cost of licenses
and royalties are fees paid to third parties for the development or license of
rights to technology and/or unique typeface designs and the costs incurred in
the fulfillment of custom orders from OEM and ISV customers. Included in cost of
product sales to end users and distributors are the direct costs associated with
the duplication, packaging and shipping of products, and any royalty fees paid
to third parties for rights to license typefaces.


                                       10

<PAGE>   11


     Operating expenses consist primarily of sales and marketing expenses
(principally compensation and marketing programs), research and development
expenses and general and administrative expenses.

IMPACT OF YEAR 2000 ISSUE

     The Year 2000 issue results from computer programs that do not
differentiate between the year 1900 and the Year 2000 because they are written
using two digits rather than four to define the applicable year. This issue
creates risk for the Company from unforeseen problems in its own computer and
embedded systems and from third parties with whom the Company deals on financial
and other transactions worldwide. Failure of the Company's and/or third parties'
computer systems could have a material impact on the Company's ability to
conduct its business.

     During 1997, the Company initiated a program to update its accounting and
information systems, where applicable, to ensure that its computer systems are
Year 2000 compliant. Bitstream currently expects to be substantially complete
analyzing its current internal systems, as well as developing contingency plans
for certain internal systems, by mid-1999. In addition, the Company maintains a
Year 2000 expert on its staff to continue to assess, plan and implement
solutions that will prepare its internal systems for January 1, 2000. Bitstream
believes that these solutions will not pose significant operational problems for
the Company, and that the costs of such preparations will not be material.
However, if contingency plans were to fail or new non-compliance issues are
identified, the Company's results of operations or financial condition could be
materially adversely affected.

     In addition, the Year 2000 issue could affect the products that the Company
sells. The Company believes that the current versions of its products are Year
2000 compliant. However there can be no assurance that the Company's current
products do not contain undetected errors or defects associated with the Year
2000 that may result in material costs to the Company or may result in exposure
to litigation. Because of the unprecedented nature of such litigation, it is
uncertain whether and to what extent the Company may be affected by it.


RESULTS OF OPERATIONS

     REVENUES. Total revenues for the three months ended September 30, 1998
decreased by approximately $2.52 million or 68.9%, to approximately $1.14
million, as compared to approximately $3.66 million for the three months ended
September 30, 1997. The decrease in revenues for the three months ended
September 30, 1998 as compared to the three months ended September 30, 1997, is
primarily a result of the sale of substantially all of the assets relating to
the Company's MediaBank(TM) and InterSep(TM) OPI product lines to Inso
Providence Corporation in August, 1998.

     Total revenues for the nine months ended September 30, 1998 decreased by
approximately $2.06 million or 22.1%, to approximately $7.28 million, as
compared to approximately $9.34 million for the nine months ended September 30,
1997. The decrease in revenues for the nine months ended September 30, 1998 as
compared to the nine months ended September 30, 1997 is primarily a result of
(a) the sale of substantially all of the assets relating to the Company's
MediaBank and InterSep OPI product lines to Inso Providence Corporation in
August, 1998, (b) weaker than expected demand in OEM channels for the Company's
traditional type products; and (c) slower than anticipated growth in emerging
markets for the Company's type and technology products. Revenues relating to
the product lines that were sold to Inso Providence Corporation as reported in
the Company's nine months ended September 30, 1998 consolidated results totaled
approximately $2.59 million.

     GROSS PROFIT. Gross profit for the three months ended September 30, 1998
decreased by approximately $2.49 million, or 73.7%, to $899,000 compared to
approximately $3.38 million for the three months ended September 30, 1997. Gross
profit as a percentage of revenues for the three months ended September 30, 1998
decreased to 79.2% compared to 92.5% for the three months ended September 30,
1997. The decreases in gross profit and gross profit as a percentage of revenues
are a result of the sale of substantially all of the assets relating to the
Company's MediaBank and InterSep OPI product lines to Inso Providence
Corporation in August, 1998.

                                       11
<PAGE>   12


     Gross profit for the nine months ended September 30, 1998 decreased by
$2.14 million, or 25.8%, to approximately $6.16 million compared to
approximately $8.30 million for the nine months ended September 30, 1997. Gross
profit as a percentage of revenues for the nine months ended September 30, 1998
decreased to 84.6% compared to 88.8% for the nine months ended September 30,
1997. The decrease in gross profit and gross profit as a percentage of revenues
are a result of the sale of substantially all of the assets relating to the
Company's MediaBank and InterSep OPI product lines to Inso Providence
Corporation in August, 1998 and an increase in the cost of third party royalties
for the mix of products sold.

     SELLING AND MARKETING. Selling and marketing expenses for the three months
ended September 30, 1998 decreased by $402,000, or19.5%, to approximately $1.66
million compared to approximately $2.06 million for the three months ended
September 30, 1997. Selling and marketing expenses as a percentage of revenues
for the three months ended September 30, 1998 increased to 146.2% from 56.3% for
the three months ended September 30, 1997. The decrease in selling and marketing
reflect a reduction in salary expense of sales and marketing personnel from the
headcount reductions that took place in March and June of 1998.

     Selling and marketing expenses for the nine months ended September 30, 1998
decreased by $37,000, or 0.8%, to approximately $4.84 million compared to
approximately $4.88 million for the nine months ended September 30, 1997.
Selling and marketing expenses as a percentage of revenues for the nine months
ended September 30, 1998 increased to 66.5% from 52.2% for the nine months ended
September 30, 1997. The decrease in selling and marketing expenses reflect a
reduction in salary expense of sales and marketing personnel from the headcount
reductions that took place in March and June of 1998 offset by the addition of
travel, trade show and other marketing program expenses from Archetype
operations for the entire nine months ended September 30, 1998.

     RESEARCH AND DEVELOPMENT. Research and development expenses for the three
months ended September 30, 1998 increased by $156,000, or 18.5%, to $997,000
compared to $841,000 for the three months ended September 30, 1997. Research and
development expenses as a percentage of revenues for the three months ended
September 30, 1998 increased to 87.8% from 23.0% for the three months ended
September 30, 1997.

     Research and development expenses for the nine months ended September 30,
1998 increased by $1.62 million, or 81.2%, to $3.62 million compared to $2.00
million for the nine months ended September 30, 1997. Research and development
expenses as a percentage of revenues for the nine months ended September 30,
1998 increased to 49.7% compared to 21.4% for the nine months ended September
30, 1997.

     The increase in research and development expenses in dollars, and as a
percentage of revenues, for the three and nine months ended September 30, 1998
as compared to the three and nine months ended September 30, 1997, respectively,
reflect the ongoing investment in additional personnel to support expanded
development of the Company's enabling technologies such as NuDoc and PageFlex.

     GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
three months ended September 30, 1998 increased by $32,000, or 6.5%, to
$527,000, compared to $495,000 for the three months ended September 30, 1997. As
a percentage of revenues, general and administrative expenses represented 46.4%
for the three months ended September 30, 1998 as compared to 13.5% for the three
months ended September 30, 1997.

     General and administrative expenses for the nine months ended September 30,
1998 decreased by $343,000, or 23.2%, to $1.14 million compared to $1.48 million
for the nine months ended September 30, 1997. General and administrative
expenses represented 15.7% of revenues for the nine months ended September 30,
1998 compared to 15.9% for the nine months ended September 30, 1997.

     The decreases in general and administrative expenses in dollars, and as a
percentage of revenues, for the nine months ended September 30, 1998 as compared
to the nine months ended September 30, 1997, 


                                       12
<PAGE>   13



are primarily due to the elimination of duplicative general and administrative
functions and administrative costs, including rent, utilities and other costs
associated with Archetype's Burlington, Massachusetts office and a reduction in
salary expense of general and administrative personnel as a result of the
headcount reductions that took place in March and June of 1998.

     Operating expenses for the three and nine months ended September 30, 1998
include $1.00 million and $2.65 million, respectively, for severance and other
non-recurring compensation expenses related to certain former executives and
employees. Operating expenses for the nine months ended September 30, 1997
reflect non-recurring expenses of $6.30 million, which includes $4.93 million
for acquired in-process research and development expenses incurred in
conjunction with the merger of Archetype, Inc. on April 28, 1997 and $1.4
million for severance and other non-recurring compensation expenses incurred in
connection with the acquisition of Archetype and certain arrangements between
the Company and certain former high-level executives.

     The Company recorded a tax benefit of $23,000 for the three months ended
September 30, 1998 reflecting a reduction of foreign tax liabilities. The
Company recorded a tax provision consisting of foreign tax liabilities, relating
mainly to sales to customers in Japan, for the nine months ended September 30,
1998 of $45,000 as compared to $57,000 and $198,000 for the three and nine
months ended September 30, 1997, respectively.

LIQUIDITY AND CAPITAL RESOURCES

    The Company has funded its operations primarily through the public sale of
equity securities and cash flows from operations.

    The Company's operating activities used cash of approximately $1.61 million
for the nine months ended September 30, 1998 as compared to $705,000 for the
nine months ended September 30, 1997. The cash used during the nine months ended
September 30, 1998 and 1997 are primarily due to operating losses offset by
non-cash charges.

    The Company's investing activities provided cash of approximately $10.7
million for the nine months ended September 30, 1998 as compared to using $4.58
million for the nine months ended September 30, 1997. The cash provided during
the nine months ended September 30, 1998 is primarily due to the net cash
receipt of $11.4 million from the sale of substantially all of the assets
relating to the Company's MediaBank and InterSep OPI product lines to Inso
Providence Corporation in August, 1998 offset by an equity investment of
$500,000 in DiamondSoft, Inc., a California corporation primarily engaged in the
business of developing, marketing and distributing software tools to a variety
of professional markets, and the purchase of property and equipment of $190,000.
For the nine months ended September 30, 1997, investing activities consisted
primarily of the purchase of Archetype, Inc. as well as the purchase of
substantially all of the assets of Mainstream Software Solutions, Ltd.

    The Company's financing activities provided cash of $223,000 for the nine
months ended September 30, 1998 and used cash of $38,000 for the nine months
ended September 30, 1997. The cash provided in the nine months ended September
30, 1998 was primarily due to proceeds from the exercise of stock options.

    The Company believes its current cash balances will be sufficient to meet
the Company's operating and capital requirements for at least the next 12
months. There can be no assurance, however, that the Company will not require
additional financing in the future. If the Company were required to obtain
additional financing in the future, there can be no assurance that sources of
capital will be available on terms favorable to the Company, if at all.

    From time to time, the Company evaluates potential acquisitions of products,
businesses and technologies that may complement or expand the Company's
business. Any such transactions consummated may use a portion of the Company's
working capital or require the issuance of equity or debt.

    Except for the historical information contained herein, this Quarterly
Report on Form 10-Q may contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Investors are cautioned 


                                       13
<PAGE>   14



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 the Company's 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 the Company's filings with the Securities and
Exchange Commission, including those risks and uncertainties discussed in the
Company's final Prospectus, dated October 30, 1996, included as part of the
Company's Registration Statement on Form S-1 (Commission File No. 333-11519), in
the section entitled "Risk Factors." The forward-looking statements contained
herein represent the Company's judgment as of the date of this report, and the
Company cautions readers not to place undue reliance on such statements.


PART II -- OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS

     Not applicable.


ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(a)   There were no unregistered securities sold by the Company during the nine
      months ended September 30, 1998.

(b)   Use of Proceeds

         As of September 30, 1998, the net proceeds of the Company's initial
public offering (IPO) of its Class A Common Stock pursuant to its Registration
Statement on Form S-1, Commission File No. 333-11519, declared effective October
30, 1996, have been used as follows: (i) approximately $200,000 for the buildout
of Bitstream's leased facilities in Cambridge, Massachusetts to accommodate the
additional personnel that joined the Company as a result of the acquisition of
Archetype; (ii) approximately $4,141,000 for the acquisition of Mainstream
Software Solutions, Ltd. and Archetype, Inc.; (iii) approximately $1,500,000 for
the repayment of indebtedness, of which approximately $548,000 was paid to
officers, directors and 10% stockholders of the Company and approximately
$762,000 of which was paid to third parties; (iv) approximately $850,000 for
royalty payments to others; (v) $500,000 for the investment in DiamondSoft,
Inc.; and (vi) approximately $650,000 for the purchase and installation of
equipment. The remaining net proceeds from the IPO are invested in short-term,
interest-bearing, investment-grade securities.


ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     Not applicable.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not applicable.


ITEM 5. OTHER INFORMATION

     Not applicable.

                                       14
<PAGE>   15


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)     Exhibits

        27.1 Financial Data Schedule for the nine months ended 
             September 30, 1998.
        27.2 Amended Financial Data Schedule for the nine months ended 
             September 30, 1997.

(b)     Reports on Form 8-K

        Not applicable.

 
                                   SIGNATURES

    Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                           BITSTREAM INC.
                                           --------------
                                           (Registrant)
<TABLE>
<CAPTION>

      SIGNATURE                               TITLE                               DATE
      ---------                               -----                               ----
<S>                               <C>                                        <C> 
/s/ Anna M. Chagnon               Executive Vice President,                  November 16, 1998
-----------------------------     Chief Financial Officer                
Anna M. Chagnon                   and General Counsel 
                                  (Principal Financial Officer)

/s/ Keith J. Maffiore             Director of Finance and                    November 16, 1998
------------------------------    Corporate Controller
Keith J. Maffiore                 (Principal Accounting Officer)
</TABLE>

                                       15