**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

| **ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d)** |
|--------------------------------------------------------------|
| **OF THE SECURITIES EXCHANGE ACT OF  1934**                  |
|                                                         |

**For thequarterly period ended March 31, 2002**

 

**or**

 

| **o TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d)** |
|----------------------------------------------------------|
| **OF THE SECURITIES EXCHANGE ACT OF  1934**              |
|                                                     |

**For thetransition period from           to          **

 

**COMMISSION FILE NUMBER: 0-21541**

 

**BITSTREAM INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                                        |   | **04-2744890**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                |   |                                  |
| **215 First Street**                                                                |   | **02142**                             |
| **Cambridge, Massachusetts**                                                        |   | (Zip Code)                            |
| (Address of principal  executive offices)                                           |   |                                  |
|                                                                                |   |                                  |
| **(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) |

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý No o

 

On May 9, 2002 there were 8,439,125 shares of Class ACommon Stock, par value $0.01 per share, of which 125,809 were designated astreasury shares, and no shares of Class B Common Stock, par value $0.01 pershare, outstanding.

 

 

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**BITSTREAM INC. AND SUBSIDIARIES**

 

**INDEX**

 
| **PART I. FINANCIAL INFORMATION**                                                                    |
|------------------------------------------------------------------------------------------------------|
|                                                                                                 |
| ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS                                                       |
|                                                                                                 |
| CONSOLIDATED BALANCE  SHEETS AS OF MARCH 31, 2002 AND DECEMBER 31, 2001                              |
|                                                                                                 |
| CONSOLIDATED  STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001            |
|                                                                                                 |
| CONSOLIDATED  STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001            |
|                                                                                                 |
| NOTES TO  CONSOLIDATED FINANCIAL STATEMENTS                                                          |
|                                                                                                 |
| ITEM  2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS |
|                                                                                                 |
| ITEM  3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                  |
|                                                                                                 |
| **PART II. OTHER INFORMATION**                                                                       |
|                                                                                                 |
| ITEM 1. LEGAL PROCEEDINGS                                                                            |
|                                                                                                 |
| ITEM  2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                                   |
|                                                                                                 |
| ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                             |
|                                                                                                 |
| ITEM  4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                         |
|                                                                                                 |
| ITEM 5. OTHER INFORMATION                                                                            |
|                                                                                                 |
| ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                            |
|                                                                                                 |
| SIGNATURES                                                                                           |

 

1

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**BITSTREAM INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(IN THOUSANDS, EXCEPT PER-SHAREAMOUNTS)**

 
|                                                                                                         |   | **March 31,  2002** |   | **December  31,  2001** |   |
|--------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| **ASSETS**                                                                                                   |   |                |   |                    |   |
| Current  assets:                                                                                             |   |                |   |                    |   |
| Cash  and cash equivalents                                                                                   |   | $                   | 5,680  |                    | $      | 5,716 |   |
| Accounts  receivable, net of allowance of $34 and $53 at March 31, 2002 and December  31, 2001, respectively |   | 705                 |   | 679                     |   |
| Prepaid  expenses and other current assets                                                                   |   | 221                 |   | 122                     |   |
| Total  current assets                                                                                        |   | 6,606               |   | 6,517                   |   |
|                                                                                                         |   |                |   |                    |   |
| Property  and equipment, net                                                                                 |   | 396                 |   | 473                     |   |
| Other  assets:                                                                                               |   |                |   |                    |   |
| Restricted  cash                                                                                             |   | 300                 |   | 300                     |   |
| Goodwill,  net of amortization of $1,168 as of March 31, 2002 and $1,618 as of December  31, 2001            |   | 727                 |   | 727                     |   |
| Investment  in DiamondSoft, Inc.                                                                             |   | 598                 |   | 599                     |   |
| Intangible  assets                                                                                           |   | 214                 |   | 218                     |   |
| Other  assets                                                                                                |   | 5                   |   | 5                       |   |
| Total  other assets                                                                                          |   | 1,844               |   | 1,849                   |   |
|                                                                                                         |   |                |   |                    |   |
| Total  assets                                                                                                |   | $                   | 8,846  |                    | $      | 8,839 |   |
|                                                                                                         |   |                |   |                    |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                               |   |                |   |                    |   |
| Current  liabilities:                                                                                        |   |                |   |                    |   |
| Accounts  payable                                                                                            |   | $                   | 128    |                    | $      | 93 |   |
| Accrued  expenses                                                                                            |   | 1,159               |   | 1,126                   |   |
| Current  portion of deferred revenue                                                                         |   | 728                 |   | 610                     |   |
| Total  current liabilities                                                                                   |   | 2,015               |   | 1,829                   |   |
|                                                                                                         |   |                |   |                    |   |
| Long-term  deferred revenue                                                                                  |   | 30                  |   | 14                      |   |
| Total  liabilities                                                                                           |   | 2,045               |   | 1,843                   |   |
|                                                                                                         |   |                |   |                    |   |
| Stockholders’  equity :                                                                                 |   |                |   |                    |   |
| Common  stock, $.01 par value                                                                                |   |                |   |                    |   |
| Authorized  — 30,500 shares                                                                             |   |                |   |                    |   |
| Issued  and outstanding—  8,433 at March 31,  2002 and 8,428 at December 31, 2001                  |   | 84                  |   | 84                      |   |
| Additional  paid-in capital                                                                                  |   | 32,375              |   | 32,383                  |   |
| Accumulated  deficit                                                                                         |   | (25,298             | )      | (25,111                 | )      |
| Treasury  stock, at cost; 126  shares as of  March 31, 2002 and December 31, 2001                  |   | (360                | )      | (360                    | )      |
| Total  stockholders’ equity                                                                             |   | 6,801               |   | 6,996                   |   |
|                                                                                                         |   |                |   |                    |   |
| Total  liabilities and stockholders’ equity                                                             |   | $                   | 8,846  |                    | $      | 8,839 |   |

 

**The accompanying notes are anintegral part of these consolidated financial statements.**

 

2

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**BITSTREAM INC. AND SUBSIDIARIES**

# **CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)**

 
|                                                   |   | **For the  Three Months   Ended March 31,** |   |
|--------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                   |   | **2002**                                    |   | **2001** | ** ** |
| Revenue:                                               |   |                                        |   |   |   |
| Software  licenses                                     |   | $                                           | 1,836  |   | $ | 1,296 |   |
| Services                                               |   | 297                                         |   | 332 |   |
| Total  revenue                                         |   | 2,133                                       |   | 1,628 |   |
|                                                   |   |                                        |   |   |   |
| Cost  of revenue:                                      |   |                                        |   |   |   |
| Software  licenses                                     |   | 312                                         |   | 200 |   |
| Services                                               |   | 103                                         |   | 84 |   |
| Cost  of revenue                                       |   | 415                                         |   | 284 |   |
|                                                   |   |                                        |   |   |   |
| Gross  profit                                          |   | 1,718                                       |   | 1,344 |   |
| Operating  expenses:                                   |   |                                        |   |   |   |
| Marketing  and selling                                 |   | 595                                         |   | 825 |   |
| Research  and development                              |   | 959                                         |   | 1,328 |   |
| General  and administrative                            |   | 342                                         |   | 412 |   |
|                                                   |   |                                        |   |   |   |
| Total operating expenses                               |   | 1,896                                       |   | 2,565 |   |
|                                                   |   |                                        |   |   |   |
| Operating  loss                                        |   | (178                                        | )      | (1,221 | ) |
|                                                   |   |                                        |   |   |   |
| Loss  on investment in DiamondSoft, Inc.               |   | (1                                          | )      | (75 | ) |
| Interest  income, net                                  |   | 23                                          |   | 87 |   |
|                                                   |   |                                        |   |   |   |
| Loss  before provision for income taxes                |   | (156                                        | )      | (1,209 | ) |
|                                                   |   |                                        |   |   |   |
| Provision  for income taxes                            |   | 31                                          |   | 49 |   |
|                                                   |   |                                        |   |   |   |
| Net  loss                                              |   | $                                           | (187   | ) | $ | (1,258 | ) |
|                                                   |   |                                        |   |   |   |
| Basic  and diluted net loss per share                  |   | $                                           | (0.02  | ) | $ | (0.16 | ) |
|                                                   |   |                                        |   |   |   |
| Basic  and diluted weighted average shares outstanding |   | 8,305                                       |   | 7,949 |   |

 

**Theaccompanying notes are an integral part of these consolidated financial statements.**

 

3

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**BITSTREAM INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

 
|                                                                         |   | **For the  Three Months Ended   March 31,** |   |
|------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                         |   | **2002**                                    |   | **2001** |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                   |   |                                        |   |   |   |
|                                                                         |   |                                        |   |   |   |
| Net  loss                                                                    |   | $                                           | (187   | ) | $ | (1,258 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |   |                                        |   |   |   |
| Depreciation                                                                 |   | 86                                          |   | 94 |   |
| Amortization                                                                 |   | 17                                          |   | 126 |   |
| Stock based  compensation                                                    |   | (15                                         | )      | (1 | ) |
| Loss  on investment in DiamondSoft, Inc. (Note 3)                            |   | 1                                           |   | 75 |   |
| Changes  in operating assets and liabilities:                                |   |                                        |   |   |   |
| Accounts  receivable                                                         |   | (26                                         | )      | 830 |   |
| Prepaid  expenses and other current assets                                   |   | (99                                         | )      | (6 | ) |
| Accounts  payable                                                            |   | 35                                          |   | (24 | ) |
| Accrued  expenses                                                            |   | 33                                          |   | 27 |   |
| Deferred  revenue                                                            |   | 134                                         |   | 67 |   |
| Net  cash used in operating activities                                       |   | (21                                         | )      | (70 | ) |
|                                                                         |   |                                        |   |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                   |   |                                        |   |   |   |
| Purchases  of property and equipment, net                                    |   | (9                                          | )      | (62 | ) |
| Additions  to Intangible assets                                              |   | (13                                         | )      | (47 | ) |
| Investment  in DiamondSoft, Inc.                                             |   |                                        |   | (150 | ) |
| Net  cash used in investing activities                                       |   | (22                                         | )      | (259 | ) |
|                                                                         |   |                                        |   |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                   |   |                                        |   |   |   |
| Proceeds  from the exercise of stock options/warrants                        |   | 7                                           |   | 104 |   |
| Net  cash provided by  financing activities                             |   | 7                                           |   | 104 |   |
|                                                                         |   |                                        |   |   |   |
| Net  Decrease in Cash and Cash Equivalents                                   |   | (36                                         | )      | (225 | ) |
| Cash  and Cash Equivalents, beginning of period                              |   | 5,716                                       |   | 7,149 |   |
| Cash  and Cash Equivalents, end of period                                    |   | $                                           | 5,680  |   | $ | 6,924 |   |
|                                                                         |   |                                        |   |   |   |
| **SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:**                       |   |                                        |   |   |   |
| Cash  paid for interest                                                      |   | $                                           | — |   | $ | 1 |   |
| Cash  paid for income taxes                                                  |   | $                                           | 43     |   | $ | 78 |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

 

4

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**BITSTREAMINC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

# **MARCH 31, 2002**

 

 

**(1)  ****Significant Accounting Policies**

 

Bitstream Inc. (“Bitstream”) and subsidiaries(together the “Company”), headquartered in Cambridge, Massachusetts, iscomposed of three separate and distinct businesses: (1) type and technology inwhich Bitstream develops and licenses font technology and custom font designsto manufacturers of Internet appliances, wireless devices, set-top boxes,embedded systems, printers, and personal digital assistants; (2) MyFonts.com, ashowcase of the world’s fonts in one easy-to-use e-commerce web site operatedby Bitstream’s wholly-owned subsidiary, MyFonts.com, Inc. (“MyFonts.com”) whichBitstream established in December 1999; and (3) Pageflex, in which theCompany’s wholly-owned subsidiary Pageflex, Inc. (“Pageflex”) develops, marketsand supports on-demand document composition solutions which automaticallyproduce customized one-to-one marketing collateral such as datasheets andbrochures directly from XML text and graphics data stored in Web servers and/ordatabases.

 

**(a)Basis of Presentation**

The consolidated financial statements of the Companypresented herein, without audit, have been prepared pursuant to the rules ofthe Securities and Exchange Commission (the “SEC”) for quarterly reports onForm 10-Q and do not include all of the information and footnote disclosuresrequired by generally accepted accounting principles. The balance sheetinformation at December 31, 2001 has been derived from the Company’s auditedconsolidated financial statements. These statements should be read inconjunction with the consolidated financial statements and notes thereto forthe period ended December 31, 2001 included in the Company’s Annual Report onForm 10-K, which was filed by the Company with the SEC on March 29, 2002.

 

The balance sheet as of March 31, 2002, the statementsof operations for the three months ended March 31, 2002 and 2001, thestatements of cash flows for the three months ended March 31, 2002 and 2001,and the notes to each are unaudited, but in the opinion of management includeall adjustments necessary for a fair presentation of the consolidated financialposition, results of operations, and cash flows of the Company and itssubsidiaries for these interim periods.

 

The results of operations for the three months endedMarch 31, 2002 may not necessarily be indicative of the results to be expectedfor the year ending December 31, 2002.

 

**(b) Property and Equipment**

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

 

|                                                   |   | **March 31,  2002** |   | **December  31,  2001** |   |
|--------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| Equipment  and computer software                       |   | $                   | 2,422  |                    | $      | 2,413 |   |
| Purchased  software                                    |   | 351                 |   | 351                     |   |
| Furniture  and fixtures                                |   | 372                 |   | 372                     |   |
| Lea/sehold  improvements                               |   | 659                 |   | 659                     |   |
|                                                   |   | 3,804               |   | 3,795                   |   |
|                                                   |   |                |   |                    |   |
| Less  — Accumulated depreciation and amortization |   |                |   |                    |   |
|                                                   |   | 3,408               |   | 3,322                   |   |
| Property  and equipment, net                           |   | $                   | 396    |                    | $      | 473 |   |

 

5

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**(c) Off-Balance Sheet Risk and Concentration of Credit Risk**

 

Financial instrumentsthat potentially expose the Company to concentrations of credit risk consistprimarily of cash and cash equivalents and trade accounts receivable.  The Company places a majority of its cashinvestments in one highly-rated financial institution.  The Company has not experienced significantlosses related to receivables from any individual customers or groups ofcustomers in any specific industry or by geographic area.  Due to these factors, no additional creditrisk beyond amounts provided for collection losses is believed by management tobe inherent in the Company’s accounts receivable.  At March 31, 2002, four customers accounted for 14%, 14%, 14% and13% of the Company’s accounts receivable.  The Company does not have any off-balance sheet risks as of March 31,2002.  At December 31, 2001, twocustomers accounted for 18% and 17% of the Company’s accounts receivable.

 

For the three monthsended March 31, 2002 and 2001, no single customer accounted for 10% or more ofthe Company’s revenue.  Furthermore, forthe three months ended March 31, 2002, one customer of the Company’s type andtechnology segment accounted for 12% of the revenue for that segment, twocustomers of the Pageflex segment accounted for 21% and 15% of the revenue forthat segment, and no customers accounted for 10% or more of the MyFonts.comsegment.  For the three months endedMarch 31, 2001, one customer of the Company’s type and technology segmentaccounted for 12% of the revenue for that segment, one customer of the Pageflexsegment accounted for 22% of that segment’s revenue, and no customers accountedfor 10% or more of the MyFonts.com segment’s revenue.

 

 

**(d) Goodwill and other intangibleassets (in thousands, except per share amounts)**

 

Goodwill is stated atcost, less accumulated amortization, and consists of the following:

 

|                                                                    |   | **March 31,  2002** |   | **December  31,  2001** |   |
|-------------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| Acquisition  of Mainstream Software Solutions Ltd                       |   | $                   | — |                    | $      | 450 |   |
| Acquisition  of Type Solutions, Inc.                                    |   | 595                 |   | 595                     |   |
| Acquisition  of Alaras Corporation                                      |   | 1,300               |   | 1,300                   |   |
|                                                                    |   | 1,895               |   | 2,345                   |   |
| Less  — Accumulated amortization                                   |   | 1,168               |   | 1,618                   |   |
|                                                                    |   |                |   |                    |   |
| Goodwill,  Net                                                          |   | 727                 |   | 727                     |   |
| Embedded  goodwill from equity investment in DiamondSoft, Inc. (Note 3) |   | 557                 |   | 557                     |   |
|                                                                    |   |                |   |                    |   |
| Total  Goodwill                                                         |   | $                   | 1,284  |                    | $      | 1,284 |   |

 

In June 2001, the FASB issued SFAS No. 142, *Goodwill andOther Intangible Assets*. The Company adopted SFAS No. 142, effectiveJanuary 1, 2002, which establishes new accounting and reporting requirementsfor goodwill and other intangible assets. Under SFAS No. 142, goodwill and indefinite-lived intangible assets areno longer amortized, but are required to be reviewed annually for impairment,or more frequently if impairment indicators arise.  Separable intangible assets that have finite lives will continueto be amortized over their useful lives. In addition, under the new pronouncement, the Company is required toestablish reporting units and allocate goodwill to each of these reportingunits.  The Company has identified thefollowing reporting units; type and technology, MyFonts.com, and Pageflex.

 

6

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The Company ceased all goodwill amortization effectiveJanuary 1, 2002.  In addition, theCompany tested recorded goodwill attributable to each reporting unit for impairment.  Management completed the initial impairmenttesting as of January 1, 2002 and determined that the fair value of itsreporting units were greater than the carrying values for those units.  The Company has recorded goodwill embeddedin its equity investment in DiamondSoft, Inc. of $557 as of March 31, 2002 andDecember 31, 2001, which is not attributable to a reporting unit.  The Company tested this embedded goodwilland determined that it was not impaired as of March 31, 2002.   As a result, no impairment charge wasrecognized.

 

The carrying amounts ofgoodwill attributable to eachreporting unit are as follows:

 
|                 |   | **March 31,  2002** |   | **December 31,  2001** |   |
|----------------------|--------|---------------------|--------|------------------------|--------|
| Type and  technology |   | $                   | 228    |                   | $      | 228 |   |
| MyFonts.com          |   | —              |   | —                 |   |
| Pageflex             |   | 499                 |   | 499                    |   |
|                 |   | $                   | 727    |                   | $      | 727 |   |

 

Had the Company applied thenon-amortization provisions of SFAS No. 142 as of January 1, 2001, results ofoperation for the three months ended March 31, 2002 and 2001, would have been as follows (in thousands,except per share amounts):

 
|                                         |   | **Three  Months Ended  March 31,** |   |
|----------------------------------------------|--------|------------------------------------|--------|
|                                         |   | **2002**                           |   | **2001** | ** ** |
| Reported net loss                            |   | $                                  | (187   | ) | $ | (1,258 | ) |
| Add:                                         |   |                               |   |   |   |
| Goodwill amortization, net of tax            |   | —                             |   | 142 |   |
| Adjusted net loss                            |   | $                                  | (187   | ) | $ | (1,116 | ) |
|                                         |   |                               |   |   |   |
| Basic and diluted loss per share as reported |   | $                                  | (0.02  | ) | $ | (0.16 | ) |
|                                         |   |                               |   |   |   |
| Basic and diluted pro forma loss per share   |   | $                                  | (0.02  | ) | $ | (0.14 | ) |

 

In connection with itsadoption of SFAS 142, the Company reassessed the useful lives and theclassification of its identifiable intangible assets and determined that they continue to be appropriate.  The components of our amortized intangible assets follow:

 
|              |   | **March 31, 2002**            |   | **December 31, 2001**          |   |
|-------------------|--------|-------------------------------|--------|--------------------------------|--------|
|              |   | **Gross   Carrying   Amount** |   | **Accumulated   Amortization** |   | **Gross   Carrying   Amount** |   | **Accumulated   Amortization** |   |
| Marketing-related |   | $                             | 70     |                           | $      | (30 | ) | $ | 70 |   | $ | (27 | ) |
| Technology-based  |   | 302                           |   | (128                           | )      | 289 |   | (114 | ) |
| Total             |   | $                             | 372    |                           | $      | (158 | ) | $ | 359 |   | $ | (141 | ) |

 

7

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Amortization expense forintangible assets during thefirst quarter of 2002 was $17,000. Estimated amortization for the remainder of 2002 and the five succeedingyears follows:

 
|             |   | **Estimated   Amortization   Expense** |   |
|------------------|--------|----------------------------------------|--------|
| 2002 (remainder) |   | $                                      | 48     |   |
| 2003             |   | $                                      | 60     |   |
| 2004             |   | $                                      | 54     |   |
| 2005             |   | $                                      | 38     |   |
| 2006             |   | $                                      | 14     |   |
| 2007             |   | $                                      | — |   |

 

**(e)  Recently Issued Accounting Standards**

 

In June 2001, the FASB issued SFAS No. 143, *Accounting for Asset Retirement Obligations*.This Statement addresses financial accounting and reporting for obligationsassociated with the retirement of tangible long-lived assets and the associatedasset retirement costs.  This Statementapplies to legal obligations associated with the retirement of long-livedassets that result from the acquisition, construction, development, or normaluse of the asset.  SFAS No. 143 iseffective for fiscal years beginning after June 15, 2002.  The Company does not expect SFAS No. 143 tohave a material impact on its financial position or results of operations uponits adoption January 1, 2003.

 

In August 2001, the FASB issued SFAS No. 144, *Accounting for the Impairment or Disposal of Long-LivedAsset*. This statement supersedes SFAS 121, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to be Disposed Of*and APB No. 30, *Reporting the Results of Operations — Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transaction*. This statementprovides guidance on recognizing and measuring impairment for long-lived assetsexcluding certain long-lived assets, such as goodwill, non-amortized intangibleassets and deferred tax assets. The adoption of this statement effectiveJanuary 1, 2002, did not have a material impact on its financial position orresults of operations.

 

**(2)   Loss Per Share**

 

Basic earnings or loss per share is determined by dividingthe net loss by the weighted average number of shares of common stockoutstanding during the period. Diluted earnings per share reflects the effectof the conversion of potentially dilutive securities, such as stock options,based on the treasury stock method. In computing diluted earnings per share,common stock equivalents are not considered in periods in which a net loss isreported, as the inclusion of the potential common stock equivalents would beantidilutive.  As a result there is nodifference between the Company’s basic and diluted loss per share for theperiods ended March 31, 2002 and 2001.

 

If the Company had been in a profitable position, thepotential common shares would have increased the weighted average number ofshares outstanding by 1,429,000 and 891,000 shares for the three months endedMarch 31, 2002, and 2001, respectively. In addition, there were warrants and options outstanding to purchase556,000 and 229,000 shares as of March 31, 2002 and 2001, respectively thatwere not included in the potential common share computations because theirexercise prices were greater than the market price of the Company’s commonstock.  These common stock equivalentsare antidilutive even when a profit is reported in the numerator.

 

8

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**(3)**   **Investment(in thousands, except percentages)**

 

On March 13, 1998, the Company made a $500 or 25%equity investment, accounted for under the equity method, in DiamondSoft, Inc.(“DiamondSoft”), a California corporation primarily engaged in the business ofdeveloping, marketing and distributing software tools to a variety ofprofessional markets. During the year ended December 31, 2001 the Company madeadditional investments totaling $410 in DiamondSoft, Inc., resulting in anincrease in Bitstream’s ownership percentage to 31.7% at December 31, 2001,which remained unchanged as of March 31, 2002.

 

Losses for the three months ended March 31, 2002, and2001 related to the Company’s investment in DiamondSoft totaled approximately$(1) and $(75), respectively, and are included in the accompanying consolidatedstatements of operations.  The Companyhas recorded goodwill related to this investment equal to the differencebetween the amount paid for the investment and the Company’s share ofDiamondSoft’s underlying net assets at the time of each investment.  Losses for the three months ended March 31,2001 included $24 in amortization.  Thisgoodwill amortization ceased in accordance with the Company’s adoption of SFASNo. 142 on January 1, 2002. (See Note 1(d))

 

On June 19, 2000, the Company deposited $300 into amoney market account at Wells Fargo Bank to secure a $300 line of creditgranted DiamondSoft by that bank.  Thiscash, which continued to secure the line of credit, is presented on theCompany’s consolidated balance sheet as restricted cash.

 

**(4)**   **AccruedExpenses, (in thousands)**

 
| **Accrued expenses consist of the following:** |   | **March 31,  2002** |   | **December 31,  2001** |   |
|------------------------------------------------|--------|---------------------|--------|------------------------|--------|
| Accrued royalties                              |   | $                   | 185    |                   | $      | 226 |   |
| Payroll and other compensation                 |   | 616                 |   | 510                    |   |
| Accrued professional and consulting services   |   | 144                 |   | 197                    |   |
| Other                                          |   | 214                 |   | 193                    |   |
| Total                                          |   | $                   | 1,159  |                   | $      | 1,126 |   |

 

**(5)**   **SegmentReporting (in thousands):**

 

The Company has determined it has three reportablesegments: (i) a type and technology segment; (ii) an Pageflex segment and (iii)MyFonts.com segment.  The Company’sreportable segments are strategic business units that sell the Company’sproducts through distinct distribution channels. They are managed separately aseach business requires different marketing strategies.  The Company’s approach is based on the waythat management organizes the segments within the enterprise for makingoperating decisions and assessing performance. The MyFonts.com segment’s revenue includes revenue from products itpurchases from the type and technology segment.  Inter-segment revenue of $85 and $23 for the three months endedMarch 31, 2002 and 2001, respectively, which were created by these transactionshave been eliminated from MyFonts.com’s segmented revenue below, as well asfrom the Company’s consolidated financial statements.  The Company evaluates performance based on profit or loss fromoperations before income taxes, not including non-recurring gains and losses.

 

9

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The following table sets forth the Company’s revenueand income (loss) from operations by segment:

 
|                                       |   | **Three months ended**March 31, |   |
|--------------------------------------------|--------|---------------------------------|--------|
|                                       |   | **2002**                        |   | **2001** | ** ** |
| **Revenue (from external customers):**     |   |                            |   |   |   |
| Type and technology                        |   | $                               | 1,213  |   | $ | 1,119 |   |
| MyFonts.com                                |   | 262                             |   | 80 |   |
| Pageflex                                   |   | 658                             |   | 429 |   |
| Consolidated revenue                       |   | $                               | 2,133  |   | $ | 1,628 |   |
|                                       |   |                            |   |   |   |
| **Segment income (loss) from operations:** |   |                            |   |   |   |
| Type and technology                        |   | $                               | 131    |   | $ | (147 | ) |
| MyFonts.com                                |   | (102                            | )      | (151 | ) |
| Pageflex                                   |   | (207                            | )      | (923 | ) |
| Consolidated loss from operations          |   | $                               | (178   | ) | $ | (1,221 | ) |

 

**(6)**   **GeographicalReporting (in thousands):**

 

The Company attributes revenues to differentgeographical areas on the basis of the location of the customer. All of theCompany’s product sales for the three months ended March 31, 2002 and 2001 wereshipped from its headquarters located in the United States or its officelocated in Cheltenham, England. Revenues by geographic area are as follows:

 
|                                                    |   | **Three  Months Ended March 31,** |   |
|---------------------------------------------------------|--------|-----------------------------------|--------|
| **Revenue:**                                            |   | **2002**                          |   | **2001** |   |
| United  States                                          |   | $                                 | 1,536  |   | $ | 789 |   |
| Japan                                                   |   | 190                               |   | 343 |   |
| Korea                                                   |   | 120                               |   | — |   |
| Finland                                                 |   | —                            |   | 83 |   |
|                                                    |   |                              |   |   |   |
| Other  (Countries less than 5% individually, by region) |   |                              |   |   |   |
| Europe,  excluding specific countries listed above      |   | 231                               |   | 308 |   |
| Asia,  excluding specific countries listed above        |   | —                            |   | 45 |   |
| Other                                                   |   | 56                                |   | 60 |   |
| Total  revenue                                          |   | $                                 | 2,133  |   | $ | 1,628 |   |

 

Long-lived tangible assets by geographic area are asfollows:

 
|          |   | **March 31,   2002** |   | **December  31,   2001** |   |
|---------------|--------|----------------------|--------|--------------------------|--------|
| United States |   | $                    | 376    |                     | $      | 452 |   |
| England       |   | 20                   |   | 21                       |   |
| Total         |   | $                    | 396    |                     | $      | 473 |   |

 

10

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**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

The following discussionshould be read in conjunction with the consolidated financial statements andnotes thereto.

 

## **OVERVIEW**

 

Bitstream Inc. (“Bitstream” or the “Company”),headquartered in Cambridge, Massachusetts, is composed of three separate anddistinct businesses: (1) type and technology, in which Bitstream develops andlicenses font technology and custom font designs to manufacturers of Internetappliances, wireless devices, set-top boxes, embedded systems, printers, andpersonal digital assistants; (2) MyFonts.com, a showcase of the world’s fontsin one easy-to-use e-commerce web site operated by Bitstream’s wholly-ownedsubsidiary, MyFonts.com, Inc. (MyFonts.com”) which Bitstream established inDecember 1999; and (3) Pageflex, in which the Company’s wholly-owned subsidiaryPageflex, Inc. (“Pageflex”) develops, markets and supports on-demand documentcomposition solutions which automatically produce customized one-to-onemarketing collateral such as datasheets and brochures directly from XML textand graphics data stored in Web servers and/or databases.  Pageflex, Inc. was established by theCompany in January 1999 as a wholly owned subsidiary for the purpose ofdeveloping on-demand marketing software.

 

## **FORWARD LOOKINGSTATEMENTS**

 

Except for the historical information containedherein, this Quarterly Report on Form 10-Q may contain forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended.Investors are cautioned that forward-looking statements are inherentlyuncertain.  Actual performance andresults of operations may differ materially from those projected or suggestedin 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 informationconcerning certain risks and uncertainties that would cause actual results todiffer materially from those projected or suggested in the forward-lookingstatements is contained in the Company’s filings with the Securities andExchange Commission, including those risks and uncertainties discussed in theCompany’s final Prospectus, dated October 30, 1996, included as part of theCompany’s Registration Statement on Form S-1 (333-11519), in the sectionentitled “Risk Factors.” The forward-looking statements contained hereinrepresent the Company’s judgment as of the date of this report, and the Companycautions readers not to place undue reliance on such statements.  Management undertakes no obligation topublicly release any revisions to the forward-looking statements or reflectevents or circumstances after the date of this document.

 

11

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**RESULTS OF OPERATIONS****(inthousands, except percent amounts)**

 

**Consolidated Gross Profit:**

 
|                  |   | **Three  Months Ended March 31,** |   |
|-----------------------|--------|-----------------------------------|--------|
|                  |   |                              |   | **% ofRevenue** |   |   |   | **% of****Revenue** |   | **Change** |   |
|                  |   | **2002**                          |   |   | **2001** |   |   | **Dollars** |   | **Percent** |   |
| **Revenue**           |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses     |   | $                                 | 1,836  |   | 86.1 | % | $ | 1,296 |   | 79.6 | % | $ | 540 |   | 41.7 | % |
| Services              |   | 297                               |   | 13.9 |   | 332 |   | 20.4 |   | (35 | ) | (10.5 | ) |
| Total revenue         |   | 2,133                             |   | 100.0 |   | 1,628 |   | 100.0 |   | 505 |   | 31.0 |   |
| **Cost  of Revenue**  |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses     |   | 312                               |   | 17.0 |   | 200 |   | 15.4 |   | 112 |   | 56.0 |   |
| Services              |   | 103                               |   | 34.7 |   | 84 |   | 25.3 |   | 19 |   | 22.6 |   |
| Total cost of revenue |   | 415                               |   | 19.5 |   | 284 |   | 17.4 |   | 131 |   | 46.1 |   |
|                  |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Gross  Profit**     |   | $                                 | 1,718  |   | 80.5 | % | $ | 1,344 |   | 82.6 | % | $ | 374 |   | 27.8 | % |

** **

**Revenue for the three months ended March 31, 2002 ascompared to the three months ended March 31, 2001 increased for all three ofthe Company’s business segments.  Theseincreases are discussed in more detail under each segment below.**

** **

The increase in cost ofrevenue for the three months ended March 31, 2002 as compared to the threemonths ended March 31, 2001 was primarily due to increased royalty payments forthe Company’s MyFonts.com segment. Cost of revenue includes direct costs oflicenses and royalties, as well as direct costs of product sales to endusers.   Included in the cost oflicenses and royalties are fees paid to third parties for thedevelopment or license of rights to technology and/or unique typeface designsand costs incurred in the fulfillment of custom orders from OEM and ISVcustomers.  Included in cost of productsales to end users and distributors are the direct costs associated with the duplication,packaging and shipping of product.

 

**Type and technology (“Type”) GrossProfit:**

 
|                         |   | **Three  Months Ended March 31,** |   |
|------------------------------|--------|-----------------------------------|--------|
|                         |   |                              |   | **% of TypeRevenue** |   |   |   | **% of Type****Revenue** |   | **Change** |   |
|                         |   | **2002**                          |   |   | **2001** |   |   | **Dollars** |   | **Percent** |   |
| **Revenue**                  |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses            |   | $                                 | 1,084  |   | 89.4 | % | $ | 967 |   | 86.4 | % | $ | 117 |   | 12.1 | % |
| Services                     |   | 129                               |   | 10.6 |   | 152 |   | 13.6 |   | (23 | ) | (15.1 | ) |
| Total revenue                |   | 1,213                             |   | 100.0 |   | 1,119 |   | 100.0 |   | 94 |   | 8.4 |   |
| Percentage of  total revenue |   | 56.9                              | %      |   |   | 68.7 | % |   |   |   |   |   |   |
|                         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Cost  of Revenue**         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses            |   | $                                 | 70     |   | 6.5 |   | $ | 115 |   | 11.9 |   | (45 | ) | (39.1 | ) |
| Services                     |   | 46                                |   | 35.7 |   | 46 |   | 30.3 |   | — |   | — |   |
| Total cost of revenue        |   | 116                               |   | 9.6 |   | 161 |   | 14.4 |   | (45 | ) | (28.0 | ) |
|                         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Gross  Profit**            |   | $                                 | 1,097  |   | 90.4 | % | $ | 958 |   | 85.6 | % | $ | 139 |   | 14.5 | % |

 

12

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**The increase in type and technology revenue for the threemonths ended March 31, 2002 versus the three months ended March 31, 2001 wasthe result of an increase in OEM technology license revenue, partially offsetby a decrease in revenue from custom design services.  Cost of revenue decreased primarily due to a decrease in royaltycosts. Royalty costs decreased due to lower sales of products for whichBitstream was obligated to pay a royalty and a decrease in packaging andmanufacturing costs.**

** **

**MyFonts.com (“MyFonts”) Gross Profit:**

** **
|                         |   | **Three  Months Ended March 31,** |   |
|------------------------------|--------|-----------------------------------|--------|
|                         |   |                              |   | **% of   MyFonts** |   |   |   | **% of   MyFonts** |   | **Change** |   |
|                         |   | **2002**                          |   | **Revenue** |   | **2001** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
| **Revenue**                  |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses            |   | $                                 | 262    |   | 100.0 | % | $ | 80 |   | 100.0 | % | $ | 182 |   | 227.5 | % |
| Total revenue                |   | 262                               |   | 100.0 |   | 80 |   | 100.0 |   | 182 |   | 227.5 |   |
| Percentage of  total revenue |   | 12.3                              | %      |   |   | 4.9 | % |   |   |   |   |   |   |
|                         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Cost  of Revenue**         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses            |   | $                                 | 213    |   | 81.3 |   | $ | 63 |   | 78.8 |   | 150 |   | 238.1 |   |
| Total cost of revenue        |   | 213                               |   | 81.3 |   | 63 |   | 78.8 |   | 150 |   | 238.1 |   |
|                         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Gross  Profit**            |   | $                                 | 49     |   | 18.7 | % | $ | 17 |   | 21.2 | % | $ | 32 |   | 188.2 | % |

** **

**Revenue for MyFonts has increased as consumer purchases ofthe Company’s products has increased. Inter-company sales, which MyFonts generated from the resale ofBitstream fonts, have been excluded. Total MyFonts revenue including revenue from inter-company salesincreased $244 to $347 for the three months ended March 31, 2002 from $103 forthe three months ended March 31, 2001. Cost of revenue increased $150 because of sales of fonts fromnon-affiliated foundries increased. Royalties payable to non-affiliated foundries are approximately 80% ofthe revenue generated.**

** **

**Pageflex Gross Profit:**

** **
|                         |   | **Three  Months Ended March 31,** |   |
|------------------------------|--------|-----------------------------------|--------|
|                         |   |                              |   | **% of   Pageflex** |   |   |   | **% of   Pageflex** |   | **Change** |   |
|                         |   | **2002**                          |   | **Revenue** |   | **2001** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
| **Revenue**                  |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses            |   | $                                 | 491    |   | 74.6 | % | $ | 249 |   | 58.0 | % | $ | 242 |   | 97.2 | % |
| Services                     |   | 167                               |   | 25.4 |   | 180 |   | 42.0 |   | (13 | ) | (7.2 | ) |
| Total revenue                |   | 658                               |   | 100.0 |   | 429 |   | 100.0 |   | 229 |   | 53.4 |   |
| Percentage of  total revenue |   | 30.8                              | %      |   |   | 26.4 | % |   |   |   |   |   |   |
|                         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Cost  of Revenue**         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| Software licenses            |   | $                                 | 30     |   | 6.1 |   | $ | 22 |   | 8.8 |   | 8 |   | 36.4 |   |
| Services                     |   | 56                                |   | 33.5 |   | 38 |   | 21.1 |   | 18 |   | 47.4 |   |
| Total cost of revenue        |   | 86                                |   | 13.1 |   | 60 |   | 14.0 |   | 26 |   | 43.3 |   |
|                         |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Gross  Profit**            |   | $                                 | 572    |   | 86.9 | % | $ | 369 |   | 86.0 | % | $ | 203 |   | 55.0 | % |

 

13

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**The increase in Pageflex revenue for the three months endedMarch 31, 2002 as compared to the three months ended March 31, 2001 wasprimarily the result of an increase in sales of Mpower, as well as an increasein Mpower monthly subscription fees generated by an expanding customer base.The decrease in revenue from services was the result of non-recurringdevelopment fees for an OEM contract with Atex Media Solutions, Inc. ofapproximately $85 recognized during the three months ended March 31, 2001,partially offset by an increase in maintenance support fees attributable to theincreased customer base.  The increasein cost of revenue is due to increases in shipping and manufacturing supplycosts and to payroll costs resulting from the reassignment of two employees toprovide support and infrastructure to the Company’s increased customer supportbase.**

** **

**Selling and Marketing**:

 
|                               |   | **Three  Months Ended March 31,** |   |
|------------------------------------|--------|-----------------------------------|--------|
|                               |   |                              |   | **% of   Segment** |   |   |   | **% of   Segment** |   | **Change** |   |
|                               |   | **2002**                          |   | **Revenue** |   | **2001** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
| Type and technology                |   | $                                 | 332    |   | 27.4 | % | $ | 374 |   | 33.4 | % | $ | (42 | ) | (11.2 | )% |
| MyFonts.com                        |   | 15                                |   | 5.7 |   | 9 |   | 11.3 |   | 6 |   | 66.7 |   |
| Pageflex                           |   | 248                               |   | 37.7 |   | 442 |   | 103.0 |   | (194 | ) | (43.9 | ) |
| Consolidated selling and marketing |   | $                                 | 595    |   | 27.9 | % | $ | 825 |   | 50.7 | % | $ | (230 | ) | (27.9 | )% |

 

The decrease in marketing and selling expenses inabsolute dollars and as a percentage of revenue for the three months endedMarch 31, 2002 as compared to the three months ended March 31, 2001 reflectsexpense reductions implemented by management during 2001.  The decrease in type and technologymarketing expenses was primarily due to reductions in personnel, employeebenefits and travel expenditures. Pageflex salaries and benefits decreased by $63 to $165 for the threemonths ended March 31, 2002, while tradeshow and travel expenses for Pageflexdecreased by $73 to $12 for the three months ended March 31, 2002.

 

**Research and Development (“R&D”):**

 
|                                   |   | **Three  Months Ended March 31,** |   |
|----------------------------------------|--------|-----------------------------------|--------|
|                                   |   |                              |   | **% of   Segment** |   |   |   | **% of   Segment** |   | **Change** |   |
|                                   |   | **2002**                          |   | **Revenue** |   | **2001** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
| Type and technology                    |   | $                                 | 439    |   | 36.2 | % | $ | 486 |   | 43.4 | % | $ | (47 | ) | (9.7 | )% |
| MyFonts.com                            |   | 112                               |   | 42.8 |   | 143 |   | 178.8 |   | (31 | ) | (21.7 | ) |
| Pageflex                               |   | 408                               |   | 62.0 |   | 699 |   | 162.9 |   | (291 | ) | (41.6 | ) |
| Consolidated research and  development |   | $                                 | 959    |   | 45.0 | % | $ | 1,328 |   | 81.6 | % | $ | (369 | ) | (27.8 | )% |

 

14

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The decrease in R&Dexpenses in absolute dollars and as a percentage of revenue for the threemonths ended March 31, 2002 as compared to the three months ended March 31,2001 is primarily attributable to cost reductions adopted in 2001.  The type and technology decrease included adecrease of $30 in goodwill amortization of technology associated with theacquisition of Type Solutions, Inc. resulting from the Company’s adoption of SFAS No. 142. See Note 1(d) inthe Notes to the Consolidated Financial Statements included herewith.  The MyFonts decrease was primarily theresult of the decreased use of outside consultants and the absorption of thatwork by employees.  The Pageflexdecrease included headcount reductions completed as part of the Company’srestructuring in October 2001, which resulted in savings of $195 in salariesand benefits during the quarter, and a decrease in the outsourcing ofengineering projects and the absorption of those projects by current employees,which resulted in a savings of $62.

 

**General and Administrative(“G&A”):**

** **
|                                     |   | **Three  Months Ended March 31,** |   |
|------------------------------------------|--------|-----------------------------------|--------|
|                                     |   |                              |   | **% of   Segment** |   |   |   | **% of   Segment** |   | **Change** |   |
|                                     |   | **2002**                          |   | **Revenue** |   | **2001** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
| Type and technology                      |   | $                                 | 195    |   | 16.1 | % | $ | 245 |   | 21.9 | % | $ | (50 | ) | (20.4 | )% |
| MyFonts.com                              |   | 24                                |   | 9.2 |   | 16 |   | 20.0 |   | 8 |   | 50.0 |   |
| Pageflex                                 |   | 123                               |   | 18.7 |   | 151 |   | 35.2 |   | (28 | ) | (18.5 | ) |
| Consolidated general and  administrative |   | $                                 | 342    |   | 16.0 | % | $ | 412 |   | 25.3 | % | $ | (70 | ) | (17.0 | )% |

 

The decrease in type and technology G&A expenses for thethree months ended March 31, 2002 as compared to the three months ended March31, 2001 is primarily the result of a decrease in professional servicesassociated with the production and printing of the company’s annual report toshareholders and a savings of $22 in goodwill amortization related to theacquisition of Mainstream Software Solutions, Ltd., which was fully amortizedas of December 31, 2001. Pageflex G&A reflects decreases in employeeinsurance and administrative allocations, which are based on employeeheadcount, of approximately $60 attributable to the headcount reductioncompleted as part of the Company’s restructuring in October 2001.  Pageflex also had a decrease in goodwillamortization from the Alaras acquisition of $65.  This goodwill amortization ceased in accordance with theCompany’s adoption of SFAS No. 142 on January 1, 2002.  The net goodwill from this transaction isinstead subject to impairment valuation. See Note 1(d) in the Notes to the ConsolidatedFinancial Statements included herewith for further information.  These decreases were partially offset by achange in bad debt expense of $97 from a net recovery of $(114) for the threemonths ended March 31, 2001 to a net recovery of $(17) for the three monthsended March 31, 2002.

 

15

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**Loss on Investment in DiamondSoft,Inc.:**

** **
|                                    |   | **Three  Months Ended March 31,** |   |
|-----------------------------------------|--------|-----------------------------------|--------|
|                                    |   |                              |   | **% ofRevenue** |   |   |   | **% of****Revenue** |   | **Change** |   |
|                                    |   | **2002**                          |   |   | **2001** |   |   | **Dollars** |   | **Percent** |   |
| Loss on investment in DiamondSoft, Inc. |   | $                                 | (1     | ) | (0.1 | )% | $ | (75 | ) | (4.6 | )% | $ | 74 |   | 98.7 | % |
|                                         |        |                                   |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In March 1998 the Company made a $500 equityinvestment in DiamondSoft, Inc. (“DiamondSoft”) representing a 25% ownershipinterest.  During the year endedDecember 31, 2001 the Company made additional investments totaling $410 inDiamondSoft, resulting in an increase in Bitstream’s ownership percentage to31.7% at December 31, 2001 and March 31, 2002. The loss represents the Company’s pro rata share of DiamondSoft’s loss.(See Note 3 in the Notes to the Consolidated Financial Statements includedherewith.)

 

**Interest income, net:**

 
|                 |   | **Three  Months Ended March 31,** |   |
|----------------------|--------|-----------------------------------|--------|
|                 |   |                              |   | **% of** |   |   |   | **% of****Revenue** |   | **Change** |   |
|                 |   | **2002**                          |   | **Revenue** |   | **2001** |   |   | **Dollars** |   | **Percent** |   |
| Interest income, net |   | $                                 | 23     |   | 1.1 | % | $ | 87 |   | 5.3 | % | $ | (64 | ) | (73.6 | )% |
|                      |        |                                   |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest income consists primarily of income earned oncash and money market instruments and has decreased as the Company has usedcash to fund operations and also as the interest rate received has decreased.

 

**Provision for income taxes:**

** **
|       |   | **Three  Months Ended March 31,** |   |
|------------|--------|-----------------------------------|--------|
|       |   |                              |   | **% ofRevenue** |   |   |   | **% of****Revenue** |   | **Change** |   |
|       |   | **2002**                          |   |   | **2001** |   |   | **Dollars** |   | **Percent** |   |
| Income Tax |   | $                                 | 31     |   | 1.5 | % | $ | 49 |   | 2.9 | % | $ | (18 | ) | (36.7 | )% |
|            |        |                                   |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Company’s taxprovision for the three months ended March 31, 2002 is attributable solely toforeign income taxes.  The Company’s taxprovision for the three months ended March 31, 2001 is comprised of $2 invarious state minimum taxes and $47 in foreign income taxes.

 

16

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**LIQUIDITY AND CAPITAL RESOURCES (inthousands, except share amounts)**

 

The Company has funded its operations primarilythrough the public sale of equity securities, cash flows from operations andcash received from the sale of the Company’s MediaBank and InterSep OPI productlines to Inso Providence Corporation in August of 1998.  As of March 31, 2002, the Company had networking capital of $4,591 versus $4,688 at December 31, 2001.

 

The Company’s operating activities used cash ofapproximately $21 and $70 during the three months ended March 31, 2002 and 2001respectively. The cash was used primarily to fund the Company’s net losses. Thenet losses after adjustment for non-cash expenses resulted in a use of $98 and$964 in cash during the three months ended March 31, 2002 and 2001,respectively.  Changes in operatingassets and liabilities generated cash during both periods.  During the three months ended March 31,2002, the primary source of funds resulting from changes in operating assetsand liabilities was the receipt of $118 more in cash than the Companyrecognized in deferred revenue.  Duringthe three months ended March 31, 2001, the primary source of funds resultingfrom changes in operating assets and liabilities was the collection of accountsreceivable and the resulting $830 decrease in outstanding accounts receivable.

 

The Company’s investing activities used cash of $22and $259 for the three months ended March 31, 2002 and 2001, respectively.  Additions of property and equipment andintangible assets used $22 and $109 in cash for the three months ended March31, 2002 and 2001, respectively.  Duringthe three months ended March 31, 2001 the Company also increased its investmentin DiamondSoft, Inc. by $150.

 

The Company’s financing activities provided cash of $7and $104 for the three months ended March 31, 2002 and 2001, respectively fromthe exercise of stock options.

 

The Company believes its current cash and cashequivalent balances will be sufficient to meet the Company’s operating andcapital requirements for at least the next 12 months.  There can be no assurance, however, that the Company will notrequire additional financing in the future. If the Company were required to obtain additional financing in thefuture, there can be no assurance that sources of capital will be available onterms favorable to the Company, if at all.

 

As of March 31, 2002, the Company had no materialcommitments for capital expenditures. From time to time, the Company evaluates potential acquisitions ofproducts, businesses and technologies that may complement or expand theCompany’s business.  Any suchtransactions consummated may use a portion of the Company’s working capital orrequire the issuance of equity or debt. As of March 31, 2002, theCompany had future minimum annual lease payments under the Company’s leasedfacilities of $301 for the remainder of 2002 and $301 for the year endedDecember 31, 2003.

 

# **RECENT ACCOUNTING PRONOUNCEMENTS**

 

In June 2001, the FASB issued SFAS No. 143, *Accounting for Asset Retirement Obligations*.This Statement addresses financial accounting and reporting for obligationsassociated with the retirement of tangible long-lived assets and the associatedasset retirement costs.  This Statementapplies to legal obligations associated with the retirement of long-livedassets that result from the acquisition, construction, development, or normaluse of the asset.  SFAS No. 143 iseffective for fiscal years beginning after June 15, 2002.  The Company does not expect SFAS No. 143 tohave a material impact on its financial position or results of operations uponits adoption January 1, 2003.

 

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**PART 1, ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**DerivativeFinancial Instruments, Other Financial Instruments and Derivative CommodityInstruments.**

 

As of March 31, 2002, the Company did not participatein any derivative financial instruments or other financial and commodityinstruments for which fair value disclosure would be required under SFAS No.107. All of the Company’s investments are short-term, investment-gradecommercial paper, and money market accounts that are carried on the Company’sbooks at amortized cost, which approximates fair market value. Accordingly, theCompany has no quantitative information concerning the market risk ofparticipating in such investments.

 

**Primary Market Risk Exposures**

 

The Company’s primary market risk exposures are in theareas of interest rate risk and foreign currency exchange rate risk. The Company’sinvestment portfolio of cash equivalent and short-term investments is subjectto interest rate fluctuations, but the Company believes this risk is immaterialdue to the short-term nature of these investments.  The Company’s exposure to currency exchange rate fluctuations hasbeen and is expected to continue to be modest due to the fact that theoperations of its international subsidiaries are almost exclusively conductedin their respective local currencies. International subsidiary operating resultsare translated into U.S. dollars and consolidated for reporting purposes. Theimpact of currency exchange rate movements on inter-company transactions wasimmaterial for the three months ended March 31, 2002.  Currently the Company does not engage in foreign currency hedgingactivities.

 

# **PART II — OTHERINFORMATION**

** **

**ITEM 1. LEGAL PROCEEDINGS**

 

The Company is not a party to any material litigation.

 

**ITEM2. CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

(a)        Instruments defining therights of the holders of any class of registered securities of the Company havenot been materially modified during the three months ended March 31, 2002.

 

(b)       Rights evidenced by anyclass of registered securities of the Company have not been materially limitedor qualified by the issuance or modification of any other class of securitiesduring the three months ended March 31, 2002.

 

(c)        There were no unregisteredsecurities sold by the Company during the three months ended March 31, 2002.

 

**ITEM3. DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

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**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to a vote of securityholders during the three months ended March 31, 2002.

 

**ITEM 5. OTHER INFORMATION**

 

Not applicable.

 

**ITEM6. EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)    Exhibits

 None

 

(b)     Reportson Form 8-K

 No reports on Form 8-K were filed during thethree months ended March 31, 2002.

 

# **SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

**BITSTREAMINC.**

(Registrant)

 
| **SIGNATURE**        |   | **TITLE**                                                                                                      |   | **DATE**     |
|----------------------|--------|----------------------------------------------------------------------------------------------------------------|--------|--------------|
| /s/ Anna M.  Chagnon |   | President, Chief Operating Officer, Chief Financial  Officer and General Counsel (Principal Financial Officer) |   | May 13, 2002 |
| Anna M. Chagnon      |   |                                                                                                           |
|                 |   |                                                                                                           |   |         |
| /s/ James P.  Dore   |   | Corporate Controller (Principal Accounting Officer)                                                            |   | May 13, 2002 |
| James P. Dore        |   |                                                                                                           |   |         |

 

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