**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 SECURITIESEXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 30, 2001**

 

**or**

 

o    **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**For the transition 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****Cambridge,  Massachusetts**               |   | **02142**                             |
| (Address of principal  executive offices)                       |   | (Zip Code)                            |

 

**(617)497-6222**

(Registrant's telephonenumber, including area code)

 

**Not Applicable**

(Former name, formeraddress 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 November 9, 2001 there were 8,277,628 shares ofClass A Common Stock, par value $0.01 per share, and no shares of Class BCommon Stock, par value $0.01 per share, outstanding.

 

 

 

 

**BITSTREAM INC. AND SUBSIDIARIES**

 

**INDEX**

 

 
| **PART I. FINANCIAL  INFORMATION**                                                                      |   |
|---------------------------------------------------------------------------------------------------------|--------|
|                                                                                                    |   |
| ITEM 1. CONDENSED  CONSOLIDATED FINANCIAL STATEMENTS                                               |   |
|                                                                                                    |   |
| CONSOLIDATED BALANCE SHEETS  AS OF SEPTEMBER 30, 2001 AND DECEMBER 31, 2000                             |   |
|                                                                                                    |   |
| CONSOLIDATED  STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED  SEPTEMBER 30, 2001 AND 2000 |   |
|                                                                                                    |   |
| CONDENSED  CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED  SEPTEMBER 30, 2001 AND 2000 |   |
|                                                                                                    |   |
| NOTES  TO CONDENSED 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                                                                                              |   |

**PART 1,****ITEM 1.FINANCIAL STATEMENTS**

 

**BITSTREAM INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

**(In thousands)**

**(Unaudited)**
|                                                                                                                                          |   | **September 30,** |   | **December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|------------------|--------|
|                                                                                                                                          |   | ** 2001**    |   | **2000**         |   |
| **ASSETS**                                                                                                                                    |   |              |   |             |   |
| Current  assets:                                                                                                                              |   |              |   |             |   |
| Cash  and cash equivalents                                                                                                                    |   | $                 | 6,003  |             | $      | 7,149 |   |
| Accounts  receivable, net of allowance of $177 and $663 at September 30, 2001 and  December 31, 2000, respectively                            |   | 1,068             |   | 2,043            |   |
| Prepaid  expenses and other current assets                                                                                                    |   | 71                |   | 198              |   |
| Total  current assets                                                                                                                         |   | 7,142             |   | 9,390            |   |
|                                                                                                                                          |   |              |   |             |   |
| Property  and equipment, net                                                                                                                  |   | 536               |   | 636              |   |
|                                                                                                                                          |   |              |   |             |   |
| Other  assets:                                                                                                                                |   |              |   |             |   |
| Restricted  cash                                                                                                                              |   | 300               |   | 300              |   |
| Goodwill,  net of amortization of $1,501 and $1,149 at September 30, 2001 and December  31, 2000, respectively                                |   | 844               |   | 1,196            |   |
| Investment  in DiamondSoft, Inc.                                                                                                              |   | 480               |   | 449              |   |
| Other                                                                                                                                         |   | 243               |   | 136              |   |
| Total  other assets                                                                                                                           |   | 1,867             |   | 2,081            |   |
|                                                                                                                                          |   |              |   |             |   |
| Total  assets                                                                                                                                 |   | $                 | 9,545  |             | $      | 12,107 |   |
|                                                                                                                                          |   |              |   |             |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                |   |              |   |             |   |
| Current  liabilities:                                                                                                                         |   |              |   |             |   |
| Accounts  payable                                                                                                                             |   | $                 | 342    |             | $      | 261 |   |
| Accrued  expenses                                                                                                                             |   | 1,236             |   | 1,287            |   |
| Deferred  revenue                                                                                                                             |   | 663               |   | 471              |   |
|                                                                                                                                          |   |              |   |             |   |
| Total  current liabilities                                                                                                                    |   | 2,241             |   | 2,019            |   |
|                                                                                                                                          |   |              |   |             |   |
| Long-term  deferred revenue                                                                                                                   |   | 11                |   | 39               |   |
|                                                                                                                                          |   |              |   |             |   |
| Total  liabilities                                                                                                                            |   | 2,252             |   | 2,058            |   |
|                                                                                                                                          |   |              |   |             |   |
| Stockholders’  equity :                                                                                                                  |   |              |   |             |   |
| Common  stock, $.01 par value: Authorized - 30,500 shares. Issued: 8,265 and 7,903 at  September 30, 2001 and December 31, 2000, respectively |   | 83                |   | 79               |   |
| Additional  paid-in capital                                                                                                                   |   | 32,192            |   | 31,960           |   |
| Accumulated  deficit                                                                                                                          |   | (24,622           | )      | (21,630          | )      |
| Treasury  stock, at cost; 126 shares                                                                                                          |   | (360              | )      | (360             | )      |
| Total  stockholders’ equity                                                                                                              |   | 7,293             |   | 10,049           |   |
|                                                                                                                                          |   |              |   |             |   |
| Total  liabilities and stockholders’ equity                                                                                              |   | $                 | 9,545  |             | $      | 12,107 |   |

 

 

**Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.**

 

 

**BITSTREAMINC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)(Unaudited)**

 

** **
|                                                   |   | **For the Three  Months Ended  September 30,** |   | **For the Nine  Months Ended  September 30,** |   |
|--------------------------------------------------------|--------|----------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                                   |   | **2001**                                                 |   | **2000**                                                |   | **2001** |   | **2000** |   |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Revenues:                                              |   |                                                     |   |                                                    |   |   |   |   |   |
| Software  licenses                                     |   | $                                                        | 1,818  |                                                    | $      | 2,079 |   | $ | 4,787 |   | $ | 5,865 |   |
| Services                                               |   | 296                                                      |   | 163                                                     |   | 826 |   | 1,029 |   |
| Total  revenues                                        |   | 2,114                                                    |   | 2,242                                                   |   | 5,613 |   | 6,894 |   |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Cost  of revenues:                                     |   |                                                     |   |                                                    |   |   |   |   |   |
| Software  licenses                                     |   | 348                                                      |   | 197                                                     |   | 816 |   | 564 |   |
| Services                                               |   | 124                                                      |   | 67                                                      |   | 300 |   | 534 |   |
| Total  cost of revenues                                |   | 472                                                      |   | 264                                                     |   | 1116 |   | 1,098 |   |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Gross  profit                                          |   | 1,642                                                    |   | 1,978                                                   |   | 4,497 |   | 5,796 |   |
| Operating  expenses:                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Selling  and marketing                                 |   | 645                                                      |   | 878                                                     |   | 2,201 |   | 2,809 |   |
| Research  and development                              |   | 1,191                                                    |   | 1,126                                                   |   | 3,784 |   | 3,621 |   |
| General  and administrative                            |   | 511                                                      |   | 654                                                     |   | 1,344 |   | 1,791 |   |
| Total  operating expenses                              |   | 2,347                                                    |   | 2,658                                                   |   | 7,329 |   | 8,221 |   |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Loss  from operations                                  |   | (705                                                     | )      | (680                                                    | )      | (2,832 | ) | (2,425 | ) |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Other  income:                                         |   |                                                     |   |                                                    |   |   |   |   |   |
| (Loss)  income on investment in DiamondSoft, Inc.      |   | (68                                                      | )      | (10                                                     | )      | (219 | ) | 1 |   |
| Interest  income, net                                  |   | 47                                                       |   | 117                                                     |   | 198 |   | 355 |   |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Loss  before provision for income taxes                |   | (726                                                     | )      | (573                                                    | )      | (2,853 | ) | (2,069 | ) |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Provision  for income taxes                            |   | 59                                                       |   | 39                                                      |   | 139 |   | 171 |   |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Net  loss                                              |   | $                                                        | (785   | )                                                       | $      | (612 | ) | $ | (2,992 | ) | $ | (2,240 | ) |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Basic  and diluted net loss per share                  |   | $                                                        | (0.10  | )                                                       | $      | (0.08 | ) | $ | (0.37 | ) | $ | (0.29 | ) |
|                                                   |   |                                                     |   |                                                    |   |   |   |   |   |
| Basic  and diluted weighted average shares outstanding |   | 8,075                                                    |   | 7,811                                                   |   | 8,019 |   | 7,726 |   |

 

 

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

 

 

 

 

**BITSTREAMINC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(In thousands)(Unaudited)**

 
|                                                                         |   | **For the Nine Months ended September  30,** |   |
|------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                   |   | **2001**                                     |   | **2000** |   |
|                                                                         |   |                                         |   |   |   |
| Net  loss                                                                    |   | $                                            | (2,992 | ) | $ | (2,240 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |   |                                         |   |   |   |
| Depreciation                                                                 |   | 280                                          |   | 339 |   |
| Amortization                                                                 |   | 391                                          |   | 393 |   |
| Compensation on  grant of stock options                                      |   | 5                                            |   | 14 |   |
| Loss  (income) on investment in DiamondSoft, Inc.                            |   | 219                                          |   | (1 | ) |
| Changes  in assets and liabilities—                                     |   |                                         |   |   |   |
| Accounts  receivable                                                         |   | 975                                          |   | (455 | ) |
| Prepaid  expenses and other current assets                                   |   | 127                                          |   | 202 |   |
| Accounts  payable                                                            |   | 81                                           |   | (53 | ) |
| Accrued  expenses                                                            |   | (51                                          | )      | 135 |   |
| Deferred  revenue                                                            |   | 192                                          |   | 153 |   |
| Long-term  liabilities                                                       |   | (28                                          | )      | (1 | ) |
| Net  cash used in operating activities                                       |   | (801                                         | )      | (1,514 | ) |
|                                                                         |   |                                         |   |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                   |   |                                         |   |   |   |
| Purchases  of property and equipment                                         |   | (180                                         | )      | (218 | ) |
| Increase in  restricted cash                                                 |   | ---                                          |   | (300 | ) |
| Investment in  DiamondSoft                                                   |   | (250                                         | )      | --- |   |
| Change in other  assets                                                      |   | (146                                         | )      | 9 |   |
| Net  cash used in investing activities                                       |   | (576                                         | )      | (509 | ) |
|                                                                         |   |                                         |   |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                   |   |                                         |   |   |   |
|                                                                         |   |                                         |   |   |   |
| Proceeds  from the exercise of stock options/warrants                        |   | 231                                          |   | 463 |   |
|                                                                         |   |                                         |   |   |   |
| Net  decrease in cash and cash equivalents                                   |   | (1,146                                       | )      | (1,560 | ) |
| Cash  and cash equivalents, beginning of period                              |   | 7,149                                        |   | 9,037 |   |
|                                                                         |   |                                         |   |   |   |
| Cash  and cash equivalents, end of period                                    |   | $                                            | 6,003  |   | $ | 7,477 |   |
|                                                                         |   |                                         |   |   |   |
| Cash  paid for Interest                                                      |   | $                                            | ---    |   | $ | 1 |   |
| Cash  paid for Income Taxes                                                  |   | $                                            | 188    |   | $ | 139 |   |
|                                                                              |        |                                              |        |  |  |  |  |  |  |

 

 

 

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

 

**BITSTREAM INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS****SEPTEMBER 30, 2001(Unaudited)**

**(1) SignificantAccounting Policies**

 

**BASISOF PRESENTATION**

The consolidated financial statements of BitstreamInc. (the "Company" or “Bitstream”) presented herein, without audit,have been prepared pursuant to the rules of the Securities and ExchangeCommission (the “SEC”) for quarterly reports on Form 10-Q and do not includeall of the information and footnote disclosures required by generally acceptedaccounting principles. The balance sheet information at December 31, 2000 hasbeen derived from the Company's audited consolidated financial statements.These statements should be read in conjunction with the consolidated financialstatements and notes thereto for the period ended December 31, 2000 included inthe Company's Annual Report on Form 10-K, which was filed by the Company withthe SEC on April 2, 2001.

 

The balance sheet as of September 30, 2001, thestatements of operations for the three and nine months ended September 30, 2001and 2000, the statements of cash flows for the nine months ended September 30,2001 and 2000, and the notes to each thereof are unaudited, but in the opinionof management include all adjustments necessary for a fair presentation of theconsolidated financial position, results of operations, and cash flows of theCompany and its subsidiaries for these interim periods.

 

The results of operations for the three and ninemonths ended September 30, 2001 may not necessarily be indicative of theresults to be expected for the year ending December 31, 2001.

 

 

**PRINCIPLESOF CONSOLIDATION**

The accompanying consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiaries:Bitstream World Trade, Inc. (a Delaware corporation), a holding company forBitstream, B.V. (a Dutch corporation); Mainstream Software Solutions Ltd. (anEnglish corporation); Type Solutions, Inc. (a New Hampshire corporation);Archetype, Inc. (a Delaware corporation); Pageflex, Inc. (a Delawarecorporation) and MyFonts.com, Inc. (a Delaware corporation). All materialinter-company transactions and balances have been eliminated in consolidation.

 

 

**REVENUERECOGNITION**

The Company recognizes revenue in accordance withStatement of Position 97-2 (SOP 97-2), *Software Revenue Recognition*, as modifiedby SOP 98-9*,Modifications of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions.* The Company derives revenues from softwareproduct licenses, professional consulting, and support maintenance services.Licenses and royalty revenues are recognized when persuasive evidence of anagreement exists, the product has been delivered, the Company has no remainingsignificant obligations with regard to implementation, the fee is fixed ordeterminable, and collection of the fee is probable.

** **

 

Licensing fees and royalty revenues include: (1) paymentspaid by OEM and ISV customers for text imaging and page layout technologies;(2) direct and indirect sales of software publishing applications for thecreation, enhancement, management, transport, viewing and printing ofelectronic information; (3) direct sales of custom and other type products toend users such as graphic artists, desktop publishers and corporations; and (4)sales of type products to foreign customers primarily throughdistributors.  Certain OEM and ISVcustomers pay royalties only upon the sublicensing of the Company's products toend users. Royalties due from these OEM and ISV customers are recognized whensuch sublicenses are reported to the Company by the OEM or ISV customer.

 

Professionalservices include custom design and development and training.  The Company recognizes professional servicesrevenue under software development contracts as services are provided for perdiem contracts or by using the percentage-of-completion method of accountingfor long-term fixed price contracts. Provisions for any estimated losses on uncompleted contracts are made inthe period in which such losses become probable.  The Company recognizes revenue from support maintenanceagreements ratably over the term of the agreement.

 

Revenue from guaranteed minimum royalty licenses isrecognized upon delivery of the software since no further obligations of theCompany exist, while revenue on pay-as-you-go licenses is recognized in theperiod when sublicenses to end users are reported to the Company by the OEM orISV customer. In certain guaranteed minimum royalty licenses, the Company willenter into extended payment programs with creditworthy customers.  Revenue related to extended payment programsis recognized when payment becomes due to the Company.

 

Revenue from end user product sales is recognized upondelivery of the software, net of estimated returns and allowances, if there areno significant post delivery obligations and if collection is probable. Revenuefrom maintenance contracts is recognized pro rata over the term of themaintenance contract.  Revenue oncertain long-term development contracts is recognized using thepercent-of-completion method, as the services are performed.  Provisions for any estimated losses onuncompleted contracts are made in the period in which such losses becomeprobable.  Revenue related to theextended payment programs is recognized when payment becomes due to theCompany.

 

Deferred revenue includes unearned softwaremaintenance revenue, certain prepaid royalties and advance billings undersoftware development contracts.

 

Cost of revenues consists primarily of costsassociated with consulting and custom product development services.  Costs also include costs to distribute theproduct, including the cost of the media on which it is delivered.  Additional costs include fees paid to thirdparties for the development of unique typeface designs and costs associatedwith fulfilling such orders.

 

The Company generally warrants that its products willfunction substantially in accordance with documentation provided to customersfor approximately 90 days following initial delivery.  As of September 30, 2001, the Company had not incurred anysignificant expenses related to warranty claims.

 

**RECLASSIFICATIONS**

Certain prior year account balances have beenreclassified to be consistent with the current year’s presentation.

 

**RECENTLYISSUED ACCOUNTING STANDARDS**

In September 2000,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities*.  SFAS No. 140provides accounting and reporting standards for transfers and servicing offinancial assets and extinguishments of liabilities.  Under SFAS No. 140, after a transfer of financial assets, anentity recognizes the financial and servicing assets it controls and theliabilities it has incurred, derecognizes financial assets when control hasbeen surrendered, and derecognizes liabilities when extinguished.  SFAS No. 140 also provides standards fordistinguishing transfers of financial assets that are sales from transfers thatare secured borrowings.  SFAS No. 140 iseffective for certain transactions occurring after March 31, 2001 and certaindisclosures for the year ending December 31, 2001.  The Company has adopted SFAS No. 140, which did not have amaterial impact on the Company’s financial position or results of operations.

 

In June 1998, the FASB issued SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities. *This statement establishes accounting and reportingstandards for derivative instruments, including certain derivative instrumentsembedded in other contracts, and for hedging activities.  It requires that an entity recognize allderivatives as either assets or liabilities in the statement of financialposition and measure those instruments at fair value.  This statement, as amended by SFAS No. 137 and SFAS No. 138, iseffective for fiscal years ending December 31, 2001 and thereafter.  The Company has adopted SFAS No. 133 asamended, which did not have a material impact on the Company’s financialposition or results of operations.

 

On June 29, 2001, the FASB issued SFAS No. 141, *BusinessCombinations,* and SFAS No. 142, *Goodwill and Other Intangible Assets*.These statements establish new standards for accounting for businesscombinations, goodwill, and intangible assets. Statement 141 eliminates the pooling-of-interests method of accountingfor business combinations except for qualifying business combinations that wereinitiated prior to July 1, 2001 and changes the criteria to recognizeintangible assets apart from goodwill. The requirements of Statement 141 are effective for any businesscombination accounted for by the purchase method that is completed after June 30,2001.  Statement 142 supersedes APBOpinion No. 17, *Intangible Assets* (which required that goodwill andintangible assets be amortized over a life not to exceed 40 years), and carriesforward its provisions related to internally developed intangible assetswithout the FASB’s reconsideration. Under Statement 142, goodwill and indefinite-lived intangible assets areno longer amortized but are reviewed annually for impairment, or morefrequently if impairment indicators arise. Goodwill is required to be tested for impairment between the annualtests if an event occurs or circumstances change that more-likely-than-notreduce the fair value of a reporting unit below its carrying value.  An indefinite-lived intangible asset isrequired to be tested for impairment between the annual tests if an eventoccurs or circumstances change indicating that the asset might beimpaired.  Separable intangible assetsthat have finite lives will continue to be amortized over their useful lives,for which Statement 142 does not impose a limit.  Any required goodwill impairment charges would be presented as aseparate line item within the operating section of the income statement.  The Company has adopted Statement 141, whichdid not have a material impact on the Company’s financial position or resultsof operations.  The Company is requiredto adopt Statement 142 on January 1, 2002 and is currently evaluating theimpact on the Company’s financial position and results of operations.

 

In August 2001, the FASB issued SFAS no. 144,"Accounting for the Impairment or Disposal of Long-Lived Assets".This statement supersedes SFAS 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed Of” and APB no. 30,“Reporting the Results of Operations – Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently OccurringEvents and Transactions”. This statement provides guidance on recognizing andmeasuring impairment for long-lived assets excluding certain long-lived assets,such as goodwill, non-amortized intangible assets and deferred tax assets. Thisstatement is effective for the Company in the first quarter of its fiscal yearending December 2002. Management is currently evaluating the impact that this statementwill have on the Company's financial statements.

 

 

**(2) Property and Equipment (in thousands)**

 

Property and equipmentare stated at cost, less accumulated depreciation and amortization. Propertyand equipment consists of the following:
|                                                   |   | **September 30,** |   | **December 31,** |   |
|--------------------------------------------------------|--------|-------------------|--------|------------------|--------|
|                                                   |   | **2001**          |   | **2000**         |   |
|                                                   |   |              |   |             |   |
| Office and  computer equipment                         |   | 2,408             |   | $                | 2,069  |   |
| Purchased  software                                    |   | 348               |   | 347              |   |
| Equipment under  capital lease                         |   | ---               |   | 167              |   |
| Furniture and  fixtures                                |   | 372               |   | 366              |   |
| Leasehold  improvements                                |   | 659               |   | 659              |   |
|                                                   |   | 3,787             |   | 3,608            |   |
|                                                   |   |              |   |             |   |
| Less —  Accumulated depreciation and amortization |   | 3,251             |   | 2,972            |   |
| Property and  equipment, net                           |   | 536               |   | $                | 636    |   |

 

 

**(3) Concentration of Credit Risk**

 

SFAS No. 105. *Disclosure of Information About Financial Instrumentswith Off-Balance Sheet Risk and Financial Instruments with Concentration ofCredit Risk*, requires disclosure of any significant off-balancesheet and credit risk concentrations. Financial instruments that potentially expose the Company toconcentrations of credit risk consist primarily of cash and cash equivalentsand trade accounts receivable.  TheCompany places a majority of its cash investments in one financialinstitution.  The Company has not experiencedsignificant losses related to receivables from any individual customers orgroups of customers 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 September 30, 2001,one customer accounted for 30% each of the Company’s accounts receivable.  At December 31, 2000, one customer accountedfor 18% of the Company’s accounts receivable. The Company does not have any financial instruments with off-balance sheetrisk as of September 30, 2001.  For thethree months ended September 30, 2001 two customers accounted for 18% and 8%,respectively, of the Company’s revenue. For the nine months ended September 30,2001, no customers accounted for more than 10% of the Company’s revenue.  For the three months ended September 30,2000, one customer accounted for 11% of the Company’s revenue. For the ninemonths ended September 30, 2000, one customer accounted for 12% of the Company’srevenue.

 

For the three monthsended September 30, 2001, two customers of the Company’s type and technologysegment accounted for 24% and 10%, respectively, of that segment’s revenue, andone customer of the Pageflex segment accounted for 13% of that segment’srevenue.  For the nine months endedSeptember 30, 2001, one customer of the Company’s type and technology segmentaccounted for 10% of that segment’s revenue, and no customers of the Pageflexsegment accounted for 10% or more of that segment’s revenue.   For the three months ended September 30,2000, one customer of the Company’s type and technology segment accounted for16% of the revenue for that segment, and three customers of the Pageflexsegment accounted for 32%, 15% and 14%, respectively, of that segment’srevenue.   For the nine months endedSeptember 30, 2000, no customers of the Company’s type and technology segmentaccounted for 10% or more of the revenue for that segment, while two customersof the Pageflex segment accounted for 42% and 16%, respectively, of thatsegment’s revenue.

 

The Company’s MyFonts.comsegment had no customers responsible for 10% or more of its accounts receivablebalance as of September 30, 2001 or December 31, 2000, and had no customersthat accounted for 10% or more of its revenue for the three or nine monthsended September 30, 2001 or 2000.

### ** **

 

### **(4) Accrued Expenses (in thousands)**

 

Accrued expenses consist of the following:

 
|                                          |   | **September 30,** |   | **December 31,** |   |
|-----------------------------------------------|--------|-------------------|--------|------------------|--------|
|                                          |   | **2001**          |   | **2000**         |   |
| Accrued  royalties                            |   | $                 | 271    |             | $      | 210 |   |
| Payroll  and other compensation               |   | 595               |   | 648              |   |
| Accrued  professional and consulting services |   | 98                |   | 169              |   |
| Other                                         |   | 272               |   | 260              |   |
| Total                                         |   | $                 | 1,236  |             | $      | 1,287 |   |

 

 

**(5)   Loss Per Share (in thousands)**

 

In accordance with SFASNo. 128, *EarningsPer Share*, basic loss per share was determined by dividing net lossby the weighted average shares of common stock outstanding during theapplicable period. Diluted loss per share reflects dilution from potentiallydilutive securities, primarily stock options based on the treasury stockmethod.  In computing diluted loss pershare, common stock equivalents are not considered in periods in which a netloss is reported, as the inclusion of the potential common stock equivalentswould be antidilutive.  Thus potentialcommon shares were not included for the three or nine months ended September30, 2001 or 2000.  Had the numeratorbeen a profit, the potential common shares would have increased the weightedaverage shares outstanding by 1,262 and 1,543 shares for the nine months endedSeptember 30, 2001 and 2000, respectively, and by 993 and 2,003 for the ninemonths ended September 30, 2001 and 2000, respectively.  In addition, there were warrants and optionsto purchase 262 and 235 shares for the three months ended September 30, 2001and 2000, respectively, and 278 and 116 shares for the nine months endedSeptember 30, 2001 and 2000, respectively, that were not included in thepotential common share computations because their exercise prices were greaterthan the market price of the Company’s common stock.  These common stock equivalents are antidilutive even when aprofit is reported in the numerator.

 

 

**(6) SegmentReporting (in thousands)**

 

The Company has three reportable business segments:(1) its type and technology segment, (2) its Pageflex segment, and (3) itsMyFonts.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. MyFonts.com’s revenues include revenue generated from the sale ofproducts it purchases from the type and technology segment.  The inter-segment revenues created by thesetransactions have been eliminated from MyFonts.com’s 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.

** **
|                                        |   | **Three  months ended** |   | **Nine  months ended** |   |
|---------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                        |   | **September 30,**       |   | **September 30,**      |   |
| **Revenue (from external customers):**      |   | **2001**                |   | **2000**               |   | **2001** |   | **2000** |   |
|                                        |   |                    |   |                   |   |   |   |   |   |
| Type and  technology                        |   | $                       | 1,414  |                   | $      | 1,610 |   | $ | 3,767 |   | $ | 4,869 |   |
| MyFonts.com                                 |   | 144                     |   | 7                      |   | 337 |   | 9 |   |
| Pageflex                                    |   | 556                     |   | 625                    |   | 1,509 |   | 2,016 |   |
| Consolidated  revenue                       |   | $                       | 2,114  |                   | $      | 2,242 |   | $ | 5,613 |   | $ | 6,894 |   |
|                                        |   |                    |   |                   |   |   |   |   |   |
| **Segment (loss) income from  operations:** |   |                    |   |                   |   |   |   |   |   |
| Type and  technology                        |   | $                       | 248    |                   | $      | 339 |   | $ | 64 |   | $ | 822 |   |
| MyFonts.com                                 |   | (263                    | )      | (97                    | )      | (584 | ) | (310 | ) |
| Pageflex                                    |   | (690                    | )      | (922                   | )      | (2,312 | ) | (2,937 | ) |
| Consolidated  loss from operations          |   | $                       | (705   | )                      | $      | (680 | ) | $ | (2,832 | ) | $ | (2,425 | ) |

 

 

**(7) Geographical Reporting (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 and nine months ended September 30, 2001and 2000 were shipped from its headquarters located in the United States or itsoffice located in Cheltenham, England. Revenues by geographic area are as follows:

 
|                                                     |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|----------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| Revenue:                                                 |   | **2001**                              |   | **2000**                             |   | **2001** |   | **2000** |   |
| United States                                            |   | $                                     | 1,078  |                                 | $      | 1,381 |   | $ | 2,914 |   | $ | 4,436 |   |
| Canada                                                   |   | 94                                    |   | 82                                   |   | 296 |   | 269 |   |
| Japan                                                    |   | 221                                   |   | 343                                  |   | 796 |   | 868 |   |
| Korea                                                    |   | 374                                   |   | ---                                  |   | 432 |   | --- |   |
| United  Kingdom                                          |   | 142                                   |   | 217                                  |   | 425 |   | 454 |   |
|                                                     |   |                                  |   |                                 |   |   |   |   |   |
| Other  (countries less than 5% individually, by region): |   |                                  |   |                                 |   |   |   |   |   |
| Europe,  excluding UK                                    |   | 195                                   |   | 185                                  |   | 701 |   | 717 |   |
| Asia,  excluding those specified above                   |   | 10                                    |   | 34                                   |   | 49 |   | 150 |   |
| Total  revenue                                           |   | $                                     | 2,114  |                                 | $      | 2,242 |   | $ | 5,613 |   | $ | 6,894 |   |
|                                                     |   |                                  |   |                                 |   |   |   |   |   |

 

 

 

Long-lived tangible assets by geographic area are asfollows:
|          |   | **September 30,** |   | **December 31,** |   |
|---------------|--------|-------------------|--------|------------------|--------|
|          |   | **2001**          |   | **2000**         |   |
| United States |   | $                 | 520    |             | $      | 628 |   |
| England       |   | 16                |   | 8                |   |
| Total         |   | $                 | 536    |             | $      | 636 |   |

 

 

 

 

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

 

Thefollowing discussion should be read in conjunction with the consolidatedfinancial statements and notes thereto.

 

**OVERVIEW**

 

        BitstreamInc. (“Bitstream” or the “Company”), headquartered in Cambridge, Massachusetts,is composed of three separate and distinct businesses: (1) type and technology,in which Bitstream develops and licenses font technology and custom fontdesigns to manufacturers of Internet appliances, wireless devices, set-topboxes, embedded systems, printers, and personal digital assistants; (2)MyFonts.com, a showcase of the world’s fonts in one easy-to-use e-commerce website operated by Bitstream’s wholly-owned subsidiary, MyFonts.com, Inc.(“MyFonts.com”); and (3) Pageflex, formerly referred to as the Company’son-demand marketing segment, 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.

 

**FORWARD LOOKING STATEMENTS**

 

        Except for the historical information contained herein, thisQuarterly Report on Form 10-Q may contain forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended. Investors are cautionedthat forward-looking statements are inherently uncertain. Actual performanceand results of operations may differ materially from those projected orsuggested in the forward-looking statements due to certain risks anduncertainties, including, without limitation, market acceptance of theCompany's products, competition and the timely introduction of new products.Additional information concerning certain risks and uncertainties that wouldcause actual results to differ materially from those projected or suggested inthe forward-looking statements is contained in the Company's filings with theSecurities and Exchange Commission, including those risks and uncertaintiesdiscussed in the Company's final Prospectus, dated October 30, 1996, includedas part of the Company's Registration Statement on Form S-1 (333-11519), in thesection entitled "Risk Factors", and in the Company’s 2000 AnnualReport on Form 10-K filed on April 2, 2001. The forward-looking statements contained herein represent the Company'sjudgment as of the date of this report, and the Company cautions readers not toplace undue reliance on such statements. Management undertakes no obligation to publicly release any revisions tothe forward-looking statements or reflect events or circumstances after thedate of this document.

 

 

 

 

**RESULTS OF OPERATIONS****(in thousands, except percent amounts)**

 

**ConsolidatedRevenues:**
|                 |   | **September 30,** |   |        |   |     |   |
|----------------------|--------|-------------------|--------|-------------|--------|----------|--------|
|                 |   |              |   | **% of**    |   |     |   | **% of** |   | **Change** |   |
|                 |   | **2001**          |   | **Revenue** |   | **2000** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
| Three months  ended: |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Software  licenses   |   | $                 | 1,818  |        | 86.0   | %        | $      | 2,079 |   | 92.7 | % | $ | (261 | ) | (12.6 | )% |
| Services             |   | 296               |   | 14.0        | %      | 163      |   | 7.3 | % | 133 |   | 81.6 | % |
| Total revenues       |   | $                 | 2,114  |        | 100.0  | %        | $      | 2,242 |   | 100.0 | % | $ | (128 | ) | (5.7 | )% |
|                 |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Nine months  ended:  |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Software  licenses   |   | $                 | 4,787  |        | 85.3   | %        | $      | 5,865 |   | 85.1 | % | $ | (1,078 | ) | (18.4 | )% |
| Services             |   | 826               |   | 14.7        | %      | 1,029    |   | 14.9 | % | (203 | ) | (19.7 | )% |
| Total revenues       |   | $                 | 5,613  |        | 100.0  | %        | $      | 6,894 |   | 100.0 | % | $ | (1,281 | ) | (18.6 | )% |

** **

**Thedecrease in revenue for the three months ended September 30, 2001 as comparedto the three months ended September 30, 2000 was attributable to decreases inrevenue for the type and technology segment of $196 and the Pageflex segment of$69, partially offset by an increase in MyFonts.com revenues of $137.  The decrease in revenue for the nine monthsended September 30, 2001 as compared to the nine months ended September 30,2000 was attributable to decreases in revenue for the type and technology segmentof $1,102 and the Pageflex segment of $507, partially offset by an increase inMyFonts.com revenues of $328.  Thesesegments are discussed in more detail below.**

** **

**Typeand Technology Revenues:**
|                          |   | **September 30,** |   |        |   |     |   |
|-------------------------------|--------|-------------------|--------|-------------|--------|----------|--------|
|                          |   |              |   | **% of**    |   |     |   | **% of** |   | **Change** |   |
|                          |   | **2001**          |   | **Revenue** |   | **2000** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
|                          |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Three months  ended:          |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Software  licenses            |   | $                 | 1,308  |        | 92.5   | %        | $      | 1,547 |   | 96.1 | % | $ | (239 | ) | (15.5 | )% |
| Services                      |   | 106               |   | 7.5         | %      | 63       |   | 3.9 | % | 43 |   | 68.3 | % |
| Type and  technology revenues |   | $                 | 1,414  |        | 100.0  | %        | $      | 1,610 |   | 100.0 | % | $ | (196 | ) | (12.2 | )% |
| Percentage of  total revenues |   | 66.9              | %      |        |   | 71.8     | %      |   |   |   |   |   |   |
|                          |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Nine months  ended:           |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Software  licenses            |   | $                 | 3,410  |        | 90.5   | %        | $      | 4,595 |   | 94.4 | % | $ | (1,185 | ) | (25.8 | )% |
| Services                      |   | 357               |   | 9.5         | %      | 274      |   | 5.6 | % | 83 |   | 30.3 | % |
| Type and  technology revenues |   | $                 | 3,767  |        | 100.0  | %        | $      | 4,869 |   | 100.0 | % | $ | (1,102 | ) | (22.6 | )% |
| Percentage of  total revenues |   | 67.1              | %      |        |   | 70.6     | %      |   |   |   |   |   |   |
|                          |   |              |   |        |   |     |   |   |   |   |   |   |   |

** **

**The decrease in type and technologylicense revenues for the three months and nine months ended September 30, 2001versus the three and nine months ended September 30, 2000 was due to decreasesin OEM technology licensing of $85 and $791, respectively, decreases inreseller sales of $99 and $111, respectively, and decreases in retail sales of$55 and $283, respectively.  Thesedecreases were primarily due to the softening of the market for high technologyproducts in general and increased concern over future economic conditions.  Service revenue increased $43 and $83,respectively, for the three and nine month periods ended September 30, 2001primarily because of the increased maintenance base resulting from the sale oftype and technology software products.**

 

**MyFonts.comRevenues:**
|                          |   | **September 30,** |   |
|-------------------------------|--------|-------------------|--------|
|                          |   |              |   |   |   | **Change** |   |
|                          |   | **2001**          |   | **2000** |   | **Dollars** |   | **Percent** |   |
|                          |   |              |   |   |   |   |   |   |   |
| Three months  ended:          |   |              |   |   |   |   |   |   |   |
| Software  licenses            |   | $                 | 144    |   | $ | 7 |   | $ | 137 |   | 1,957 | % |
| Percentage of  total revenues |   | 6.8               | %      | 0.3 | % |   |   |   |   |
|                          |   |              |   |   |   |   |   |   |   |
| Nine months  ended:           |   |              |   |   |   |   |   |   |   |
| Software  licenses            |   | $                 | 337    |   | $ | 9 |   | $ | 328 |   | 3,644 | % |
| Percentage of  total revenues |   | 6.0               | %      | 0.1 | % |   |   |   |   |
|                          |   |              |   |   |   |   |   |   |   |

** **

**        MyFonts.com’srevenue, prior to the elimination of inter-company royalties paid toBitstream’s type and technology segment, increased by $174 to $198 for thethree months ended September 30, 2001 as compared to $24 for the three monthsended September 30, 2000, and by $437 to $469 for the nine months endedSeptember 30, 2001 as compared to $32 for the nine months ended September 30,2000.  MyFonts.com began selling throughits web site at the end of the first quarter of 2000.  Revenue from the MyFonts.com web site and revenue that it earnsfrom managing the e-commerce portion of Bitstream’s web site have increasedeach quarter since its inception.**

** **

**PageflexRevenues:**
|                          |   | **September 30,** |   |        |   |     |   |
|-------------------------------|--------|-------------------|--------|-------------|--------|----------|--------|
|                          |   |              |   | **% of**    |   |     |   | **% of** |   | **Change** |   |
|                          |   | **2001**          |   | **Revenue** |   | **2000** |   | **Revenue** |   | **Dollars** |   | **Percent** |   |
|                          |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Three months  ended:          |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Software  licenses            |   | $                 | 366    |        | 65.8   | %        | $      | 525 |   | 84.0 | % | $ | (159 | ) | (30.3 | )% |
| Services                      |   | 190               |   | 34.2        | %      | 100      |   | 16.0 | % | 90 |   | 90.0 | % |
| Pageflex  revenues            |   | $                 | 556    |        | 100.0  | %        | $      | 625 |   | 100.0 | % | $ | (69 | ) | (11.0 | )% |
| Percentage of  total revenues |   | 26.3              | %      |        |   | 27.9     | %      |   |   |   |   |   |   |
|                          |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Nine months  ended:           |   |              |   |        |   |     |   |   |   |   |   |   |   |
| Software  licenses            |   | $                 | 1,040  |        | 68.9   | %        | $      | 1,261 |   | 62.6 | % | $ | (221 | ) | (17.5 | )% |
| Services                      |   | 469               |   | 31.1        | %      | 755      |   | 37.4 | % | (286 | ) | (37.9 | )% |
| Pageflex  revenues            |   | $                 | 1,509  |        | 100.0  | %        | $      | 2,016 |   | 100.0 | % | $ | (507 | ) | (25.2 | )% |
| Percentage of  total revenues |   | 26.9              | %      |        |   | 29.3     | %      |   |   |   |   |   |   |

 

**        Thedecrease in license revenue for the Pageflex segment for the three and ninemonths ended September 30, 2001 as compared to the three and nine months endedSeptember 30, 2000 was attributable to the decrease in non-recurring OEMlicensing fees from an existing long-term contract with Atex Media Solutions, Inc.(“Atex”) of $168 and $504, respectively. Pageflex license revenues increased $9 and $283, respectively, for thethree months and nine months ended September 30, 2001 as compared to the threemonths and nine months ended September 30, 2000, excluding the Atex licensefees, primarily due to increases in direct sales and subscriptions of theCompany’s Mpower product.  The increasein service revenue during the three months ended September 30, 2001 as comparedto the three months ended September 30, 2000 is attributable to the increase inPageflex’s customer support revenue base which consists of customers who havecontracted for support maintenance. Revenues from services decreased during the nine months ended September**30, 2001 as compared to the nine months endedSeptember 30, 2000 as a result of the completion of certain non-recurringconsulting projects during the first six months of 2000, which primarilyconsisted of non-recurring engineering for Atex.

** **

 

**ConsolidatedGross Profit:**
|                         |   |               |   |       |   |        |   |        |   |
|------------------------------|--------|--------------------|--------|------------|--------|-------------|--------|-------------|--------|
|                         |   | **September  30,** |   | **Change** |   |
|                         |   | **2001**           |   | **2000**   |   | **Dollars** |   | **Percent** |   |
| Three  months ended:         |   |               |   |       |   |        |   |        |   |
| Gross  profit                |   | $                  | 1,642  |       | $      | 1,978       |   | $           | (336   | ) | (17.0 | )% |
| Percentage  of total revenue |   | 77.7               | %      | 88.2       | %      |        |   |        |   |
|                         |   |               |   |       |   |        |   |        |   |
| Nine  months ended:          |   |               |   |       |   |        |   |        |   |
| Gross  profit                |   | $                  | 4,497  |       | $      | 5,796       |   | $           | (1,299 | ) | (22.4 | )% |
| Percentage  of total revenue |   | 80.1               | %      | 84.1       | %      |        |   |        |   |

 

The decrease in the gross profit for the three months and nine monthsended September 30, 2001 as compared to the three months and nine months endedSeptember 30, 2000 is primarily attributable to decreases in revenues discussedabove totaling $128 and $1,281, respectively, and an increase in cost ofrevenues totaling $208 and $18, respectively. Type and technology’s cost of revenues increased $62 to $256 for thethree months ended September 30, 2001 from $194 for the three months endedSeptember 30, 2000 primarily because of several large license agreementsinvolving larger than normal third party royalties. The type and technologycost of revenues decreased $85 to $602 for the nine months ended September 30,2001 from $687 for the nine months ended September 30, 2000 primarily becauseof the elimination of outside subcontractors whose services were utilizedduring 2000 and a reduction in time spent by type engineers on customerspecific projects, partially offset by the increase in royalties during thethree months ended September 30, 2001. Pageflex’s cost of revenues increased $35 to $102 for the three monthsended September 30, 2001 from $67 for the three months ended September 30, 2000primarily because of increased support costs and the use of an outsideconsultant for consulting services. Pageflex’s cost of revenues decreased $156 to $251 for the nine monthsended September 30, 2001 from $407 for the nine months ended September 30, 2000as a result of a decreased amount of consulting performed by the Company, whichhas a higher cost than licensing revenue. Cost of revenues for the nine monthsended September 30, 2000 included $67 of non-recurring development costs associatedwith Atex consulting revenue occurring in the first six months of 2000,partially offset by the increases mentioned above for the three months endedSeptember 30, 2001.  MyFonts.com’s costof revenues consist of royalties paid to third party font foundries for thesale of their fonts.  These costsincreased $111 and $259 for the three and nine months ended September 30, 2001as compared to the three and nine months ended September 30, 2000 as a resultof the increased volume of sales on the MyFonts.com web site.

 

Cost of revenue is composed of direct costs oflicenses, as well as direct costs of product sales to end-users. Included inthe cost of licenses are fees paid to third parties for the development orlicense of rights to technology and/or unique typeface designs and costsincurred in the fulfillment of custom orders from OEM and ISV customers.  Included in cost of product sales to endusers and distributors are the direct costs associated with the duplication,packaging and shipping of product.

 

 

**ConsolidatedSelling and Marketing:**
|                         |   |               |   |       |   |        |   |        |   |
|------------------------------|--------|--------------------|--------|------------|--------|-------------|--------|-------------|--------|
|                         |   | **September  30,** |   | **Change** |   |
|                         |   | **2001**           |   | **2000**   |   | **Dollars** |   | **Percent** |   |
| **Three  months ended:**     |   |               |   |       |   |        |   |        |   |
| Selling  and marketing       |   | $                  | 645    |       | $      | 878         |   | $           | (233   | ) | (26.5 | )% |
| Percentage  of total revenue |   | 30.5               | %      | 39.2       | %      |        |   |        |   |
|                         |   |               |   |       |   |        |   |        |   |
| **Nine  months ended:**      |   |               |   |       |   |        |   |        |   |
| Selling  and marketing       |   | $                  | 2,201  |       | $      | 2,809       |   | $           | (608   | ) | (21.6 | )% |
| Percentage  of total revenue |   | 39.2               | %      | 40.8       | %      |        |   |        |   |

 

**       **Selling and marketingexpenses for the type and technology segment decreased $60 or 15.3% and $85 or7.1% to $333 and $1,111 for the three and nine months ended September 30, 2001,respectively, from $393 and $1,196 for the three and nine months endedSeptember 30, 2000, respectively. Selling and marketing costs associated with the Pageflex segmentdecreased $211 or 44.0% and $570 or 35.6% to $269 and $1,032 for the three andnine months ended September 30, 2001, respectively, from $480 and $1,602 forthe three and nine months ended September 30, 2000, respectively.  These reductions resulted from management’sdecision to reduce marketing expenses including the Company’s trade showexpenses and from non-recurring costs related to new product introductions andbranding which took place on a limited basis during the first two quarters of2000.  Selling and marketing expensesfor the MyFonts.com segment increased $38 or 760% and $47 or 427% to $43 and$58 for the three and nine months ended September 30, 2001, respectively, from$5 and $11 for the three and nine months ended September 30, 2000, respectively.  These increases were primarily due toadvertising costs, which the Company did not incur in 2000.

 

**ConsolidatedResearch and Development (“R&D”)**:
|                         |   | **September,  30** |   | **Change** |   |
|------------------------------|--------|--------------------|--------|------------|--------|
|                         |   | **2001**           |   | **2000**   |   | **Dollars** |   | **Percent** |   |
| Three  months ended:         |   |               |   |       |   |   |   |   |   |
| Research  and development    |   | $                  | 1,191  |       | $      | 1,126 |   | $ | 65 |   | 5.8 | % |
| Percentage  of total revenue |   | 56.3               | %      | 50.2       | %      |   |   |   |   |
|                         |   |               |   |       |   |   |   |   |   |
| Nine  months ended:          |   |               |   |       |   |   |   |   |   |
| Research  and development    |   | $                  | 3,784  |       | $      | 3,621 |   | $ | 163 |   | 4.5 | % |
| Percentage  of total revenue |   | 67.4               | %      | 52.5       | %      |   |   |   |   |

 

        R&Dcosts associated with the type and technology segment decreased $15 or 3.8% andincreased $11 or less than one percent from $396 and $1,299 for the threemonths and nine months ended September 30, 2000, respectively, to $381 and$1,310 for the three months and nine months ended September 30, 2001,respectively. R&D costs associated with the Myfonts.com segment increased$154 or 186% and $272 or 96.8% from $83 and $281 for the three and nine monthsended September 30, 2000, respectively, to $237 and $553 for the three and ninemonths ended September 30, 2001, respectively. The increased MyFonts.com expenses relate to employee and subcontractorcosts for further development to the MyFonts.com web site.  The Company’s management expects thisexpense to decrease in future quarters as the site becomes more mature.

 

 

 

R&D costs associated with the Pageflex segmentdecreased $74 or 11.4% and $120 or 5.9%, from $647 and $2,041 for the threemonths and nine months ended September 30, 2000, respectively, to $573 and$1,921 for the three months and nine months ended September 30, 2001,respectively.  The Pageflex decrease wasdue to the decrease in use of sub-contractors primarily engaged in the qualityanalysis and testing of the Japanese version of Mpower released in 2000.

 

 

**ConsolidatedGeneral and Administrative (“G&A”)**

 
|                         |   |               |   |       |   |        |   |        |   |
|------------------------------|--------|--------------------|--------|------------|--------|-------------|--------|-------------|--------|
|                         |   | **September  30,** |   | **Change** |   |
|                         |   | **2001**           |   | **2000**   |   | **Dollars** |   | **Percent** |   |
| Three  months ended:         |   |               |   |       |   |        |   |        |   |
| General  and administrative  |   | $                  | 511    |       | $      | 654         |   | $           | (143   | ) | (21.9 | )% |
| Percentage  of total revenue |   | 24.2               | %      | 29.2       | %      |        |   |        |   |
|                         |   |               |   |       |   |        |   |        |   |
| Nine  months ended:          |   |               |   |       |   |        |   |        |   |
| General  and administrative  |   | $                  | 1,344  |       | $      | 1,791       |   | $           | (447   | ) | (25.0 | )% |
| Percentage  of total revenue |   | 23.9               | %      | 26.0       | %      |        |   |        |   |
|                         |   |               |   |       |   |        |   |        |   |

 

G&A costs associated with the type and technologysegment decreased $92 or 31.9% and $185 or 21.4%, from $288 and $865 for thethree months and nine months ended September 30, 2000, respectively, to $196and $680 for the three months and nine months ended September 30, 2001,respectively. Bad debt expense decreased $84 and $372 for the three months andnine months ended September 30, 2001, respectively, as compared to the threemonths and nine months ended September 30, 2000.  Bad debt expense decreases resulted from the net decrease inreserves for doubtful accounts during the first six months of 2001 resultingfrom the collection of several accounts receivable balances which had beenreserved for during the year ended December 31, 2000.  G&A expenses, excluding bad debt activity, decreased $8 forthe three months ended September 30, 2001 as compared to the three months endedSeptember 30, 2000, but increased $185 for the nine months ended September 30,2001 as compared to the nine months ended September 30, 2000.  The increase is primarily attributable toincreases in professional service fees of $56 and facilities related costs of$83, for the nine months ended September 30, 2001 as compared to the ninemonths ended September 30, 2000. G&A costs associated with the Pageflex segment decreased $51 or 14.5%and $286 or 31.7% from $353 and $903 for the three months and nine months endedSeptember 30, 2000, respectively, to $302 and $617 for the three months andnine months ended September 30, 2001, respectively.  Bad debt expense increased $1 for the three months endedSeptember 30, 2001 as compared to the three months ended September 30, 2000,but decreased $251 for the nine months ended September 30, 2001 as compared tothe nine months ended September 30, 2000. G&A expenses, excluding bad debt activity, decreased $51 and $33 forthe three months and nine months ended September 30, 2001 as compared to thethree months and nine months ended September 30, 2000, respectively.  G&A costs associated with the MyFonts.comsegment were unchanged at $13 for the three months ended September 30, 2001 and2000, but increased $24 from $23 for the nine months ended September 30, 2000to $47 for the nine months ended September 30, 2001.

 

 

        Asignificant portion of the Company’s operating expenses are fixed, and planned expendituresin any given quarter are based on sales and revenue forecasts.  Accordingly, if products are not completedand/or shipped on schedule and revenues do not meet the Company’s expectationsin any given quarter, the Company’s operating results and financial conditioncould be adversely affected.

 

 

**(Loss)Income on Investment in DiamondSoft, Inc.:**

 

**       **The Company made a$500 equity investment in DiamondSoft, Inc. in March of 1998 and madeadditional investments totaling $150 during the three months ended March 31,2001 and $100 during the three months ended June 30, 2001.  As of September 30, 2001 the Company’sownership percentage in DiamondSoft, Inc. is 28%.  DiamondSoft, Inc. is a California corporation primarily engagedin the business of developing, marketing and distributing software tools to avariety of professional markets.  TheCompany recognizes its share of DiamondSoft’s income or loss during eachquarter and recorded losses of $68 and $10 for the three months ended September30, 2001 and 2000, respectively, and a loss of $(219) and income of $1 for thenine months ended September 30, 2001 and 2000, respectively.

 

**Interestincome, net:**

 

Interest income consists primarily of interest income earned on theCompany’s cash equivalents.

 

**Provisionfor income taxes:**

 

The Company’s income tax expense for the three andnine months ended September 30, 2001 and 2000 primarily represents foreignincome taxes.

 

 

**LIQUIDITY AND CAPITAL RESOURCES****(inthousands)**

 

        The Company has funded itsoperations primarily through the public sale of equity securities, cash flowsfrom operations and cash received from the sale of the Company’s MediaBank andInterSep OPI product lines to Inso Providence Corporation in August of1998.  As of September 30, 2001, theCompany had net working capital of $4,901 versus $7,371 at December 31, 2000.

 

        The Company used $801 of its cash to support its operatingactivities during the nine months ended September 30, 2001 as compared to$1,514 during the nine months ended September 30, 2000.  The net cash used during the nine monthsended September 30, 2001 was primarily due to the consolidated loss partiallyoffset by the collection of $975 in receivables during the period.  The net cash used during the nine monthsended September 30, 2000 was primarily due to the net losses from the Pageflexand MyFonts.com businesses, partially offset by the income from the type andtechnology business. The net lossadjusted for non-cash expenses resulted in a use of $2,097 and $1,495 in cashduring the nine months ended September 30, 2001 and 2000, respectively.

 

 

 

        The Company used $576 of its cash for investing activitiesduring the nine months ended September 30, 2001 as compared to $509 during thenine months ended September 30, 2000. The Company used $180 and $218 of its cash to purchase property andequipment during the nine months ended September 30, 2001 and 2000,respectively.  During the nine monthsended September 30, 2001, the Company made additional investments inDiamondSoft, Inc. totaling $250. For the nine months ended September 30, 2000the Company also used $300 tosecure a $300 line of credit granted by Wells Fargo Bank to DiamondSoft,Inc.  This cash is presented on theCompany’s consolidated balance sheet as restricted cash.

 

        The Company’s financing activities provided cash of $231 and$463 for the nine months ended September 30, 2001 and 2000, respectively, fromthe exercise of stock options.

 

        The Company believes itscurrent cash and cash equivalent balances will be sufficient to meet theCompany's operating and capital requirements for at least the next 12months.  There can be no assurance,however, that the Company will not require additional financing in the future.  If the Company were required to obtainadditional financing in the future, there can be no assurance that sources ofcapital will be available on terms favorable to the Company, if at all.  As of September 30, 2001, the Company had nomaterial commitments 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.

 

        In November 1996, the Company completed an initial publicoffering ("IPO") of 2,415 shares of its Class A Common Stock. Netproceeds from the IPO were approximately $12,200, of which approximately $1,500was used to repay outstanding indebtedness.

 

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

        In September 2000, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 140, *Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities*.  SFAS No. 140 provides accounting and reporting standards fortransfers and servicing of financial assets and extinguishments ofliabilities.  Under SFAS No. 140, aftera transfer of financial assets, an entity recognizes the financial andservicing assets it controls and the liabilities it has incurred, derecognizesfinancial assets when control has been surrendered, and derecognizesliabilities when extinguished.  SFAS No.140 also provides standards for distinguishing transfers of financial assetsthat are sales from transfers that are secured borrowings.  SFAS No. 140 is effective for certaintransactions occurring after March 31, 2001 and certain disclosures for theyear ending December 31, 2001.  TheCompany has adopted SFAS No. 140, which did not have a material impact on theCompany’s financial position or results of operations.

 

        In June 1998, the FASBissued SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities. *This statementestablishes accounting and reporting standards for derivative instruments,including certain derivative instruments embedded in other contracts, and forhedging activities.  It requires that anentity recognize all derivatives as either assets or liabilities in thestatement of financial position and measure those instruments at fairvalue.  This statement, as amended bySFAS No. 137 and SFAS No. 138, is effective for fiscal years ending December31, 2001.  The Company has adopted SFASNo. 133 as amended, which did not have a material impact on the Company’sfinancial position or results of operations.

 

 

        On June 29, 2001, the FASBissued SFAS No. 141, *Business Combinations,* and SFAS No. 142, *Goodwill andOther Intangible Assets*. These statements establish new standardsfor accounting for business combinations, goodwill, and intangible assets.  Statement 141 eliminates thepooling-of-interests method of accounting for business combinations except forqualifying business combinations that were initiated prior to July 1, 2001 andchanges the criteria to recognize intangible assets apart from goodwill.  The requirements of Statement 141 areeffective for any business combination accounted for by the purchase methodthat is completed after June 30, 2001. Statement 142 supersedes APB Opinion No. 17, *Intangible Assets* (whichrequired that goodwill and intangible assets be amortized over a life not toexceed 40 years), and carries forward its provisions related to internallydeveloped intangible assets without the FASB’s reconsideration.  Under Statement 142, goodwill andindefinite-lived intangible assets are no longer amortized but are reviewedannually for impairment, or more frequently if impairment indicatorsarise.  Goodwill is required to betested for impairment between the annual tests if an event occurs or circumstanceschange that more-likely-than-not reduce the fair value of a reporting unitbelow its carrying value.  Anindefinite-lived intangible asset is required to be tested for impairmentbetween the annual tests if an event occurs or circumstances change indicatingthat the asset might be impaired. Separable intangible assets that have finite lives will continue to beamortized over their useful lives, for which Statement 142 does not impose alimit.  Any required goodwill impairmentcharges would be presented as a separate line item within the operating sectionof the income statement.  The Companyhas adopted Statement 141, which did not have a material impact on theCompany’s financial position or results of operations.  The Company is required to adopt Statement142 on January 1, 2002 and is currently evaluating the impact on the Company’sfinancial position or results of operations.

 

        In August 2001, the FASBissued SFAS no. 144, "Accounting for the Impairment or Disposal ofLong-Lived Assets". This statement supersedes SFAS 121, “Accounting forthe Impairment of Long-Lived Assets and for Long-Lived Assets to be DisposedOf” 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 Transactions”. This statement providesguidance on recognizing and measuring impairment for long-lived assetsexcluding certain long-lived assets, such as goodwill, non-amortized intangibleassets and deferred tax assets. This statement is effective for the Company inthe first quarter of its fiscal year ending December 2002. Management iscurrently evaluating the impact that this statement will have on the Company'sfinancial statements.

 

 

**PART 1, ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

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

 

        As of September 30, 2001, the Company did not participate inany 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 the areasof 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 operatingresults are translated into U.S. dollars and consolidated for reportingpurposes. The impact of currency exchange rate movements on inter-companytransactions was immaterial for the three and nine months ended September 30,2001.  Currently the Company does notengage in foreign currency hedging activities.

 

**PART II****-- OTHER INFORMATION**

 

**ITEM 1.****LEGAL PROCEEDINGS**

 

The Company is not a party to any litigation.

 

 

**ITEM 2.****CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

(a)   Instruments defining the rights of theholders of any class of registered securities of the Company have not beenmaterially modified during the three months ended September 30, 2001.

 

(b)   Rights evidenced by any class of registeredsecurities of the Company have not been materially limited or qualified by theissuance or modification of any other class of securities during the threemonths ended September 30, 2001.

 

(c)   There were no unregistered securities sold bythe Company during the three months ended September 30, 2001.

 

(d)   Use of Proceeds

        As ofSeptember 30, 2001, the approximately $12,200,000 of net proceeds from theCompany's initial public offering (IPO) of its Class A Common Stock pursuant toits Registration Statement on Form S-1, Commission File No. 333-11519, declaredeffective October 30, 1996, have been used as follows: (1) approximately$200,000 for the buildout of Bitstream's leased facilities in Cambridge,Massachusetts to accommodate the additional personnel that joined the Companyas a result of the acquisition of Archetype, Inc.; (2) approximately $6,041,000for the acquisitions of Mainstream Software Solutions, Ltd., Archetype, Inc.,Type Solutions, Inc., and certain assets of Alaras Corporation; (3)approximately $1,500,000 for the repayment of indebtedness, of whichapproximately $548,000 was paid to officers, directors and 10% stockholders ofthe Company and approximately $762,000 of which was paid to third parties; (4)approximately $1,948,000 for royalty payments to others; (5) $750,000 for theinvestment in DiamondSoft, Inc.; and (6) approximately $1,761,000 for thepurchase and installation of equipment. The Company has utilized all of the proceeds from the IPO as of the endof the three month period ended September 30, 2001, however, the Company hadapproximately $6,003,000 in cash and cash equivalents at September 30, 2001.

 

 

**ITEM 3.****DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

 

**ITEM 4.****SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

      (a) On June6, 2001, the Annual Meeting of Stockholders of the Company was held at theRoyal Sonesta Hotel, 5 Cambridge Parkway, Cambridge, Massachusetts 02142.

 

      (b) GeorgeB. Beitzel, Charles Ying, Amos Kaminski and David G. Lubrano were elected atthe Annual Meeting to serve as directors of the Company.

 

 

**PART 2, ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS (continued)**

 

      (c) Thefollowing votes were tabulated on the aforementioned proposal:

 

1. To elect a board offour (4) directors to serve until the next Annual Meeting of Stockholders oruntil their respective successors are elected and qualified.

 
| **Nominee**    |   | **For**   |   | **Withheld Authority** |
|----------------|--------|-----------|--------|------------------------|
|           |   |      |   |                   |
| George Beitzel |   | 7,447,679 |   | 215,776                |
| Amos Kaminski  |   | 7,447,679 |   | 215,776                |
| David Lubrano  |   | 7,447,679 |   | 215,776                |
| Charles Ying   |   | 7,445,321 |   | 218,134                |

 

 

(d)  Not applicable.

 

 

**ITEM 5.****OTHER INFORMATION**

 

Not applicable.

 

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

 

(a)     Exhibits

          None

 

(b)     Reportson Form 8-K

  No reports on Form 8-K were filed during the three months endedSeptember 30, 2001.

 

 

**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) | November 9, 2001 |
| Anna M. Chagnon     |          |                                                                                                           |             |
|                |          |                                                                                                           |             |
| /s/ James P. Dore   |          | Corporate Controller (Principal Accounting Officer)                                                            | November 9, 2001 |
| James P. Dore       |          |                                                                                                           |
|                     |               |                                                                                                                |                  |           |        |        |          |        |  |