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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 0-21541

 

 

BITSTREAM INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		04-2744890
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

500 Nickerson Road, Marlborough, Massachusetts 01752-4695

(Address of principal executive offices and zip code)

(617) 497-6222

(Registrant’s telephone number, including area code)

 

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨		Smaller reporting company		x

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

On November 11, 2009, there were 9,919,172 shares of Class A Common Stock, par value $0.01 per share issued and outstanding, and no shares of Class B Common Stock, par value $0.01 per share, issued or outstanding.

 

 

 

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Table of Contents

INDEX

 

		PAGE NUMBERS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2009 AND DECEMBER 31, 2008		2
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008		3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008		4
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS		5
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		22
ITEM 4. CONTROLS AND PROCEDURES		22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS		23
ITEM 1A. RISK FACTORS		23
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		23
ITEM 5. OTHER INFORMATION		23
ITEM 6. EXHIBITS		24
SIGNATURES		24

 

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PART I — FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

BITSTREAM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

(Unaudited)

 

		September 30, 2009				December 31, 2008
ASSETS
Current assets:
Cash and cash equivalents		$	17,673				16,162
Accounts receivable, net of allowance of $186 and $32 at September 30, 2009 and December 31, 2008, respectively			1,399				1,827
Short-term investments, prepaid expenses and other current assets			800				527
Restricted cash – short-term			150				150
Total current assets			20,022				18,666
Property and equipment, net			630				427
Other long-term assets:
Goodwill			727				727
Intangible assets, net			68				81
Restricted investment – long-term			136				—
Total other assets			931				808
Total assets		$	21,583			$	19,901
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,479			$	832
Accrued payroll and other compensation			380				1,057
Other accrued expenses			557				583
Deferred revenue			1,565				1,937
Total current liabilities			3,981				4,409
Deferred rent			407				—
Total liabilities			4,388				4,409
Commitments and contingencies (Note 4)
Stockholders’ equity:
Preferred stock, $0.01 par value, Authorized – 6,000 shares, Issued and outstanding- 0 at September 30, 2009 and December 31, 2008			—				—
Common stock, $0.01 par value, Authorized – 30,000 Class A and 500 Class B. Class A shares – Issued – 10,120 and 10,116, and outstanding – 9,919 and 9,614 at September 30, 2009 and December 31, 2008, respectively.			101				101
Class B- Issued and outstanding- 0 at September 30, 2009 and December 31, 2008			—				—
Additional paid-in capital			34,960				35,725
Accumulated deficit			(16,641	)			(17,326	)
Treasury stock, at cost- 201 and 502 shares at September 30, 2009 and December 31, 2008, respectively			(1,195	)			(2,989	)
Accumulated other comprehensive loss			(30	)			(19	)
Total stockholders’ equity			17,195				15,492
Total liabilities and stockholders’ equity		$	21,583			$	19,901

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

 

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BITSTREAM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

(Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2009			2008			2009			2008
Revenue:
Software licenses		$	4,512		$	4,222		$	12,361		$	14,563
Services			1,148			1,261			3,549			3,807
Total revenue			5,660			5,483			15,910			18,370
Cost of revenue:
Software licenses			1,779			1,696			4,946			5,555
Services			500			598			1,622			1,782
Cost of revenue			2,279			2,294			6,568			7,337
Gross profit			3,381			3,189			9,342			11,033
Operating expenses:
Marketing and selling			871			979			2,778			3,358
Research and development			1,234			1,334			3,641			4,048
General and administrative			740			713			2,195			2,072
Total operating expenses			2,845			3,026			8,614			9,478
Operating income			536			163			728			1,555
Interest and other income, net			18			30			53			160
Total other income and expense			18			30			53			160
Income before provision for income taxes			554			193			781			1,715
Provision for income taxes			35			6			96			56
Net income		$	519		$	187		$	685		$	1,659
Basic net income per share		$	0.05		$	0.02		$	0.07		$	0.17
Diluted net income per share		$	0.05		$	0.02		$	0.07		$	0.16
Basic weighted average shares outstanding			9,799			9,521			9,770			9,621
Diluted weighted average shares outstanding			10,248			10,160			10,179			10,332

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

 

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BITSTREAM INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS) (Unaudited)

 

		Nine Months Ended September 30,
		2009				2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	685			$	1,659
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			208				225
Net loss (gain) on disposal of Property and Equipment			5				—
Amortization			21				29
Share based compensation.			616				540
Changes in operating assets and liabilities:
Accounts receivable			428				401
Prepaid expenses, restricted cash and other assets			(410	)			(153	)
Accounts payable			647				(76	)
Accrued payroll and other compensation			(677	)			(191	)
Other accrued expenses			(26	)			31
Deferred revenue			(372	)			75
Deferred rent			407				(40	)
Net cash provided by operating activities			1,532				2,500
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net			(417	)			(131	)
Additions to intangible assets			(8	)			(33	)
Net cash used in investing activities			(425	)			(164	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock			—				(4,118	)
Proceeds from exercise of stock options/warrants			413				562
Net cash provided by (used in) financing activities			413				(3,556	)
Effect of foreign currency exchange rates on cash and cash equivalents			(9	)			—
Net increase (decrease) in cash and cash equivalents			1,511				(1,220	)
Cash and cash equivalents, beginning of period			16,162				16,420
Cash and cash equivalents, end of period		$	17,673			$	15,200

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

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Operations and Significant Accounting Policies

Bitstream Inc. (together with its subsidiaries, “Bitstream” or the “Company”) is a software development company focused on bringing unique software products to a wide variety of markets. Today, our core software products include award-winning fonts and font rendering technologies, mobile browsing technologies and variable data publishing and Web-to-print technologies.

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

(a) Use of Estimates

The accompanying unaudited condensed consolidated financial statements reflect the application of certain accounting policies as described in this note and elsewhere in the accompanying condensed consolidated financial statements and notes. The preparation of the accompanying condensed consolidated financial statements requires the use of certain estimates by us in determining our assets, liabilities, revenues and expenses. Actual results may differ from these estimates.

(b) Basis of Presentation

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

We evaluated subsequent events through November 16, 2009, the date of financial statement issuance, to determine whether or not any such events required disclosure in this Form 10-Q.

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

(c) Property and Equipment (in thousands)

Property and equipment are stated at cost, less accumulated depreciation and amortization. Property and equipment consist of the following:

 

		September 30, 2009			December 31, 2008
Equipment		$	1,891		$	1,999
Purchased software			423			462
Furniture and fixtures			581			375
Leasehold improvements			81			143
			2,976			2,979
Less — Accumulated depreciation and amortization			2,346			2,552
Property and equipment, net		$	630		$	427

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

 

Asset Classification		Estimated Useful Life
Equipment		3 Years
Purchased software		3 Years
Furniture and fixtures		5 Years
Leasehold improvements		Life of lease

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

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

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

Financial instruments that potentially expose us to concentrations of credit risk consist primarily of cash and cash equivalents, trade accounts receivable, and investments. We place a majority of our cash investments and other investments in one highly-rated financial institution in excess of federally insured limits. We have not experienced significant losses related to receivables from any individual customers or groups of customers in any specific industry or by geographic area. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by us to be inherent in our accounts receivable. At September 30, 2009, one customer accounted for 11% of our accounts receivable. At December 31, 2008, two customers accounted for 17% and 11% of our accounts receivable, respectively. No single customer accounted for 10% or more of our revenue for the three and nine month periods ended September 30, 2009 or 2008. We do not have any off-balance sheet risks as of September 30, 2009 or December 31, 2008, respectively.

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

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

We do not amortize goodwill or indefinite-lived intangible assets, rather we review them annually for impairment, or more frequently, if impairment indicators arise. We have determined that we do not have separate reporting units and thus goodwill is combined and tested for impairment based upon an enterprise wide valuation. Separable intangible assets that have finite lives are amortized over their useful lives. The components of our amortized intangible assets follow:

 

		September 30, 2009										December 31, 2008
		Gross Carrying Amount			Accumulated Amortization				Net Carrying Amount			Gross Carrying Amount			Accumulated Amortization				Net Carrying Amount
Marketing-related		$	84		$	(80	)		$	4		$	84		$	(79	)		$	5
Technology-based			607			(543	)			64			599			(523	)			76
Total		$	691		$	(623	)		$	68		$	683		$	(602	)		$	81

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

 

Estimated Amortization Expense:
2009, remainder		$	7
2010			23
2011			20
2012			13
2013			5
		$	68

(f) Comprehensive Income (in thousands)

Comprehensive income consists of net income, and adjustments to stockholders’ equity for foreign currency translation adjustments. For the purposes of comprehensive income disclosures, the Company does not record tax provisions or benefits for the net changes in the foreign currency translation adjustment, as the Company intends to permanently reinvest undistributed earnings in its foreign subsidiaries

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

The components of comprehensive income are as follows

 

		Three months ended September 30,							Nine months ended September 30,
		2009				2008			2009				2008
Net income		$	519			$	187		$	685			$	1,659
Foreign currency translation adjustment			(2	)			—			(11	)			—
Total comprehensive income		$	517			$	187		$	674			$	1,659

Accumulated other comprehensive loss consisted of the following:

 

		September 30, 2009				December 31, 2008
Foreign currency translation adjustment		$	(30	)		$	(19	)

(g) Recently Issued Accounting Standards

In June 2009, the Financial Accounting Standards Board (FASB) issued the FASB Accounting Standards Codification (Codification). The Codification will become the single source for all authoritative GAAP recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. The Codification does not change GAAP and will not have an affect on our financial position, results of operations or liquidity.

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

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

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

We elected to defer until January 1, 2009 the implementation of this authoritative guidance as it relates to our non-financial assets and non-financial liabilities that are recognized and disclosed at fair value in the financial statements on a nonrecurring basis. We adopted this authoritative guidance for all nonfinancial assets and

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

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

This guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We have certain financial assets and liabilities recorded at fair value (principally cash equivalents and investments) that have been classified as Level 1, 2 or 3 within the fair value hierarchy. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points for the asset or liability.

At September 30, 2009 our assets and liabilities that were measured at fair value on a recurring basis included money market funds of $10 and a restricted investment of $136, consisting of a certificate of deposit with an original maturity of greater than twelve months from the date of the balance sheet, which were Level 1 financial assets.

The carrying amounts reflected in the consolidated balance sheets for restricted cash, accounts receivable, other current assets, accounts payable, and accrued expenses and other current liabilities approximate fair values due to their short-term maturities.

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

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

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

(2) Income Per Share (in thousands)

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

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

A reconciliation of basic and diluted weighted average shares outstanding for basic and diluted earnings per share is as follows:

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2009		2008		2009		2008
Basic weighted average shares outstanding		9,799		9,521		9,770		9,621
Dilutive effect of options		435		638		401		711
Dilutive effect of unvested restricted shares		14		1		8		—
Shares used to compute diluted net income per share		10,248		10,160		10,179		10,332

In addition, there were unvested restricted shares and options outstanding to purchase 439 and 698 shares for the three and nine month periods ended September 30, 2009, respectively, and there were unvested restricted shares and options outstanding to purchase 596 shares for the three and nine month periods ended September 30, 2008, that were not included in the potential common share computations because their exercise prices were greater than the average market price of our common stock during the applicable period.

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

We currently estimate the fair value of share-based awards using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of share-based awards include the exercise price of the award, the expected option term, the expected volatility of our stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and our expected annual dividend yield. We do not anticipate paying any cash dividends in the foreseeable future and, therefore, use an expected dividend yield of zero in the option valuation model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. We believe that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. These amounts, and the amounts applicable to future quarters, are also subject to future quarterly adjustments based upon a variety of factors, which include but are not limited to, the issuance of new share-based awards. The following table summarizes the weighted average assumptions we utilized for grants of share-based awards during the three and nine months ended September 30, 2009 and 2008:

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2009		2008 *		2009		2008
Risk-free interest rates		2.8%		—		2.8%		2.8% - 3.3%
Expected dividend yield		None		—		None		None
Expected term		6.07 Years		—		6.07 Years		5.7 Years - 6.2 Years
Expected volatility		73.7%		—		73.7%		84.1% - 84.7%

 

*	No share-based awards were granted during the three months ended September 30, 2008.

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

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

Our results for the three months ended September 30, 2009 and 2008 include $216 and $197, respectively, and for the nine months ended September 30, 2009 and 2008 include $616 and $540, respectively, of share-based compensation within the applicable expense classification where we report the share-based award holders’ compensation expense. The following table presents share-based compensation expense included in our condensed consolidated statement of operations:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2009			2008			2009			2008
Cost of revenue-software licenses		$	1		$	1		$	3		$	3
Cost of revenue-services			19			19			56			56
Marketing and selling			10			9			36			35
Research and development			87			79			248			220
General and administrative			99			89			273			226
Share-based compensation expense before tax			216			197			616			540
Income tax benefit			—			—			—			—
Net compensation expense		$	216		$	197		$	616		$	540

(4) Commitments and Contingencies, (in thousands)

Lease commitments

We conduct our operations in leased facilities. The previous lease for our corporate offices expired August 31, 2009. That lease requires that we maintain a Letter of Credit for $150 through October 31, 2009 which is classified as current restricted cash on our Balance Sheet. In June 2009, we entered into a ten-year lease agreement for 27 square feet of office space with the right of first refusal on an additional 4 square feet in a building located in Marlborough, Massachusetts. Our current lease agreement commenced September 1, 2009 and obligates us to make minimum lease payments plus our pro-rata share of future real estate tax increases and certain operating expense increases above the base year. The lease payments begin after three (3) free months of rent and increase approximately 2% per annum. The total commitment under the lease is approximately $5,390, net of a tenant allowance of $411. We record rent expense on a straight-line basis, taking into consideration the free rent period, the tenant allowance received at the outset of the lease, and annual incremental increases to the lease payments. Our current lease agreement also required us to obtain a Letter of Credit in the amount of $136 to be in place through October 31, 2019, which we collateralized with a certificate of deposit classified as a long-term restricted asset on our Balance Sheet.

In July 2008, Bitstream India Pvt. Ltd., our wholly-owned subsidiary, entered into a 33 month lease agreement in Nodia India. This lease agreement commenced May 1, 2008 and obligates us to make monthly payments including service taxes. Our total financial commitment during the 33 month lease period is approximately $132 U.S. dollars.

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

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

 

Operating leases:
2009, remainder		$	53
2010			542
2011			524
2012			521
2013			535
2014			549
2015			562
2016			576
2017			590
2018			603
2019			411
		$	5,466

Royalties

We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is primarily based on a dollar amount per unit shipped or a percentage of the underlying revenue. Royalty expense is recorded under our cost of software license revenue on our consolidated Statement of Operations.

Indemnification

We enter into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual after execution of the agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of our liability under these agreements is minimal.

Legal Actions

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

(5) Income Taxes (in thousands)

We account for income taxes under the asset and liability method, and determine our deferred tax asset or liability based on the difference between the financial statement and the tax basis of assets and liabilities, as measured by enacted tax rates in effect when these differences are expected to reverse.

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

The Company’s income tax provisions for the three and nine months ended September 30, 2009 and 2008 are primarily attributable to state income taxes in the U.S. and taxes related to foreign jurisdictions. Federal and state tax provisions for those periods included amounts in relation to the Company’s income generated in the U.S., reduced by previously unused net operating loss (NOL) carry forwards and tax credits that were recorded on the balance sheet with a full valuation allowance. As of September 30, 2009, a full valuation allowance was recorded against the Company’s net deferred tax assets in the U.S. At December 31, 2008, the Company had U.S. federal and state net operating loss (“NOL”) carryforwards of $12,626 and $59, respectively, of which the benefit of approximately $7,532 and $59, respectively, when realized, will be recorded as a credit to additional paid in capital. The Company’s NOL carry-forwards begin to expire in 2020 for federal purposes. The Company also had U.S. federal and state research and development credit (“R&D Credit”) carryforwards of $932 and $331, respectively. These R&D credit carryforwards begin to expire in 2009 for federal purposes and 2016 for state purposes. As of December 31, 2008, we had foreign tax credit carryforwards of $380. These foreign tax credit carryforwards begin to expire in 2012.

We continued to provide a full valuation allowance for our net deferred tax assets at September 30, 2009, as we believe it is more likely than not that the future tax benefits from accumulated net operating losses and deferred taxes will not be realized. We continue to assess the need for the valuation allowance at each balance sheet date based on all available evidence. However, it is possible that the “more likely than not” criterion could be met in future periods, which could result in the reversal of a significant portion or all of the valuation allowance, which, at that time, would be recorded as a tax benefit in the consolidated statement of operations.

Foreign taxes include foreign withholding taxes which vary with OEM license royalties from customers in countries who are a party to tax conventions with the United States including Korea, Israel and Poland, as well as, foreign taxes paid by Bitstream India Pvt. Ltd., our subsidiary, in India. The following is a summary of the components of the provision for income taxes:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2009			2008			2009			2008
Current:
State		$	15		$	—		$	67		$	14
Foreign			20			6			29			42
Total		$	35		$	6		$	96		$	56

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

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

We recognize interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2009, we had no accrued interest or penalties related to uncertain tax positions. The tax years 2004 through 2008 remain open to examination by the major taxing jurisdictions to which we are subject. We have determined that it is more likely than not that the deferred tax assets will not be realized, therefore, a valuation allowance has reduced the deferred tax assets to zero.

(6) Geographical Reporting (in thousands)

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

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2009			2008			2009			2008
*Revenue:
United States		$	4,687		$	4,609		$	12,987		$	15,302
United Kingdom (UK)			345			246			899			1,056
Canada			222			249			533			484
Other (Countries less than 5% individually, by Region)
Europe, excluding UK			212			283			705			1,033
Asia			176			88			647			441
Other			18			8			139			54
Total revenue		$	5,660		$	5,483		$	15,910		$	18,370

 

*	If revenue attributable to a specific country is greater than 5% in any period, revenue attributable to that country is disclosed for all periods. E-commerce credit card revenue is all included as attributable to the United States.

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

 

		September 30, 2009			December 31, 2008
United States		$	616		$	410
India			14			17
Total		$	630		$	427

 

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

CONDITION AND RESULTS OF OPERATIONS

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

OVERVIEW

Bitstream Inc. was incorporated in the State of Delaware in 1981. Bitstream Inc. (together with its subsidiaries, “Bitstream” or the “Company”) is a software development company focused on bringing unique software products to a wide variety of markets. Today, our core software products include award-winning fonts and font rendering technologies, mobile browsing technologies and variable data publishing and Web-to-print technologies.

We maintain our executive offices at 500 Nickerson Road, Marlborough, Massachusetts 01752-4695. Our telephone number is (617) 497-6222. We maintain websites at www.bitstream.com, www.myfonts.com, and www.pageflex.com.

Investors may obtain copies of our filings with the Securities and Exchange Commission (the “SEC”) free of charge from our website at www.bitstream.com or from the SEC’s website at www.sec.gov.

CRITICAL ACCOUNTING POLICIES

We incorporate herein by reference the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Critical Accounting Policies” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and filed with the SEC on March 31, 2009. No changes have been made to those policies since December 31, 2008.

FORWARD LOOKING STATEMENTS

Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, without limitation, market acceptance of our products, competition and the timely introduction of new products. Additional information concerning certain risks and uncertainties that would cause actual results to differ materially from those projected or suggested in the forward-looking statements is contained in our filings with the SEC, including those risks and uncertainties discussed under the section entitled “Forward Looking Statements” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 filed with the SEC on March 31, 2009. The forward-looking statements contained herein represent our judgment as of the date of this report, and we caution readers not to place undue reliance on such statements. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

 

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RESULTS OF OPERATIONS (in thousands, except percentages and per share amounts)

Revenue and Gross Profit:

 

		Three Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars				Percent
Revenue
Software licenses		$	4,512		79.7			$	4,222		77.0			$	290			6.9	%
Services			1,148		20.3				1,261		23.0				(113	)		(9.0	)%
Total revenue			5,660		100.0				5,483		100.0				177			3.2	%
Cost of Revenue
Software licenses			1,779		39.4				1,696		40.2				83			4.9	%
Services			500		43.6				598		47.4				(98	)		(16.4	)%
Total cost of revenue			2,279		40.3				2,294		41.8				(15	)		(0.7	)%
Gross Profit		$	3,381		59.7	%		$	3,189		58.2	%		$	192			6.0	%

Revenue and Gross Profit:

 

		Nine Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars				Percent
Revenue
Software licenses		$	12,361		77.7	%		$	14,563		79.3	%		$	(2,202	)		(15.1	)%
Services			3,549		22.3				3,807		20.7				(258	)		(6.8	)%
Total revenue			15,910		100.0				18,370		100.0				(2,460	)		(13.4	)%
Cost of Revenue
Software licenses			4,946		40.0				5,555		38.1				(609	)		(11.0	)%
Services			1,622		45.7				1,782		46.8				(160	)		(9.0	)%
Total cost of revenue			6,568		41.3				7,337		39.9				(769	)		(10.5	)%
Gross Profit		$	9,342		58.7	%		$	11,033		60.1	%		$	(1,691	)		(15.3	)%

License revenue from direct sales, which includes e-commerce sales, decreased $280, or 8.9%, to $2,855 for the three months ended September 30, 2009 as compared to $3,135 for the three months ended September 30, 2008. License revenue from resellers decreased $96, or 28.6%, to $240 for the three months ended September 30, 2009 as compared to $336 for the three months ended September 30, 2008. License revenue from OEMs and ISVs increased $666, or 88.7%, to $1,417 for the three months ended September 30, 2009 as compared to $751 for the three months ended September 30, 2008. License revenue from direct sales, which includes e-commerce sales, decreased $1,585, or 16.1%, to $8,231 for the nine months ended September 30, 2009 as compared to $9,816 for the nine months ended September 30, 2008. License revenue from resellers decreased $446, or 39.7%, to $677 for the nine months ended September 30, 2009 as compared to $1,123 for the nine months ended September 30, 2008. License revenue from OEMs and ISVs decreased $171, or 4.7%, to $3,453 for the nine months ended September 30, 2009 as compared to $3,624 for the nine months ended September 30, 2008.

License revenue varies between quarters due to the timing of license agreements. With the exception of new OEM license revenue for the three months ended September 30, 2009, revenue for the three and nine month periods ended September 30, 2009 decreased across all of our product lines due to delays in purchasing decisions by customers and decreases in royalties from consumer-based shipments by OEMs and ISVs during the respective periods. License revenue from OEMs increased during the three months ended September 30, 2009 and compared to the same period for the prior year due to the signing of several new licenses in a particularly strong September. We believe that the decreases we have experienced can be attributed primarily to the economic conditions affecting consumers and that our license revenue may continue to be similarly affected until general economic conditions improve.

 

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The decrease in revenue from services for the three months ended September 30, 2009 was due to a decrease in consulting and training services of $106, or 46.8% to $121 as compared to $227 for the three months ended September 30, 2008, as well as, a decrease in revenue related to support contracts of $5, or 0.5%, to $1,028 for the three months ended September 30, 2009 as compared to $1,033 for the three months ended September 30, 2008. The decrease in revenue from services for the nine months ended September 30 2009 was due to a decrease in consulting and training services of $299, or 39.2% to $464 as compared to $763 for the nine months ended September 30, 2008. This decrease was partially offset by increases in revenue related to support contracts primarily driven by increases in our customer base and customer demand for publishing support services, of $42, or 1.4%, to $3,086 for the nine months ended September 30, 2009 as compared to $3,044 for the nine months ended September 30, 2008. We believe that our overall services revenue during 2009 will approximate the level attained in 2008 but if general economic conditions do not improve, service revenue for the quarter ending December 31, 2009 may continue to be lower than the level of service revenue achieved for the same period in 2008.

We recognize license revenue from direct sales and from licensing our products and third party products including e-commerce sales made via our websites, from licensing agreements with OEMs and ISVs, and from the resale of our products through various resellers. We recognize reseller revenue if collection is probable, upon notification from the reseller that it has sold the product or, if for a physical product, upon delivery of the software. E-commerce sales include revenue from the licensing of Bitstream fonts and font technology, licensing of our browser, licensing of fonts and font technology developed by third parties and from fees received from referring customers to other sites for which we have referral agreements. Referral income for the three months ended September 30, 2009 and 2008 was $9 and $17, respectively. Referral income for the nine months ended September 30, 2009 and 2008 was $31 and $40, respectively. There are minimal costs associated with referral revenue, and such costs primarily represent the time to load copies of the fonts provided by each participating foundry to the MyFonts.com database. We expense those costs as incurred.

The increase in cost of license revenue for the three months ended September 30, 2009 and the decrease in cost of license revenue for the nine months ended September 30, 2009 as compared to the same periods ended September 30, 2008 was primarily due to an increase of $62 and decrease of $635, for the three and nine month periods, respectively, in direct costs, including royalty costs, associated with sales of third party products, which vary with the product mix sold and the royalty rate paid on those products. We expect the cost of license revenue as a percentage of license revenue for the fiscal year ending December 31, 2009 to approximate the percentage for the year ended December 31, 2008, although the results may vary based upon the mix of products sold during the remainder of the year.

The decrease in cost of services revenue for the three and nine month periods ended September 30, 2009 as compared to the same periods ended September 30, 2008 was primarily due to a transfer of costs associated with the internal deployment of custom design personnel onto research and development projects during the second and third quarters of 2009 of $61 and $37, respectively, and a reduction in personnel and related salary and benefit costs of $50 during the third quarter of 2009. During the remainder of 2009, we expect our cost of services as a percentage of service revenue to approximate the percentages for 2008 but if economic conditions do not improve, our cost of services as a percentage of service revenue may increase unless we make certain infrastructure changes.

Cost of revenue includes royalties and fees paid to third parties for the development of, or license of rights to, technology and/or unique typeface designs, costs incurred in the fulfillment of custom orders, costs incurred in providing customer support, maintenance, and training, and costs associated with the duplication, packaging and shipping of product.

 

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Operating Expenses:

 

		Three Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars				Percent
Marketing and selling		$	871		15.4	%		$	979		17.9	%		$	(108	)		(11.0	)%
Research and development			1,234		21.8				1,334		24.3				(100	)		(7.5	)
General and administrative			740		13.1				713		13.0				27			(3.8	)
Total operating expenses		$	2,845		50.3			$	3,026		55.2	%		$	(181	)		(6.0	)%

Operating Expenses:

 

		Nine Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars				Percent
Marketing and selling		$	2,778		17.5	%		$	3,358		18.3	%		$	(580	)		(17.3	)%
Research and development			3,641		22.9				4,048		22.0				(407	)		(10.1	)
General and administrative			2,195		13.8				2,072		11.3				123			5.9
Total operating expenses		$	8,614		54.1	%		$	9,478		51.6	%		$	(864	)		(9.1	)%

Marketing and selling (“M&S”) expense consists primarily of salaries and benefits, commissions, travel expense and facilities costs related to sales and marketing personnel, as well as marketing program-related costs including trade shows and advertising. The decrease in M&S expense for the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 was primarily the result of decreases in payroll costs of approximately $105 primarily due to a temporary decrease of $52 in salaries due to changes in personnel and $27 in commissions and bonuses from decreased commissionable sales and bonuses. The decrease in M&S expense for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 was primarily the result of an $83 decrease in professional marketing agency services and decreases in payroll costs and advertising and marketing activities. Payroll costs decreased primarily due to decreases of $112 in commissions and bonuses from decreased commissionable sales and bonuses, a temporary decrease of $80 in salaries due to changes in personnel and a one-time bonus reversal of $33, which had been reversed during the second quarter of 2009. Advertising and marketing activities decreased $228 including a $200 decrease in tradeshow costs from the non-recurrence of the Drupa tradeshow during 2009. Drupa is held once every four years and was last held during the second quarter of 2008 in Düsseldorf, Germany. We expect our M&S expenses to increase above the level recorded for the nine months ended September 30, 2009 as a result of planned increases in trade show expenses and salaries including commissions during the remainder of 2009, but we also expect our M&S expenses for the year ending December 31, 2009 to remain below the level recorded for the year ended December 31, 2008.

Research and development (“R&D”) expense consists primarily of salary and benefits costs, contracted third-party development costs, and facility costs related to software developers and management. The decrease in R&D expense for the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 was primarily the result of decreases in salaries and benefits and the use of third party contractors of $110 and decreases in facility related costs of $13, partially offset by an increase in the utilization of custom design and consulting personnel on R&D projects of approximately $37. The decrease in R&D expense for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 was primarily the result of decreases in salaries and benefits and the use of third party contractors of $488 partially offset by an increase in the utilization of custom design and consulting personnel on R&D projects of approximately $108. The decrease in R&D payroll costs for the three and nine month periods ended September 30, 2009 as compared to the same periods ended September 30, 2008 is primarily due to decreases in bonus accruals during 2009 reflecting our decreased performance caused by the current economic environment. We expect our development efforts to increase during the remainder of 2009 and to approximate the level recorded during the fourth quarter of 2008.

 

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General and administrative (“G&A”) expense consists primarily of salaries, benefits, and other related costs including travel and facility expenses for finance, human resource, legal and executive personnel, legal and accounting professional services, provision for bad debts and director and officer insurance. The increase in G&A for the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 is primarily due to increases in bad debt expense of $43, state franchise tax and filing costs of $27, temporary and professional services of $39, and move related costs of $22, partially offset by a decrease in salary and benefits of $84. The increase in G&A for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 is primarily due to an increase in bad debt expense of $190 attributable to an increase in the allowance for doubtful accounts, an increase in state franchise tax and filing costs of $65, and an increase in temporary and professional service fees of $62, partially offset by decreases in salary and benefits of $177. The decrease in administrative payroll costs for the three and nine month periods ended September 30, 2009 as compared to the same periods ended September 30, 2008 is primarily due to decreases in bonus accruals during 2009 reflecting our decreased performance caused by the current economic environment. We expect G&A expense to increase moderately during the remainder of 2009.

Other Income, Net:

 

		Three Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars				Percent
Interest and other income, net		$	18		0.3	%		$	30		0.5	%		$	(12	)		(40.0	)%
		Nine Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars				Percent
Interest and other income, net		$	53		0.3	%		$	160		0.9	%		$	(107	)		(66.9	)%

Other income includes interest income earned on cash and money market instruments and foreign currency transaction gains. Transaction gains for the three months ended September 30, 2009 and 2008 were $18, and $0, respectively. Transaction gains for the nine months ended September 30, 2009 and 2008 were $45, and $0, respectively. Net interest income has decreased as compared to the same periods in the prior year due to a lower rate of interest earned on our cash and money market instruments.

Provision for Income Taxes:

 

		Three Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars			Percent
Provision for income taxes		$	35		0.6	%		$	6		0.1	%		$	29		483.3	%
		Nine Months Ended September 30,												Change
		2009			% of Revenue			2008			% of Revenue
														Dollars			Percent
Provision for income taxes		$	96		0.6	%		$	56		0.3	%		$	40		71.4	%

The Company’s income tax provisions for the three and nine month periods ended September 30, 2009 and 2008 are primarily attributable to state income taxes in the U.S. and taxes related to foreign jurisdictions. Federal and state tax provisions for those periods included amounts in relation to the Company’s income generated in the U.S., reduced

 

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by previously unused net operating loss (NOL) carry forwards and tax credits that were recorded on the balance sheet with a full valuation allowance. As of September 30, 2009, a full valuation allowance was recorded against the Company’s net deferred tax assets in the U.S. At December 31, 2008, the Company had U.S. federal and state net operating loss (“NOL”) carryforwards of $12,626 and $59, respectively, of which the benefit of approximately $7,532 and $59, respectively, when realized, will be recorded as a credit to additional paid in capital. The Company’s NOL carry-forwards begin to expire in 2020 for federal purposes. The Company also had U.S. federal and state research and development credit (“R&D Credit”) carryforwards of $932 and $331, respectively. These R&D credit carryforwards begin to expire in 2009 for federal purposes and 2016 for state purposes. As of December 31, 2008, we have foreign tax credit carryforwards of $380. These foreign tax credit carryforwards begin to expire in 2012.

We continued to provide a full valuation allowance for our net deferred tax assets at September 30, 2009, as we believe it is more likely than not that the future tax benefits from accumulated net operating losses and deferred taxes will not be realized. We continue to assess the need for the valuation allowance at each balance sheet date based on all available evidence. However, it is possible that the “more likely than not” criterion could be met in future periods, which could result in the reversal of a significant portion or all of the valuation allowance, which, at that time, would be recorded as a tax benefit in the consolidated statement of operations.

Foreign taxes include foreign withholding taxes which vary with OEM license royalties from customers in countries who are a party to tax conventions with the United States including Korea, Israel and Poland, as well as, foreign taxes paid by Bitstream India Pvt. Ltd., our subsidiary, in India.

LIQUIDITY AND CAPITAL RESOURCES (in thousands, except share and per share amounts)

The Company has funded its operations primarily through the public sale of equity securities, cash flows from operations, cash received from the sale of our MediaBank and InterSep OPI product lines to Inso Providence Corporation in August of 1998, and cash received from the sale of our investment in DiamondSoft to Extensis in July of 2003. As of September 30, 2009, we had net working capital of $16,041 versus $14,257 at December 31, 2008, an increase of $1,784 or 13%.

Our operating activities generated cash during the nine months ended September, 2009 and 2008 of $1,532 and $2,500, respectively. Cash from operating activities was generated primarily from our net income after consideration for non-cash expenses which increased cash for the nine months ended September 30, 2009 and 2008 by $1,535 and 2,453, respectively. We used cash of $425 and $164 for the nine months ended September 30, 2009 and 2008, respectively, for the purpose of acquiring additional property and equipment and intangible assets. Our financing activities for the nine months ended September 30, 2009 provided cash of $413 from the exercise of stock options, while our financing activities for the nine months ended September 30, 2008 provided $562 in cash from the exercise of stock options, but used cash of $4,118 to repurchase shares of our common stock. Our cash balance also decreased during the period ended September 30, 2009 by $9 from the effect of foreign currency exchange rates applied to the balances and activities of our subsidiary, Bitstream India Pvt. Ltd, whose functional currency is the Indian Rupee.

We conduct our operations in leased facilities. The previous lease for our corporate offices expired August 31, 2009. That lease requires that we maintain a Letter of Credit for $150 through October 31, 2009 which is classified as current restricted cash on our Balance Sheet. In June 2009, we entered into a ten-year lease agreement for 27 square feet of office space with the right of first refusal on an additional 4 square feet in a building located in Marlborough, Massachusetts. Our current lease agreement commenced September 1, 2009 and obligates us to make minimum lease payments plus our pro-rata share of future real estate tax increases and certain operating expense increases above the base year. The lease payments begin after three (3) free months of rent and increase approximately 2% per annum. The total commitment under the lease is approximately $5,390, net of a tenant allowance of $411. We record rent expense on a straight-line basis, taking into consideration the free rent period, the tenant allowance received at the outset of the lease, and annual incremental increases to the lease payments. Our current lease agreement also required us to obtain a Letter of Credit in the amount of $136 to be in place through October 31, 2019, which we collateralized with a certificate of deposit classified as a long-term restricted asset on our Balance Sheet.

In July 2008, Bitstream India Pvt. Ltd., our wholly-owned subsidiary, entered into a 33 month lease agreement in Nodia India. This lease agreement commenced May 1, 2008 and obligates us to make monthly payments including service taxes. Our total financial commitment during the 33 month lease period is approximately $132 U.S. dollars.

 

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

 

Operating leases:
2009, remainder		$	53
2010			542
2011			524
2012			521
2013			535
2014			549
2015			562
2016			576
2017			590
2018			603
2019			411
		$	5,466

As of September 30, 2009, we had no material commitments for capital expenditures.

We believe our current cash and cash equivalent balances will be sufficient to meet our operating and capital requirements for at least the next 12 months. There can be no assurance, however, that we will not require additional financing in the future. If we were required to obtain additional financing in the future, there can be no assurance that sources of capital would be available on terms favorable to us, if at all.

We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is primarily based on a dollar amount per unit shipped or a percentage of the underlying revenue. Royalty expense is recorded as cost of license revenue on our Consolidated Statement of Operations.

Off-Balance Sheet Arrangements

We enter into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of our liability under these agreements is minimal, but we can provide no assurance that payments will not be required to be made under these agreements in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the Financial Accounting Standards Board (FASB) issued the FASB Accounting Standards Codification (Codification). The Codification will become the single source for all authoritative GAAP recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. The Codification does not change GAAP and will not have an effect on our financial position, results of operations or liquidity.

 

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

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments.

As of September 30, 2009, we did not participate in any derivative financial instruments or other financial and commodity instruments for which fair value disclosure would be required under SFAS No. 107. All of our investments are short-term money market accounts and bank deposits that are carried on our books at fair market value. Accordingly, we have no quantitative information concerning the market risk of participating in such investments.

Primary Market Risk Exposures

Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. Our investment portfolio of cash equivalent and short-term investments is subject to interest rate fluctuations, but we believe this risk is immaterial due to the short-term nature of these investments. Our exposure to currency exchange rate fluctuations has been and is expected to continue to be modest due to the fact that the operations of our international subsidiary are almost exclusively conducted in the local currency. The impact of currency exchange rate movements on inter-company transactions was immaterial for the three months ended September 30, 2009. International subsidiary operations will be translated into U.S. dollars and consolidated for reporting purposes. Currently, we do not engage in foreign currency hedging activities.

 

ITEM 4.

CONTROLS AND PROCEDURES

Managements’ evaluation of our disclosure controls and procedures.

Our principal executive officer and principal financial officer, after evaluating the effectiveness of our “disclosure controls and procedures,” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), with the participation of our management, have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective and were designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. It should be noted that any system of controls is designed to provide reasonable, but not absolute, assurances that the system will achieve its stated goals under reasonably foreseeable future circumstances. Our principal executive officer and principal financial officer have concluded that, as of such date, the Company’s disclosure controls and procedures are effective at a level that provides such reasonable assurances.

Changes in internal control over financial reporting.

There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2009 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

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

 

ITEM 1A.

RISK FACTORS

We incorporate herein by reference the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Risk Factors” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and filed with the SEC on March 31, 2009. There have not been any material changes in the risk factors previously disclosed in our Annual Report on Form 10-K.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a)	Instruments defining the rights of the holders of any class of our registered securities have not been materially modified during the three months ended September 30, 2009.

 

(b)	Rights evidenced by any class of our registered securities have not been materially limited or qualified by the issuance or modification of any other class of securities during the three months ended September 30, 2009.

 

(c)	There were no unregistered securities sold by us during the three months ended September 30, 2009.

 

(d)	There were no repurchases of our equity securities during the three months ended September 30, 2009.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

 

ITEM 5.

OTHER INFORMATION

 

(a)

Consistent with Section 10A(i)(2) of the Exchange Act, as added by Section 202 of Sarbanes-Oxley, the Company is responsible for listing the non-audit services approved during any reporting period by its Audit Committee to be performed by PricewaterhouseCoopers LLP, the Company’s external auditor.

 

(b)

During the three months ended September 30, 2009, no amounts for services were brought before the Audit Committee for approval.

 

(c)

During the three months ended September 30, 2009, there were no changes made to the procedures by which security holders may recommend nominees to the Company’s Board of Directors.

 

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ITEM 6.

EXIBITS

(a) Exhibits

 

		CERTIFICATIONS
31.1		Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

PART II — SIGNATURES

SIGNATURES

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

 

 

SIGNATURE		TITLE		DATE
/S/    ANNA M. CHAGNON         Anna M. Chagnon		President and Chief Executive Officer (Principal Executive Officer)		November 16, 2009
/S/    JAMES P. DORE         James P. Dore		Vice President and Chief Financial Officer (Principal Financial Officer)		November 16, 2009

 

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