UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Markmark one)

For the fiscal year ended December 31, 20032005

or

For the transition period from              to             

COMMISSION FILE NUMBER: 0-21541

BITSTREAM INC.

(Exact name of registrantRegistrant as specified in its charter)

245 First Street, 17th17^th Floor, Cambridge, Massachusetts 02142-1270

(Address of principal executive offices)

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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock

Exchange on which Class A Common Stock registered: Nasdaq Small Cap market

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.        Yes¨    Nox

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.        Yes¨    Nox

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to suchthe filing requirements for the past 90 days.        Yesx    No¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference ininto Part III of this Form 10-K or any amendment to this Form 10-K.        ¨

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

Large accelerated filer¨            Accelerated filer¨            Non-accelerated filerx

Indicate by a check mark whether the registrant is an accelerated filera shell company (as defined in Rule 12b-2 of the Exchange Act).        Yes¨    Nox

The aggregate market value of voting stock and non-voting stock held by non-affiliates of the Registrant as of March 15, 20042006 was approximately $22.7$67 million.

On March 15, 2004,2006, there were 8,575,0299,006,613 shares of Class A Common Stock, par value $0.01 per share issued, including 125,809 shares issued and designated as treasury shares, and no shares of Class B Common Stock, par value $0.01 per share, issued or outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive proxy statement for the 20042006 Annual Meeting of Stockholders to be held on June 1, 2006, to be filed with the Securities and Exchange Commission, are incorporated by reference into Part III of this Annual Report on Form 10-K. Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statementproxy statement is not deemed to be filed as part hereof.

INDEXTABLE OF CONTENTS

Special Note about Forward-Looking Statements

In addition toCertain statements in this report, other than purely historical information, this Annual Report on Form 10-K containsincluding 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. Forward-looking statements are based on current expectations and assumptions that involveare subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially. Factors that might cause or contribute tomaterially from such differences include, but are not limited to, those discussedforward-looking statements is included in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. You should carefully review the risks described herein and in other documents we file from time to time with the Securities and Exchange Commission (“SEC”), including the Quarterly Reports on Form 10-Q to be filed in 2004. When used in this report the words “expects,” “could,” “would”, “may,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “targets,” “estimates,” “looks for,” “looks to,” and similar expressions, as well as statements regarding the Company’s focus for the future, are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K.entitled “Risk Factors”. We undertake no obligation to update or revise publicly release any revisions to the forward-looking statements, or reflectwhether as a result of new information, future events or circumstances after the date of this document.otherwise.

PART I

ITEM 1. Business

GENERAL

Founded in 1981, Bitstream Inc. (“Bitstream”was incorporated in the State of Delaware in 1981. Bitstream Inc. (together with its subsidiaries, “Bitstream” or the “Company”) is a software development company that enablesmakes communications compelling. We enable our customers worldwide to render high-quality text, browse the Webweb on wireless devices, select from the largest collection of fonts online, create high-quality variable documents dynamically, and customize documents over the Internet. ItsOur core competencies include fonts and font technology, browsing technology, and publishing technology.

The Company maintainsWe maintain our executive offices at 245 First Street, 17^th Floor, Cambridge, Massachusetts 02142.02142-1270. Our telephone number is 617-497-6222. We(617) 497-6222 and we maintain a Web sitewebsites atwww.bitstream.com,www.myfonts.com, andwww.pageflex.com. Investors canmay obtain copies of our SEC filings from this sitewith the Securities and Exchange Commission (the “SEC”) free of charge as well as from our website at www.bitstream.com or the SEC Web siteSEC’s website atwww.sec.gov.

PRODUCTS AND MARKETS OVERVIEW

The Company categorizes itsWe categorize our products and technologies into three business segments:product lines: (1) Type, which consists of fonts and font technology, and(2) browsing technology; (2) MyFonts;technology, and (3) Pageflex.

TYPE

publishing technology.

FONTS AND FONT TECHNOLOGY

Techniques used to present text and graphics are based on existing desktop publishing technologies and, when used in new distribution media, often result in a loss of visual integrity, degraded system performance, or both. To efficiently deliver digital information that retains the author’s intended visual impression, computer systems must use enabling technologies that reduce file size, minimize bandwidth consumption, and operate reliably across heterogeneous computing environments. The evolution of real timereal-time operating systems cell(RTOS), mobile phone operating systems, wireless Internet devices, PDAs, set-top boxes, information appliances, and embedded systems in general will require the transition from (a) the use of bitmaps to display text being displayed on these devices, as bitmaps, as is currently done today, to (b) the use of outlines and vector-based shapes to display text that can be scaled to fit the content being viewed on the device.these devices. Text that is easy to read on any hardware device, on any software platform, at any size, and at any resolution is immeasurably important.

Since its establishment as the world’s first independent digital font foundry in 1981, Bitstream has played a leading role in the development of industry-standard font products and enabling technologies, including font rendering

and display software. The Company hasWe have built substantial expertise in digital typetypeface design and production, technical font formats, and font portability and compaction software. Bitstream intends

We believe that certain features of our products, such as performance, speed, compact size, system scalability, cross-platform portability, and high typographic quality, facilitate the adoption of such products in new and emerging markets. These markets include mobile handsets and smart phones, handheld and wireless devices, gaming software, graphics applications, Internet and corporate intranet software, interactive TV and set-top boxes, high-definition digital theater and television, and embedded systems. We are currently developing, adapting, and marketing our enabling technologies and font solutions to third parties whose products address these new and developing markets.

Our products and technologies are designed to support existing and new technological and typographic standards, such as OpenType, TrueType, and PostScript Type 1, as well as Unicode and native encodings and to be embedded within full-featured products produced by OEMs (original equipment manufacturers) and ISVs (independent software vendors). Our products are also designed to function in multi-platform computing environments, including Windows, Macintosh, UNIX, Linux, RTOS, and Java. We plan to continue to develop or acquire technology to support its leadership positionpromote the use of our products in these areas.multi-vendor configurations.

Bitstream hasWe have a long history of working with standardsstandards’ organizations worldwide to enhance technological development. BitstreamWe created the portable font resource (PFR) as a highly compact, resolution independent representation of characters that couldcan be displayed on different systems while retaining font fidelity. Independent organizations responsible for setting digital TV standards have adopted the PFR font format as their standard for digital television, including ATSC (Advanced Television Systems Committee), DAVIC (Digital Audio Visual Council), DVB (Digital Video Broadcasting), DTG (Digital TV Group), MHP (Multimedia Home Platform), ISO/IEC 16500-6:1999 (International Organization for Standardization / International Electrotechnical Commission), and OCAP (OpenCable(Open Cable Application Platform). Bitstream currently supports PFRs through its Font Fusion and TrueDoc font technology solutions.

The Company believes that certain features of its products, such as performance, speed, compact size, system scalability, cross-platform portability, and high typographic quality, will facilitate the adoption of such products in new and emerging markets. These markets include cell and smart phones, handheld and wireless devices, gaming software, Internet and corporate intranet software, interactive TV and set-top boxes, high-definition digital theater and television, and embedded systems. Bitstream is currently developing, adapting, and marketing its enabling technologies and font solutions to third parties whose products address these new and developing markets.

Bitstream’s products and technologies have been designed to support existing and new technological and typographic standards, such as Unicode, OpenType, TrueType, and Type 1, and to be embedded within full-featured products produced by OEMs and ISVs. The Company’s products haveWe also been designed to function in multi-platform computing environments, including Windows, UNIX, Linux, Macintosh, RTOS (real-time operating systems), and Java. The Company plans to continue to promote the use of its products in multi-vendor configurations.

Our font technology products include:

Our font products include:

BROWSING TECHNOLOGY

The Company has also expanded its product lines based on its font technology to include ThunderHawk^™, a browser for mobile devices. Management believes that the addition of ThunderHawk to its growing product line will significantly expand Bitstream’s traditional font technology business into a new business focused on providing leading-edge browsing technology to small handheld devices, such as PDAs and cell and smart phones. Today, Bitstream offers the complete ThunderHawk client-server solution to corporations, wireless carriers and operators, device manufacturers, and consumers.

ThunderHawk is a wireless Web browsing technology for small wireless devices, including Pocket PCs and cell and smart phones. ThunderHawk relies on a server infrastructure combined with a small piece of thin-client code on the handheld device. The server infrastructure transmits Web content in a more compact format to the device, making fast and full-featured wireless Web browsing possible. ThunderHawk’s reliance on the server allows smart phones, Pocket PCs, and other wireless devices to have a high degree of compliance with open HTML standards. In addition, ThunderHawk gives customers the fast and full featured browsing capability on a handheld device that they get from the desktop. This includes viewing the full text and images of any Web page without excessive scrolling. ThunderHawk does not rely on WAP (Wireless Application Protocol) or cHTML (Compact HyperText Markup Language). This removes the need for Web content developers to create separate, simplified Web sites optimized for small devices, or for companies to license separate software that converts Web sites into a format appropriate for wireless devices. Instead, ThunderHawk enables users to see a Web page just as it appears on the desktop.

There are three editions of ThunderHawk, described in more detail below.

workforce complete access to Internet and corporate intranet Web pages. Enterprise Server allows corporate IT departments to deploy ThunderHawk on their networks, giving their mobile workforce access to crucial corporate data, whether on the road or in the office. Employees can make database inquiries, update inventories, order products and publications, communicate with clients in the field, and schedule services and repairs. It is often more convenient for mobile employees to work with small wireless devices than bulky laptops. Enterprise Server also allows companies to display different interfaces to specific users based on permission levels set in intranet applications, thus ensuring information security and privacy. It gives workforces access to secure corporate data without corporations having to sink excess dollars into building specialized or streamlined applications.

MYFONTS

designers. Traditionally, individual digital fonts and font packages consisting of a variety of fonts have been sold through many different channels including: (1) catalog sales;sales, (2) resellers who typically offer and sell fonts from multiple foundries;foundries, and (3) CD ROMs containing many fonts that can be unlocked by means of a purchased key code. While these approaches to selling fonts are generally satisfactory for professionals, they represent a barrier for the non-professional, casual user who is simply looking for a particular font. For example, if someone sees a font used in a magazine, traditional sales channels offer no quick and easy way of finding out what it is. Even when the name of the font can be determined, it is not obvious where to buy it from among the hundreds, if not thousands, of font foundries offering their fonts through numerous channels. As a result of such obstacles, font sales to non-professionals have historically been almost non-existent. Bitstream believes that this audience represents a large untapped market for fonts, and established MyFonts in 1999 to capitalize on this market. The mission of MyFonts is to make fonts accessible to everyone, which benefits both users and the font foundries.

For the general computer user, fonts have been difficult to find, purchase, and install, and often represent an unknown aspect of theirhis or her desktop environment. MyFonts hopesOur goal is to provide access to fonts for all users, not just graphic arts professionals.

In early 2000, Bitstream officially launched the MyFonts.com, Web site. Created by Bitstreamcreated with the participation of some of the industry’s most influential font foundries, the site provides one of the largest collections of fonts ever assembled. It features new ways to find and purchase fonts on-line, and offers unique typographic resources and a forum for interacting with font experts. As of the date of this filing,March 15, 2006, over 150250 foundries, large and small, domestic and international, participateparticipated as partners with MyFonts to offer their fonts for sale. This represents an aggregate collection of over 34,00045,000 fonts.

Some of the key features of MyFonts.com are: (1) an advanced search feature, which enables customers to browse and locate fonts using keywords both a novice and expert can understand; (2) WhatTheFont^™SM, which

allows customers to scan images of typefaces and upload them to MyFonts.com for identification; (3) the ability to find fonts similar to a particular typeface design using the “Show me more fonts like this…” feature; (4) test driving a font in text the user enters; (5) exploring the world of fonts with links to typographic resources available on the Web;web; (6) the ability to collect fonts into one or more Font Albums for side-by-side comparison and collaborative decision making; and (7) the ability to interactaccess all previously purchased fonts for downloading in cases where the original has been deleted in error.

On May 9, 2005, the Company announced that the U.S. Patent and Trademark Office awarded a patent for MyFonts’ system for selecting and distributing fonts in conjunction with its e-commerce system. MyFonts was awarded the patent, number U.S. 6,853,980 B1, for specific technology underlying MyFonts.com that (1) enables users to find a font expertshaving a particular look or particular features, (2) enables users to upload an image of a font or font shapes, (3) displays fonts on the MyFonts website that most closely match (“pattern match”) the font or image the user is searching for, and fellow(4) allows users on-line, ask questions, or jointo purchase and download the on-line MyFonts Forum.

matching font.

MyFonts is designedtechnology relies on computerized systems to handle virtually allorganize fonts available irrespective of their source. The Company’s strategyin such a way that visitors to MyFonts.com will be able to find a font similar to the one for which they are searching, as accessed through the MyFonts.com Web site is to become the universal“More Fonts Like This” feature and complete sourcethrough keyword searches. MyFonts technology also relies on computerized pattern matching for fonts, from allas accessed through the “WhatTheFont” feature. WhatTheFont is a font vendorsidentifier for users who have found a font they like in a book, magazine, newspaper, or other source, but don’t know its name. WhatTheFont accepts image files of fonts uploaded by users, analyzes the images, and designers. To implement its strategy,then displays the Company approached a number of keyfonts on MyFonts.com that most closely match the font foundries and invited them to participateshapes captured in the MyFonts.com Web site. Three levels of participation are currently available:image.

Bitstream font technology products include:

Bitstream font products include:

Since launching

BROWSING TECHNOLOGY

Today, nearly all information is web-enabled. Yet numerous analysts have found that mobile browsing at the consumer level has monitored salesnot taken off as expected because users do not feel they are getting a true web browsing experience, but rather a “stripped down” version of the Internet. The top issue confronting mobile operators, device manufacturers and feedback from its usersothers involved in disseminating news, commerce and usedentertainment data is how to effectively display this information on a mobile device in order to make ongoing improvementscreate a robust revenue stream in the wireless market.

Recognizing that mobile operators and device manufacturers have a mandate to develop new revenue opportunities in the Web site. Asdata services market in order to remain competitive, we developed ThunderHawk™, a result,mobile browser that covers a full range of operating systems for both high end and mass market mobile phones and PDAs. Mobile operators and device manufacturers offering ThunderHawk provide subscribers with an easy-to-use, familiar interface that bridges the gap between mobile and desktop environments. With ThunderHawk, browsing the web on a cell phone is similar to browsing on the desktop because ThunderHawk technology includes functionality that enhances the end user experience in ways that other browsers do not.

ThunderHawk relies on a server infrastructure combined with a small piece of thin-client code on the mobile phone or PDA. The server infrastructure provides many advantages, the most important being speed and security. A compact transport format and progressive rendering creates a fast, positive user experience that encourages subscribers to browse the web on mobile devices at greater frequencies and intervals. ThunderHawk employs both SSL and 128-bit encryption technology, allowing users to send and receive e-mail, go shopping online and complete other commercial transactions from cell phones and other mobile devices.

The client/server architecture also gives ThunderHawk a high degree of compliance with open HTML standards, including 128-bit encryption both ways, desktop level Java 1.5.0, and JavaScript (ECMA script 262), among others, making fast and full-featured wireless web browsing possible. ThunderHawk does not rely on WAP (Wireless Application Protocol) or cHTML (Compact HyperText Markup Language), removing the need to repurpose content into simplified, “stripped down” websites optimized for small devices. Instead, ThunderHawk offers mobile subscribers a real Internet experience. With sharp text and clear graphics on full HTML web pages, ThunderHawk enables subscribers to view the real web on a mobile device, just as the websites appear on the desktop.

The Company believes thatgained recognition from numerous industry publication, includingSmartphone & Pocket PC magazine,Wireless Week andEntrepreneur. We have been invited to showcase ThunderHawk and discuss mobile browsing technology at leading industry events including iWireless World, Mobile Business Expo, Mobile Enterprise, NetWorld + Interop and the current Web site presents substantially fewer obstacles to findingWireless Security Conference.

Currently, mobile operators, device manufacturers and buying fonts than any other Web site offering fontscorporations can license ThunderHawk technology for sale.Windows Mobile 5.0, 2003 and 2002 Pocket PCs, Windows Mobile 2003 and 2002 Smartphones and Symbian Series60 phones. There are currently four editions of ThunderHawk, which are described in more detail below.

Corporate marketing departments in

PUBLISHING TECHNOLOGIES

In the past fewseveral years, corporate marketing departments have learned to take advantage of the Webweb as a new marketing medium. These departments are becoming familiar with the qualities and opportunities of the new medium, such as the abilities to update information quickly and easily, to generate content pages dynamically directly from corporate databases, and to personalize the customer experience. At the same time, companies are realizing the increased customer loyalty and profits that result from treating customers as individuals. They

recognize the importance of identifying their most valuable customers and lavishing attention on them in a way

tailored specifically to their needs. Marketing industry consultants Don Peppers and Martha Rogers have popularized the notion of marketing to an audience of one. To implement one-to-one communications, all marketing communications must be moved from a one-size-fits-all approach to a custom manufacturing model, in which thousands of variations can be produced at low cost. The market is demanding solutions to implement this one-to-one concept. With the advent of high-speed color printers and digital presses, it is no longer cost-prohibitive to print smaller quantities, whether for localized marketing materials (short-run) or for one-to-one personalized materials (a run of one).

Our publishing products, which are marketed and sold under the Pageflex products and technologiesname, consist of:

the market to enable database-driven personalized output in both print and e-mail. We released Persona Cross Media Suite in December 2005. Among its compelling features are cross-media capabilities for creating coordinated print and e-mail campaigns, variable-length document capability, flexible layouts, and the ability to compose text in more than 60 languages, including Japanese and Chinese. Another key capability is its cross compatibility with Pageflex server-class products, meaning all templates, variables, and projects can be easily reused for web-to-print applications, providing a variety of options for migration and expanded Pageflex configurations.

NuDoc is its ability to dynamically create layout-intensive pages through import of separate content and style files. The Company is making plans to develop its NuDoc composition engine for XSL. This version of NuDoc will make Pageflex solutions based entirely on open standards, using XML for content and XSL for form, and joining them together to create PDF, PostScript, and other output formats.

The Company’s PageflexWe design our publishing products and technologies have been designed to support technological standards. Pageflex isWe are a founding member of the Print On Demand Initiative (PODi), an alliance of key vendors and service providers working in the digital color printing market. PODi members include Adobe, Creo, Electronics for Imaging (EFI), Hewlett-Packard, IBM, Kodak, and Xerox. PageflexWe also participatesparticipate in the PODi Personal Printing Initiative (PPI). The PPI has completed and released a PPML standard harmonizing the ten vendor-specific proprietary protocols currently used to drive digital presses at high speed into one open standard supporting PostScript, PDF, and AFP. PageflexOur publishing software, since its inception, has sought to drive all brands of digital printers. With strong Pageflex input from the Company, PPML has been adopted as a standard across the industry, and Pageflex continueswe continue to play a leading role in thethis standardization program. Pageflex also is actively involved in the Extensible Stylesheet Language (XSL) working group of the World Wide Web Consortium (W3C). Pageflex was invited onto the committee by the chairperson, based on the Company’s years of experience developing style sheet languages. XSL is one of the components of the W3C XML standards effort. Dr. Jeffrey Caruso represents Pageflex and serves along with representatives from Adobe, Sun, IBM, Microsoft, and about twenty other prominent firms. Dr. Caruso worked with Adobe to co-edit the print-oriented formatting part of the standard. In October 2001 the World Wide Web Consortium released XSL 1.0 as a formal W3C Recommendation.

SALES & MARKETING

SalesWe manage our sales and marketing efforts are managed from the Company’sour corporate headquarters in Cambridge, Massachusetts. Sales personnel receive a base salary plus commissions, based on meeting sales targets, with additional commissions for sales in excess of annual targets. The CompanyOur sales and marketing organization focuses on direct sales and marketing activities and on maintaining and expanding reseller and OEM relationships. We also seeksseek to enhance itsour relationships with existing and potential customers and hashave training and technical support teams who work with existing and potential customers, resellers, and strategic partners to support the sales process and to facilitate the implementation and use of the Company’s software products and technologies. Type also has a sales agent based in Tokyo to facilitate OEM sales to Japanese hardware manufacturers.

Type promotes itsWe promote our products through (1) attendance and exhibition at major industry trade shows, (2) participation in booths sponsored by our strategic partners for our publishing technologies, (3) participation in several standards committees, for digital television,(4) advertising in industry publications, (5) engaging in direct marketing activities, (6) our various websites including, www.bitstream.com, www.myfonts.com, and www.pageflex.com., and (7) through its Web site,www.bitstream.com. search engine optimization of websites.

The principal objective of Type’sour marketing strategy for fonts and font technology is to continue to expand the sale of Type’s font technologiesincrease sales to OEMs and ISVs, who integrate Type’sBitstream font technology software into their own products;products, and to continue to expand the saleincrease sales of itsour fonts to retail and corporate customers. OEM and ISV agreements to which we are a party range in size from a license for a small group of typefaces to agreements whereby an entire range of font products and/or technologies are incorporated into the customer’s hardware or software products. As new opportunities arise, the Company intends to evaluate other marketing approaches.

The ThunderHawk sales team is focused on increasing direct sales to corporations and end-users, as well as, on maintaining and expanding relationships with resellers and wireless carriers. The Company promotes its ThunderHawk technologies through attendance and exhibition at major industry trade shows, such as CTIA; through advertising in wireless and PocketPC publications; and through the Web atwww.bitstream.com/wireless. The principal objective of the Company’smarketing strategy for the ThunderHawk browsing technology is to expand awareness of our browsing technologies while generating new business relationships with major mobile operators and device manufacturers. The principal objective of marketing strategy for the publishing technologies is to continue to expand awareness of its browsing technologies to wireless carriers, corporations with mobile work forces, and end users.

Since its inception, MyFonts’ marketing activities have been focused on recruiting participation from font foundries, making Web users aware of MyFonts.com and attracting them to the Web site. Since 2002, the Company has focused marketing efforts for MyFonts.com on increasing awareness of, and sales on, the site. Marketing activities to increase awareness on the part of potential font buyers consists of a tradeshow presence in combination with efforts aimed at building Web links from search engines and other Internet sites, as well as

referrals. To complement this presence, the Company strives to further increase awareness by encouraging editorial coverage in relevant publications and through print and Internet advertising. Analysis of sales results suggests that most of MyFonts.com’s customers find the site by means of search engine queries. The Company has worked and continues to work vigorously to develop and improve its ranking on search engines. In addition, the Company enters into referrer agreements with selected Internet sites that share a portion of revenue in return for referring new customers and has established relationships connecting font management software published by Corel Corporation and Extensis. Using the same technology that enables font managers to handle the purchasing and addition of fonts, MyFonts also provides back-end font searching and e-commerce facilities to other Web sites, includingwww.bitstream.com.

The Pageflex sales and marketing organization is focused on direct sales and marketing activities, as well as, on maintaining and expanding reseller and OEM relationships. Pageflex promotes its products through attendance and exhibition at major industry trade shows such as Direct Marketing and Print on Demand; through participation in booths sponsored by its strategic partners, like EFI, Xerox, and Creo; through advertising in industry publications; and through its Web site,www.pageflex.com. The principal objective of Pageflex marketing strategy is to continue to expand awareness of itsour on-demand marketing software products to Web-to-printweb-to-print providers, digital service and print providers, corporate marketing departments, design firms, advertising agencies, direct mail houses, and

other corporations and end users.

Since 2002, marketing activities for our e-commerce initiative have been focused on recruiting participation from font foundries, making web users aware of MyFonts.com and attracting them to the website. Marketing activities to increase awareness on the part of potential font buyers consists of efforts aimed at building web links from search engines and other Internet sites, as well as referrals. We plan to continue these marketing efforts in the future and, as new opportunities arise, we intend to evaluate other marketing approaches.

CUSTOMERS

Type licenses itsWe license our font and font technology products to a variety of OEM and ISV customers worldwide. The CompanyWe also sellssell custom and other typeface products directly to corporate customers and individual end users. The Company licenses itsusers through various means including sales to consumers worldwide through our e-commerce website. We license our ThunderHawk browsing technology to corporations, wireless carriers andmobile operators, device manufacturers, corporations and consumers. No single Type segment customer accounted for 10% or more ofWe also host ThunderHawk and license the Company’s revenue for any of the years ended December 31, 2003, 2002, or 2001. For the years ended December 31, 2003 and 2001, no single Type customer accounted for 10% or more of the revenue for that segment. For the year ended December 31, 2002, one Type customer accounted for 10% of the revenue for that segment.

MyFonts licenses fontsbrowser directly to consumers worldwide through its e-commerce Web site. No single MyFonts segment customer accounted for 10% or more of the Company’s revenue or the MyFonts segment’s revenue for the years ended December 31, 2003, 2002, or 2001.

Pageflex licenses itsindividual end users who purchase a subscription. We license our publishing products directly to Web-to-printweb-to-print providers, print service providers, marketing services companies, advertising agencies, major corporations and end users, and indirectly through resellers and strategic partners. No single customer of the Pageflex business segment accounted for 10% or more of the total Company revenue for the years ended December 31, 2003, 2002 and 2001, nor did any single Pageflex customer account for 10% or more of that segment’s revenue during those years. The Company intendsWe intend to continue to broaden itsour customer base through increased marketing efforts, by developing relationships with systems integrators, OEMs, and partners in 2004,2006, and by introducing new product offerings.

No customer accounted for 10% or more of our revenue for any of the years ended December 31, 2005, 2004, or 2003. From time to time, product sales to large customers during a single fiscal quarter may constitute more than 10% of Companyour revenue for such quarter. The Company hasWe have broadened and intendsintend to continue to broaden itsour customer base through expanded product offerings and increased marketing efforts. Revenue by geographic area is included in Footnote 109 in the Notes to the financial statementsConsolidated Financial Statements enclosed herewith.

RESEARCH AND DEVELOPMENT

Bitstream is committed to developing innovative software to enhance communications. In particular, we focus on (1) developing the best browsing experience on wirelessmobile devices, and to improve(2) developing premier font technology solutions that render high-quality text imaging. Bitstream is also committed toin any language for any application or device, (3) developing leading-edge technology for its

MyFonts.com, Web site, and (4) advancing our publishing technologies to advancing the Company’s on-demand marketing products and technologies.secure a broader range of market appeal. To accomplish these goals, the Company haswe have invested, and expectsexpect to continue to invest, significant resources in research and development.

During 2003, the Company’s2005, our research and development activities produced:produced the following:

enhancements. Taken together, our support for lossless font compression and our optimized cache manager will benefit applications running on devices with memory and performance constraints, including consumer electronics devices, mobile handsets, set-top boxes and interactive TVs, and other small embedded systems. During 2005, we also continued work on future Font Fusion technologies, including the release of a Font Fusion based solution for Symbian OS. Bitstream integrated the Font Fusion font rendering engine with Symbian OS, the operating system that powers today’s most popular smart phones.

COMPETITION

The Company’sOur font technology products compete with the solutions offered by a variety of companies, including other suppliers of enabling technologies, software application developers, and vendors of computer operating systems. Moreover, the market for the Company’sour enabling technologies and products may be

adversely affected by the extent that computer hardware, operating system, and application software vendors incorporate similar functionality or bundle competitive offerings with their products and thereby reduce the market for the Company’sour technology or products. The competition for the Company’sour sales of typefaces generally comes from a number of comparably sized or smaller

companies offering their own typeface libraries and custom typeface services. Competition with the Company’s enablingour font rendering, font compression, and worldwide text layout technologies principally comes from Agfa Monotype with its iTypeImaging Corp., Arphic, and Universal Font Scaling Technology (“UFST”). UFST has a similar architecture to the Company’s TrueDoc Imaging System (TDIS). The competition for Font Fusion and TrueDoc consists primarily of software from Agfa Monotype, which includes a font rendering technology known as iType and a font compression technology known as MicroType Express. In addition, competition for Font Fusion, btX2, and TrueDoc comes from FreeType, an open source collaborative organization that provides its Linux font rendering code for free. TwoThree limitations of the FreeType organization are (1) its inability to provide fonts; and(2) its inability to provide a license for TrueType hinting, important for rendering readable, legible characters and retaining character shapes at small sizes on low-resolution screens and computer monitors.monitors; and (3) its inability to provide hands-on, one-to-one engineering support. Both Bitstream and Agfa Monotype Imaging can license TrueType hinting technology and fonts to developers. Competitors to our e-commerce initiative, MyFonts.com, include individual font foundry websites and other font-related websites that offer a variety of fonts for sale online.

Bitstream’sOur ThunderHawk browsing technology competes with the browsing solutions offered by a wide variety of companies, including large software companies and small companies focused solely on delivering solutions to a narrow part of the mobile browsing market. Our mobile browser market. The markets for browsing solutions are the subject of intense industry activity,competitors include Microsoft Corp., Opera Software ASA, Access Co., Ltd., and it is likely that a number of software developers are devoting significant resources to developing and marketing technology and products that may compete with the Company’s technology and products. Bitstream believesNovarra Inc. ThunderHawk compares favorably against the competitionthese competitors primarily because of the desktop-like Web browsingbrowser’s client/server technology, which provides many advantages, the most important being user experience, robust code,speed and security. The client/server architecture also gives ThunderHawk a high degree of compliance with open HTML standards. Browser competitors include Pocket Internet Explorer from Microsoft Corporation; Opera for Smartphone/PDA from Opera Software ASA; NetFront from Access Co. Ltd.;standards, making fast and Blazer from PalmOne, Inc. The competing solutions produce a more limitedfull-featured mobile web browsing experience by offering a scrollable view of only a small section of the Web page or by reformatting the page into a tall one-dimensional structure.possible.

Competitors to MyFonts include individual font foundry Web sites and other font-related Web sites that offer a variety of fonts for sale online, including fonts.com, owned and operated by Agfa Monotype. However, MyFonts believes that it has no direct competitors who offer such a wide variety of fonts on one easy-to-use Web site aimed at people who have never previously purchased a font. But there can be no assurance that consumers will prefer to use MyFonts.com over Web sites hosted by individual font foundries.

The Company’s PageflexOur publishing software competes with vendors offering end-to-end solutions and integration services that include on-demand publishing tools. These solutions in turn compete with solutions created by Pageflexour customers. Mpower, .EDIT, and .EDITStorefront are server-based enterprise applications targeted at the customized print or Web-to-printweb-to-print segment of the on-demand publishing market. This market is characterized by rapidRapid technological developments and frequent product introductions.

introductions characterize this market. Competitive solutions also include VDP products bundled with digital presses, or integrated with print-shop management in the print provider market. In the corporate market, competitive solutions include those integrated with marketing campaign management and CRM strategies. Participants in this market compete based on functionality, price, service, customizability, and interoperability with other e-publishing solutions and components. These competitors include Banta, DeskNet, Digital VIP, Saepio, XMPie, Quark DDSPressSense, Printable, GMC, Objectif Lune, and 3B2 Online.XMPie. In addition, Pageflexwe may face new competition from emerging products and technologies. Pageflex believes itsWe believe our publishing products compete favorably based on rich feature sets, ease of use, stability, and scalability.

The Company believesWe believe that the principal competitive factors affecting all of itsour products include product features and functionalities, such as scalability, ease of integration, ease of implementation, ease of use, quality, performance, price, customer service and support, and effectiveness of sales and marketing efforts. Although the Company believeswe believe that itwe currently competescompete effectively with respect to such factors, there can be no assurance that the Companywe will be able to maintain itsour competitive position against current and potential competitors. See “Risk Factors-If we are unable to successfully compete in our markets, our financial results will be negatively affected”.

INTELLECTUAL PROPERTY

The CompanyBitstream relies on a combination of trade secret, copyright, patent, and trademark laws and contractual restrictions to establish and protect proprietary rights in its technology. The Company has entered intoWe are party to confidentiality and invention assignment agreements with itsour employees, and, when obtainable, entersenter into non-disclosure agreements with itsour suppliers, distributors and others so as to limit access to, and disclosure of, itsour proprietary information. There can be no assurance that these statutory and contractual arrangements will prove sufficient to deter misappropriation of the Company’sour technologies or that the Company’sour competitors will not independently develop non-infringing technologies that are substantially similar to or superior to the Company’sour technology. The laws of certain foreign countries in which the Company’sour products are or may be developed, manufactured or licensed may not protect the Company’sour products or intellectual property rights to the same extent as do the laws of the United States and, thus, make the possibility of piracy of the Company’sour technology and products more likely. The Company believesWe believe that, because of the rapid pace of technological change in the software and electronic commerce markets, legal protection for itsour products will be a less

significant factor in the Company’sour future success than the knowledge, ability and experience of the Company’sour employees, the frequency of product enhancements and theour ability of the Company to satisfy itsour customers.

See “Risk Factors-We may not be able to protect our intellectual property rights against piracy, infringement of our patents, or declining legal protection”.

The Company’sOur policy is to apply for U.S. patents with respect to itsour technology and seek copyright registration of itsour technology and trademark registration of itsour marks from time to time when management determines that it is competitively advantageous and cost effective to do so. The Company hasWe have been granted fiveseven patents by the United States Patent and Trademark Office, three of which are directed tofor certain aspects or applications of the Company’s TrueDoc technology;technology, one of which is directed to the Company’sfor our DocLock technology;technology, one for our Font Fusion technology one for our Pageflex technology, and one patent directed to the Company’s Font Fusion technology.for our technology behind our MyFonts.com website. Furthermore, multiple U.S., PCT, EPO, and Japanese applications are pending on some of the Company’s newer technologies. The Company is currently in the process of registering several trademarks and preparing a variety of patent applications relating to MyFonts.com and its Pageflex software. Bitstream^®, Font Fusion^®, TrueDoc^®, T2K^®, MyFonts^® and Cyberbit^® are federally registered trademarks of the Company or its subsidiaries.Company. All other trademarks, service marks or trade names referred to in this Annual Report on Form 10-K are the property of their respective owners.

EMPLOYEES

As of March 15, 2004,2006, the Company employed 5462 persons, including 1316 in sales and marketing, 615 in customer support and consulting, 2421 in research and development, and 1110 in general and administrative functions. Of the Company’s 54our 62 employees, 5158 are full time and 34 are part time. The CompanyWe also retainsretain short-term consultants from time to time to assist itus with particular projects for limited periods of time. The Company believesprojects. We believe that itsour future success will depend in part on itsour ability to attract, motivate and retain highly qualified personnel. None of the Company’sour employees is represented by a labor union and the Company haswe have not experienced any work stoppages. The Company considers itsWe consider our employee relations to be good.

EXECUTIVE OFFICERS OF THE REGISTRANT

The Company’s executive officers and their ages as of March 15, 20042006 are as follows:

Anna M. Chagnon has served as Chief Executive Officer of the Company since October 2003. She has also served as President of the Company since June 2000 and as General Counsel since July 1997. She previously served as Chief Operating Officer from August 1998 to October 2003, and Chief Financial Officer from August 1998 to March 2003. From July 1997 to August 1998, she served in various positions at the Company including Vice President, Finance and Administration, Chief Financial Officer and General Counsel, and Vice President and General Counsel. From November of 1996 to July 1997, Ms. Chagnon was Counsel to Progress Software Corporation, a developer and worldwide supplier of solutions to build, deploy and manage applications across Internet, client/server and host/terminal computing environments. From August 1994 to November 1996, she was an attorney for the Boston law firm of Peabody & Arnold LLP where she specialized in corporate, securities, finance and intellectual property law. She holds a Bachelor of Science degree, summa cum laude, from Northeastern University, a Juris Doctor degree from Boalt Hall School of Law of the University of California at Berkeley, and a Master of Business Administration, summa cum laude, from Babson College.

John S. Collins has been Vice President and Chief Technology Officer of the Company since August 1998. From 1988 to August 1998, he served as Vice President of Engineering. Mr. Collins was the inventorinvented or a co-inventor ofco-invented a number of the patents held by the Companyproducts/technologies relating to font imaging technology. technology for which the Company holds patents.

He is the principal inventor of the Company’s TrueDoc technology. Mr. Collins holds a B.Sc. and a Ph.D. in Electrical Engineering from the University of London.

James P. Dore was named a Vice President and the Company’s Chief Financial Officer in March 2003. From June 1999 to March 2003, he served as the Company’s Corporate Controller for the Company.Controller. From January 1997 to June 1999, Mr. Dore served as Corporate Controller at Celerity Solutions Inc. (bulletin board- CLTY), a developer and marketer of supply chain and warehouse management business software, hesoftware. He also served as Celerity’s Chief Financial Officer and Treasurer from April 1999 to June of 1999. Mr. Dore has over twenty20 years of service in various senior financial positions, holdsis a C.P.A. certificate and holds a B.S. degree, with distinction, from Clarkson University.

Sampo Kaasila has served as Vice President, Research and Development, of the Company since November 2001. Mr. Kaasila serves as the principal architect of the Company’s Font Fusion and ThunderHawk products. From November 1998, when Mr. Kaasila joined Bitstream upon the acquisition of Type Solutions, Inc., to November 2001, he served as Director of Research and Development, Type Solutions. From August 1989 to November 1998, he was a founder and President of Type Solutions, Inc., a leading developer of font technologies including T2K^™T2K™, a font renderer which provides an object oriented design, advanced architecture and algorithms, and a clean API resulting in maximum reliability, performance, and easy integration. From August 1987 to August 1989, Mr. Kaasila worked at Apple Computer Inc. andwhere he was the lead engineer and inventor of the True Type technology now part of every MacIntosh and Windows PC. Mr. Kaasila holds a Masters degree in Electrical Engineering from the Royal Institute of Technology in Stockholm, Sweden where he graduated first in his class in January 1983.

Costas Kitsos has been Vice President of Engineering at the Company since November 1999. Mr. Kitsos heads engineering for the Publishing product line and also serves as a principal architect of the Pageflex Mpower and Persona products, and is also the technical lead for the Company’s end user type application products.architect. From October 1998 to November 1999, he served as Director of Research and Development of the Company. From November 1996 to October 1998, he was a Senior Software Engineer at the Company. Mr. Kitsos is a veteran software developer with over ten15 years experience in type and publishing application development. From May 1987 to November 1996, Mr. Kitsos headed IconWorks, which developed award winning type applications and offered consulting services on end user programs and graphical user interfaces. He holds a Masters degree from the University of California, Los Angeles.

ITEM 1A. Risk Factors

Michael MattozziSet forth below are the risks that we believe are material to our investors. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements in the section above entitled “Special Note about Forward-Looking Statements”.

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 believe that our future results of operations could be affected by various factors including, but not limited to, the following:

If we are unable to successfully compete in our markets, our financial results will be negatively affected.The computer software market is highly competitive and is characterized by rapid technological change and adoption of new industry standards. As the markets in which our products are sold continue to develop and as we enter new markets, we expect to continue to face substantial competition from other software developers and anticipate that additional competitors will enter those markets. Many of our competitors or potential competitors have significantly greater financial, marketing and technical resources than us. These competitors may be able to adapt more quickly to new or emerging technologies and standards or changes in customer requirements and may be able to devote greater resources to the promotion and sale of their products than us. Many of our competitors currently market, or have potential to market, their products directly to the ultimate consumers of such products as part of a broader product offering. There can be no assurance that we will be able to compete successfully against these entities. To compete successfully, we must continue our investment in research and product development and must devote substantial resources to our marketing and sales functions. There can be no assurance that we will have the necessary capital resources to fund such investment.

If we are unable to meet our customers’ demands for cutting-edge products and services, our revenue and operating results may be adversely affected. If we are unable to consistently introduce new products, services, and enhancements, our revenue and operating results are likely to decrease. Any failure by us to anticipate or respond to new technological developments and customer requirements, or any significant delays in product development or introduction, could have a material adverse effect on our business, financial condition and results of operations. New products, when first released by us, may contain undetected errors that, despite quality control measures employed by us, are discovered only after a product has been Vice Presidentintegrated into the OEM and ISV product and used by customers. Such errors may cause delays in product acceptance and may require design modifications which could have a material adverse effect on our business, financial condition and results of operations.

General economic risks may affect our revenue and profitability. Our business may be affected by general worldwide economic conditions and related uncertainties affecting markets in which we operate. Adverse economic conditions could adversely impact our business in 2006 and beyond, resulting in: reduced demand for some of our products; increased pressure on the prices for our products and services; and greater difficulty in collecting accounts receivable. To address this issue, we are pursuing a number of strategies to generate revenue growth, including: identifying new markets for our products; developing new applications for our technologies; allocating research and development funding to products with high revenue potential; and strengthening our presence in selected geographic markets. Due to limited resources, we may not be able to continue to successfully implement these strategies, which could have a material adverse effect on our business, results of operations and financial condition.

Risks related to our international sales. Sales to customers outside the United States represented 20.0% of our revenue for ThunderHawk since August 18, 2003. From April 2001the year ended December 31, 2005. This revenue does not include revenue derived from products sold into the international market by our domestic OEM and ISV customers or foreign purchases downloaded from MyFonts.com . We expect that our international business will continue to March 2003 he served as Area Sales Directoraccount for Business Objects S.A., a leadingsignificant portion of our future revenue. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore less competitive in foreign markets. Additional risks inherent in our international business intelligence software company. From June 2000activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, longer accounts receivable payment cycles, potentially adverse tax consequences, and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have an adverse effect on our future revenue and our results of operations. In addition, our European business is significant and has historically been negatively affected during our fiscal quarter ending September 30 due to March 2001 Mr. Mattozzi served as Vice Presidentthe summer closing or slowdown of Sales, Easternseveral European customers. These seasonal factors have affected, and Canada Regions for SABA Software,may continue to affect, our results of operations.

Failure to attract and retain talented employees would have a leading providermaterial adverse effect on our operations and financial results.Our performance depends to a significant extent on the continued service of human capital developmentour senior management and management solutions. Fromkey technical employees. Our future results will depend upon our ability to attract

January 1998and retain highly skilled technical, managerial, and marketing personnel. Competition for such personnel in the software industry is intense. We rely on competitive compensation packages to June 2000, he servedrecruit and retain highly skilled employees in a competitive environment, but we do not enter into employment agreements with our personnel. There can be no assurance that we will be successful in attracting and retaining the personnel required to sustain our business. Failure to attract and retain such personnel could have a material adverse effect on our business, financial condition and results of operations.

We may not be able to protect our intellectual property rights against piracy, infringement of our patents, or declining legal protection.We regard our software as Vice Presidentproprietary and attempt to protect it with a combination of Sales, Eastern Regioncopyright, patent, trademark, and trade secret laws, employee and third-party nondisclosure agreements and other methods of protection. There can be no assurance that these measures will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. It may be possible for Open Text, Inc., a leaderunauthorized third parties to copy or reverse engineer portions of our products or otherwise obtain and use information that we regard as proprietary. Furthermore, the laws of certain foreign countries in providing Enterprise Content Management solutions. Mr. Mattozzi has over 20 years of experience in sales leadership and has held various sales positions at other companies including Cullinet Software, Image Business Systems, and FileNet. Mr. Mattozzi is a graduatewhich our products are or may be developed, manufactured or sold may not protect our products or intellectual property rights to the same extent as do the laws of the UniversityUnited States and thus make the possibility of Massachusetts at Amherst.unauthorized use of our technologies and products more likely. We also rely on confidentiality agreements with our collaborators, employees, and consultants to protect our trade secrets and proprietary know-how. These agreements may be breached and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by our competitors. In connection with the enforcement of our own intellectual property rights or in connection with disputes relating to the validity or alleged infringement of third-party rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation as part of our policy to vigorously defend our intellectual property rights, including rights derived from third-party licensors. Intellectual property disputes and litigation are typically very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. Adverse decisions in such litigation or disputes could have negative results, including subjecting us to significant liabilities, requiring us to seek licenses from others, preventing us from making, using, selling, distributing, or marketing our products and services in the United States or abroad, or causing severe disruptions to our operations or the markets in which we compete, any one of which could seriously harm our business. Additionally, although we actively pursue software pirates as part of our enforcement of our intellectual property rights, we do lose revenue due to illegal use of our software. If piracy activities increase, it may further harm our business.

Fluctuations in quarterly operating results may have an adverse effect on the market price of our Common Stock.We have previously experienced quarter-to-quarter fluctuations in our operating results as a result of a number of factors including the timing of new product introductions, announcements of new products by us, our competitors or our customers, slower-than-anticipated growth rates of emerging markets, slower adoption of new products and technologies into which our products are incorporated, delays in customer purchases in anticipation of industry developments, and gross margin fluctuations relating to variations in product mix. Furthermore, a significant portion of our expenses are relatively fixed in nature and we may not be able to reduce spending in response to shortfalls or delays in sales. Such shortfalls or delays may result in a material adverse effect on our business, financial condition and results of operations. As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Moreover, we do not operate with a significant backlog and often tend to realize a disproportionate share of our revenue in the last few weeks of a fiscal quarter, thereby impairing our ability to accurately forecast quarter-to-quarter sales results. Due to the foregoing factors, it is likely that in one or more future fiscal quarters our operating results may be below the expectations of public market analysts and investors. Such an event could have a material adverse effect on the market price of our Class A Common Stock which could have a negative effect on our ability to obtain additional funding, if necessary, on terms favorable to us.

Changes in accounting rules may adversely affect our financial results and the price of our Class A Common Stock. We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. These principles are subject to interpretation by the American Institute of Certified Public Accountants, the SEC, the Public Company Accounting Oversight Board, and various bodies formed to interpret and create appropriate accounting policies. A change in these principles and policies could have a significant impact on our reported results and may even retroactively affect previously reported transactions. Changes to these rules may have a material adverse effect on future financial results or in the way in which we conduct our business. For example, in December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) 123(R) which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in our consolidated statements of income. We were required to adopt SFAS 123(R) in the reporting period beginning January 1, 2006. Although we have not yet determined whether the adoption of SFAS 123(R) will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are evaluating the requirements under SFAS 123(R) and expect the adoption to have a significant adverse impact on our future consolidated statements of income and net income per share. Additionally, to avoid the additional expense resulting from having to expense option grants, we may refrain from granting additional options, which may make it more difficult for us to attract and retain skilled technical, managerial and marketing personnel.

Changes in tax rates and regulations.Changes in tax rates could adversely affect our future results of operations. Increases in tax rates or changes in how taxes are assessed could increase our tax liabilities, which would negatively affect our financial results and cash flow.

ITEM 1B. Unresolved Staff Comments

None.

ITEM 2. Properties

The Company’sBitstream’s corporate headquarters are located in Cambridge, Massachusetts where the Companywe currently leaseslease approximately 18,000 square feet under an operating lease expiringthat commenced in September 2003 and expires in August 2009. The minimum annual base rent including operating expenses, property taxes and assessments iswas approximately $424,000 for the first two years with the first six months abated, $460,000is $464,000 for years three and four, and $478,000will be $482,000 for years five and six.

The CompanyWe also leaseslease a small engineering office in Plaistow, New Hampshire for approximately $1,000 per month on a month to month basis.

Management believesWe believe that these facilities are adequate for our current needs. As the Company’s current needs andCompany continues to grow additional space may be required. We believe that suitable additional space, should it beif needed, will be available to us on commercially reasonable terms.

ITEM 3. Legal Proceedings

On June 24, 2003, Monotype Imaging, Inc. (formerly Agfa Monotype CorporationCorporation) and International Typeface Corporation filed a complaint in the U.S. District Court for the Northern District of Illinois Eastern Division claiming that the Company,we, through itsour TrueDoc software, infringesinfringe trademarks and copyrights and violatesviolate the Digital Millennium Copyright Act. The complaint fails to identify anyA judge of the plaintiffs’ trademarksU.S. District Court for the Northern District of Illinois Eastern Division ruled in our favor on all counts. In her opinion issued on July 12, 2005, the Judge found that we were not liable under any claims of contributory infringement, contributory trademark infringement, or copyrightsinfringement under the Digital Millennium Copyright Act. Previously, on April 21, 2005, the court held that we were not liable under claims for direct copyright or trademark infringement or for vicariously infringing Monotype Imaging, Inc.’s and International Typeface Corporation’s copyrights. We have been allegedly infringed and does not specify any amountnotified that Monotype Imaging, Inc. has filed a Notice of monetary damages. The plaintiffs do seek injunctive relief, butAppeal with the court. While we cannot predict with certainty the outcome of the appeal, we do not makeexpect any statement that anymaterial adverse impact to our business, or the results of the alleged acts have actually taken place. The Company is contesting these claims.our operations, from this matter.

From time to time, in addition to the infringement case identified above, the Company iswe 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. In accordance with generally accepted accounting principles, the Company makeswe 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 December 31, 20032005 and 2004, no liability has beenwas recorded. Litigation is inherently unpredictable and it is possible that the Company’sour financial position, cash flows, or results of operations could be materially affected in any particular period by the resolution of one or more of these contingencies or the costs involved in seeking the resolution of these contingencies.

ITEM 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2003.

2005.

PART II

ITEM 5. Market for Registrant’s Common Equity and Related Stockholder Matters

MARKET INFORMATION

The Class A Common Stock of Bitstream began trading publicly on the Nasdaq National Market on October 30, 1996 under the symbol “BITS”. Effective February 28, 2003, the Company’sdue to an amendment to Nasdaq’s continued listing standard, we transferred our Class A Common Stock was transferred from the Nasdaq National Market to the Nasdaq Small Cap market. The application to transfer to the Nasdaq Small Cap Market was made

in response to a notice from Nasdaq that the Company was not compliant with Nasdaq’s new continuing listing requirement, which became effective November 1, 2002. Nasdaq changed its National Market System continued listing standard from a minimum $4,000,000 net tangible asset requirement to a minimum $10,000,000 stockholders’ equity requirement. Bitstream did not comply with the $10,000,000 stockholders equity requirement, as its stated equity as of December 31, 2002 was $6,000,000. Upon consideration of the factors involved, the Company elected to transfer from the Nasdaq National Market. Bitstream’s common stock continues to trade under its current symbol BITS.

The Class A Common Stock of the Company began trading publicly on the Nasdaq National Market tier of The Nasdaq Stock Market on October 30, 1996 under the symbol “BITS”.same symbol. Prior to October 30, 1996, there was no public market for Bitstream’sour Class A Common Stock.

The following table sets forth the high and low closing sale prices of the Company’sbid information for our Class A Common Stock as reported on the Nasdaq National Market for the period commencing January 1, 2002 and ending February 27, 2003, and on the NASDAQ Small Cap Market for the period commencing February 28, 2003 and ending December 31, 2003.periods indicated. Such information reflects interdealer prices, without retail markup, markdown, or commission, and may not represent actual transactions.

As of March 15, 2004, the Company’s2006 our Class A Common Stock was held by approximately 100 holders of record and the Company believeswe believe that the Company’sour Class A Common Stock was beneficially held by more than 500 holders. The Company’sOur non-voting Class B Common Stock was not held by any holders of record.

DIVIDENDS

The CompanyBitstream has never declared or paid cash dividends on its capital stock. The CompanyWe currently intendsintend to retain earnings, if any, to support itsour growth strategy and doesdo not anticipate paying cash dividends on itsour capital stock in the foreseeable future.

RECENT SALES OF UNREGISTERED SECURITIES

During the years ended December 31, 2005, 2004, and 2003, 2002, and 2001, the CompanyBitstream issued an aggregate of 97,904, 46,832,45,002, 192,367, and 499,11797,904 shares, respectively, of Class A Common Stock in connection with the exercise of vested options and warrants issued under the Company’sour 1994 Stock Plan, 1996 Stock Plan, 1997 Stock Plan, and 2000 Stock Plan. There were no unregistered securities sold by the Companyus during the three years ended December 31, 2003.2005. The sales and issuances of securities in the transactions described above were deemed to be exempt from registration under the Securities Act of 1933, as amended, by virtue of Rule 701 promulgated thereunder, in that they were issued either pursuant to written compensatory benefits plans or pursuant to a written contract relating to compensation, as provided by Rule 701. In addition, on October 25, 2001, the Companywe filed a Registration Statement on Form S-8 under the Securities Act of 1933, as amended, registering up to an aggregate of 1,000,000 shares of the Company’sour Bitstream Class A Common Stock, par value $0.01 per share, which may be issued upon exercise of stock options and warrants granted or which may be granted under the Company’sour 2000 Stock Plan. For a discussion of the Company’s equity compensation plans, see Note 7- Stockholders’ Equity of the Notes to Consolidated Financial Statements included herein.

ITEM 6. Selected Consolidated Financial Data

The selected consolidated financial data presented below as of December 31, 20032005 and 2002,2004 and for the three years then ended hasDecember 31, 2005 have been derived from, and are qualified by reference to, the Company’s consolidated

financial statements, which have been audited by an independent accountants,registered public accountant, whose reports thereon are included elsewhere in this Report.report. The selected consolidated financial data presented below as of December 31, 2003, 2002 and 2001, 2000, 1999, and for the two years ended December 31, 2000 and 19992002 have been derived from, and are qualified by reference to, the Company’s audited financial statements, which are not included in this Report.report. The selected consolidated financial data set forth below should be read in conjunction with, and are qualified by reference to, the Consolidated Financial Statements of the Company and Notes thereto, the section below entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Report,, and other financial data appearing elsewhere herein.

SELECTED CONSOLIDATED FINANCIAL DATA,

(in thousands, except per share amounts).

The consolidated financial statements for fiscal years 1999 through 2001 were audited by Arthur Andersen LLP, which has ceased operations. A copy of the report previously issued by Arthur Andersen on the Company’s financial statements as of December 31, 2001 and 2000, and for each of the three years in the period ended December 31, 2001, is included elsewhere in this document. Such report has not been reissued by Arthur Andersen.

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CRITICAL ACCOUNTING POLICIES

The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect the Company’s reported and expected financial results. Note that the Company’sour preparation of this Annual Report on Form 10-K requires itus to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Revenue Recognition

The Company derives revenue from the sale of its software products, professional consulting, and support and maintenance services. LicenseWe recognize license revenue is recognized when persuasive evidence of an agreement exists, the

product has been delivered or services have been provided, the fee is fixed or determinable, and collection of the fee is probable. From time to time the Company willwe enter into extended payment programs with creditworthy customers. RevenueWe recognize revenue related to extended payment programs is recognized when payment becomes due to the Company. In making itsour decision to recognize revenue the Companywe must make a determination of the credit worthiness of itsour customer. This determination involves management judgment and while management believes that it can make reliable judgments, there is no guarantee that the revenue recognized will be collected. The credit worthiness of customers is further analyzed in connection with the Company’s accounts receivable.section below entitled “Accounts Receivable”.

The Company recognizesWe recognize revenue under multiple-element arrangements using the residual method when vendor-specific objective evidence (“VSOE”) of fair value exists for all of the undelivered elements under the arrangement. The Company hasWe have established sufficient VSOE for the value of itsour consulting, training, and other services, based on the price charged when these elements are sold separately. Accordingly, software license revenues are recognized under the residual method in arrangements in which software is licensed with consulting, training or other services. The Company’sOur products and the industries in which theywe compete are not static and the determination of VSOE involves judgment. Management believes that itwe will continue to be able to use the residual method for recognizing license revenue under multiple-element arrangements. If, the Company wasfor any reason, we are unable to continue to use the residual method, it could affect the timing of revenue recognition could be affected and, thusconsequently, the trends that the Company iswe are currently experiencing.

ProfessionalOur professional services include custom font design, andconsulting services, development, and training. The Company recognizesWe recognize professional services revenue under software development contracts as services are provided for per diem contracts or by using the percentage-of-completion method of accounting for long-term fixed price contracts. Provisions for any estimated losses on contracts in progress are made in the period in which such losses become probable. The CompanyWe had no long-term contracts in progress as of December 31, 2003.2005.

RevenueWe recognize revenue from end user product sales is recognized upon delivery of the software, net of estimated returns and allowances, if collection is probable. The Company estimatesWe estimate returns and allowances based on historical rates and as of December 31, 2003 does2005, we did not have a reserve asbecause returns and allowances have been negligible. If and when a reserve is necessary the Companywe would reduce revenue recognized for estimated future returns at the time the related revenue is recorded. TheWe periodically adjust estimates for returns are adjusted periodically based upon historical rates of return. While management believes that it can make reliable estimates, it is possible that these estimates will change in the future or that actual amounts could vary materially from our estimates.

The Company

We generally warrantswarrant that itsour products will function substantially in accordance with documentation provided to customers for approximately 90 days following initial delivery. As of December 31, 2003, the Company2005, we had not incurred any expense related to warranty claims. The Company estimatesWe estimate reserves based on historical rates and, accordingly, hashave not recorded a warranty reserve. While management believes that itwe can make reliable estimates, it is possible that these estimates will change in the future or that actual amounts could vary materially from our estimates.

Please refer to Note 1 of the Company’s Notes to Consolidated Financial Statements for further information on itsour revenue recognition policies.

Impairment of Long-Lived Assets

In accordance with the Statement of Financial Accounting Standards (“SFAS”)SFAS No. 142,Goodwill and Other Intangible Assets, the Company tested recorded goodwill attributable to each reporting unit for impairment. ManagementWe have determined that we do not have separate reporting units and thus goodwill is combined and valued based upon an enterprise wide valuation. We conducted impairment testing as of December 31, 20032005 and determined that the fair value of its reporting units werethe enterprise was greater than the carrying values for those units. Thoughvalue. Although none of the unamortized goodwill was impaired, there can be no assurance that, whenupon completion of a future review, is completed a material impairment charge will not be recorded. SFAS No. 142 required certain disclosures upon adoption that the Company haswe have included in Note 1(j)1(k) in the Notes to the Consolidated Financial Statements included herewith.

Accounts receivableReceivable

The Company performsWe perform ongoing credit evaluations of itsour customers and adjustsadjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by the Company’sour review of their current credit information. The CompanyWe continuously monitorsmonitor collections and payments from customers and maintainsmaintain a provision for estimated credit losses based on itsour historical experience and any specific customer collection issues that the Company has identified.we identify. While such credit losses have historically been within the Company’sour expectations and appropriate reserves have been established, the Companywe cannot guarantee that itwe will continue to experience the same credit loss rates that it haswe have experienced in the past.

Income taxesTaxes

As part of the process of preparing consolidated financial statements the Company iswe are required to estimate itsour income taxes in each of the jurisdictions in which it operates.we operate. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within itsour consolidated balance sheet. The CompanyWe must then assess the likelihood that itswe will recover our deferred tax assets will be recovered from future taxable income and, to the extent the Company believes thatwe believe recovery is not likely, itunlikely, we must establish a valuation allowance. To the extent the Company establisheswe establish a valuation allowance or increasesincrease this allowance in a period, itwe must include an expense within the tax provision in the statement of operations. Significant management judgment is required in determining the Company’sDetermination of our provision for income taxes, the Company’sour deferred tax assets and liabilities and any valuation allowance recorded against the Company’sour net deferred tax assets. The Company hasassets requires significant management judgment. We have fully reserved against itsour tax asset. The valuation allowance isassets due to uncertainties related to the Company’sour ability to utilize itsour deferred tax assets, primarily consisting of certain net operating losses carried forward and foreign tax credits, before they expire. TheWe base our valuation allowance is based on the Company’sour estimates of taxable income by jurisdiction in which the Company operateswe operate and the period over which itsour deferred tax assets will be recoverable. The determination of the valuation allowance requires the Companyus to make estimates, which the Companywe cannot guarantee will prove to be accurate.

OVERVIEW

Bitstream Inc. is a software development company that focusesmakes communications compelling. We enable customers worldwide to render high-quality text, browse the web on wireless devices, select from the presentationlargest collection of data. Its core competencies includefonts online, and customize documents over the Internet. We categorize our products and technologies into three product lines consisting of (1) fonts and font technology, (2) browsing technology, e-commerce technology, and (3) publishing technology. Bitstream’s offering is made up of four distinct product lines: type

Fonts and type technology, and ThunderHawk, which are both reported under the Company’s Type business segment (“Type”), MyFonts.com (“MyFonts”) and Pageflex.font technology. Bitstream is a leading developer of font technology solutions that enable developers to display high-quality text in any language for any device or application. We work with partners from around the world to provide complete text composition and font rendering solutions for consumer electronics devices, mobile handsets, set-top boxes, digital fonts,TVs, printers, graphics and custom font designs.software applications, and embedded systems. Our solutions include Bitstream licenses its TrueDoc^®Panorama™ for text composition and Font Fusion^® technologies to Webfor font rendering. Bitstream font technology supports all international languages. With our technology developers can render any scalable industry-standard and applicationcompact font format. Developers rely on Bitstream for complete font solutions, including a certified Simplified Mainland Chinese font, MobileFonts™, the Tiresias Screenfont, the Closed Captioned TV (CCTV) Font Set, the TV Font Pack, delta-hinted screen fonts, and compact stroke-based Asian fonts. Bitstream also delivers high-quality font solutions for developers, ad agencies, graphic designers, desktop publishers, corporations, small businesses, and to manufacturers of information appliances, wirelesshome office users. Our world-renowned library includes over 1,000 high-quality fonts in OpenType, TrueType, and handheld devices, set-top boxes, embedded systems,PostScript Type 1 formats for Windows, Macintosh, Unix, and printers. ThunderHawkLinux. We also sell our fonts and fonts from other foundries and designers on MyFonts.com^{™ SM} is a client-server technology that brings full-featured wireless Web browsing to mobile devices. It gives customers complete Internet access to real Web pages while maintaining full text legibility. Now in alpha release, ThunderHawk SmartPhone Edition enables users to browse the Web on SmartPhones. ThunderHawk PocketPC Edition allows consumers to browse the Web on Pocket PC devices. ThunderHawk Enterprise Server is a client-server technology for corporations and telecommunications companies. Providing wireless Web browsing across networks, it gives a mobile workforce complete access to Internet and corporate intranet Web pages. MyFonts.com^™ is, a showcase of the world’s fonts available from one easy-to-use Web site. Itwebsite. MyFonts.com provides the largest collection of fonts ever assembled for on-line delivery, and offers easy ways to find and purchase fonts on-line. MyFonts.com also offers unique typographic resources for research and forumsreference, including WhatTheFont ^SM, a unique font identifier that accepts image files of fonts uploaded by users, analyzes the images, and then displays the fonts on the MyFonts.com site that most closely match the font shapes captured in the image.

Browsing technology. Our browsing technology, ThunderHawk™, is a client-server technology that brings full-featured wireless web browsing to mobile devices. It gives mobile subscribers complete access to real web pages while maintaining full text legibility. Both ThunderHawk Smartphone Edition and ThunderHawk Symbian Series60 (S60) Edition enable subscribers to browse the web on high-end mobile phones. ThunderHawk PocketPC Edition allows mobile subscribers to browse the web on PDAs. ThunderHawk Enterprise Server is a client-server technology for interactingmobile operators, device manufacturers and corporations, allowing them to provide users with font experts. Pageflexan easy-to-use, familiar interface that bridges the gap between mobile and desktop environments.

^™ technologiesPublishing technology. Our publishing technology is the technology of choice for web-to-print applications and sophisticated personalized communications based on customer information. Smart templates ensure that design integrity and brand identity standards are rigorously maintained, while empowering local users on a brand-controlled publishing portal to customize and localize collateral and campaigns. With Pageflex-powered sites, global control with local empowerment is a reality. Database-driven personalization campaigns, which can include print, e-mail, and personalized web microsite components, enable graphic-rich, highly designed marketing communications to deliver highly targeted and relevant content on an individual basis. We pioneered flexible variable data software with its debut in 1997 and have pioneeredbeen a new directiontechnology innovator in composition software: Web-top publishing. Web-topthe variable output and web-to-print customization arena ever since. Our publishing software helps novice users create high-quality printed products using intelligent, flexible templates, without installing or learning any new desktop publishing software.technology powers on demand marketing portals for printers, advertising agencies, marketing services companies and corporate marketing departments worldwide.

Pageflex templates are intelligent and flexible because professional designers can set rules to define which elements can change, how much they can change, and who can change them. Pageflex products thus maintain corporate identity and design integrity while enabling sophisticated customizing of documents

FORWARD LOOKING STATEMENTS

Except for the historical information contained herein, this Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, without limitation, market acceptance of the Company’s products, competition and the timely introduction of new products. Additional information concerning certain risks and uncertainties that would cause actual results to differ materially from those projected or suggested in the forward-looking statements is contained in the Company’s prior filings with the Securities and Exchange Commission, including those risks and uncertainties discussed in the Company’s final Prospectus, dated October 30, 1996, included as part of the Company’s Registration Statement on Form S-1 (333-11519), in the section entitled “Risk Factors.” The forward-looking statements contained herein represent the Company’s judgment as of the date of this report, and the Company cautions readers not to place undue reliance on such statements. Management undertakes no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

The Company is subject to risks common to technology-based companies, including dependence on key personnel, rapid technological change, competition from alternative product offerings and larger companies, and challenges to the development and marketing of commercial products and services. We believe that our future results of operations could be affected by various factors, including the following:

The computer software market is highly competitive and is characterized by rapid technological change and adoption of new industry standards. As the markets in which the Company’s products are sold continue to develop and as the Company enters new markets, the Company expects to continue to face substantial competition from other software developers and anticipates that additional competitors will enter those markets. Many of the Company’s competitors or potential competitors have significantly greater financial, marketing and technical resources than the Company. These competitors may be able to adapt more quickly to new or emerging technologies and standards or changes in customer requirements or may be able to devote greater resources to the promotion and sale of their products than the Company. Many of these competitors currently market, or can potentially market, their products directly to the ultimate consumers of such products as part of a broader product offering. There can be no assurance that the Company will be able to compete successfully against these entities. To compete successfully, the Company must continue to invest in research and product development and must devote substantial resources to its marketing and sales functions. There can be no assurance that the Company

will have the necessary capital resources to fund such investment. Also, if we are unable to consistently introduce new products, services, and enhancements, our revenue and operating results are likely to decrease. Any failure by the Company to anticipate or respond to new technological developments and customer requirements, or any significant delays in product development or introduction, could have a material adverse effect on the Company’s business, financial condition and results of operations. New products, when first released by the Company, may contain undetected errors that, despite quality control measures employed by the Company, are discovered only after a product has been integrated into the OEM and ISV product and used by customers. Such errors may cause delays in product acceptance and may require design modifications which could have a material adverse effect on the Company’s business, financial condition and results of operations.

Our business may also be affected by general worldwide economic conditions and related uncertainties affecting markets in which we operate. Adverse economic conditions could adversely impact our business in 2004 and beyond, resulting in: reduced demand for some of our products; increased pressure on the prices for our products and services; and greater difficulty in collecting accounts receivable. For example, revenue from our Type segment’s font and font technology product lines decreased during the year ended December 31, 2003 as compared to 2002. The continuing weakness in the economy and aggressive competition among printer manufacturers is contributing to lower average selling prices of printers, which may result in attempts to reduce our royalty arrangements or may cause our printer customers to pursue alternative technologies. To address this issue, we are pursuing a number of strategies to generate revenue growth, including: identifying new markets for our products; developing new applications for our technologies; allocating research and development funding to products with high revenue potential; and strengthening our presence in selected geographic markets. Our investments in our Pageflex and ThunderHawk technologies reflect our commitment to these strategies. Due to limited resources, we may not be able to continue to successfully implement these strategies, which could have a material adverse effect on our business, results of operations and financial condition.

Sales to customers outside the United States represented 20.9% of the Company’s revenues for the year ended December 31, 2003. This revenue does not include revenue derived from products sold into the international market by the Company’s domestic OEM and ISV customers or foreign purchases downloaded from the Company’s Myfonts.com and Bitstream.com Web sites. The Company expects that its international business will continue to account for a significant portion of its future revenues. An increase in the value of the U.S. dollar relative to foreign currencies could make the Company’s products more expensive and therefore less competitive in foreign markets. Additional risks inherent in the Company’s international business activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, longer accounts receivable payment cycles, potentially adverse tax consequences, and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have an adverse effect on the Company’s future revenues and the Company’s results of operations. In addition, the Company’s European business is significant and has historically been negatively affected during the three months ended September 30th due to the summer closing or slowdown of several European customers. These seasonal factors have affected, and may continue to affect, the Company’s quarterly results of operations.

The Company’s performance depends to a significant extent on the continued service of its senior management and key technical employees. The Company’s future results will depend upon its ability to attract and retain highly skilled technical, managerial, and marketing personnel. Competition for such personnel in the software industry is intense. We rely on competitive compensation packages to recruit and retain highly skilled employees in a competitive environment, but we do not enter into employment agreements with our personnel. There can be no assurance that the Company will be successful in attracting and retaining the personnel required to sustain its business. Failure to attract and retain such personnel could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company regards its software as proprietary and attempts to protect it with a combination of copyright, patent, trademark, and trade secret laws, employee and third-party nondisclosure agreements and other methods of protection. There can be no assurance that these measures will be adequate or that the Company’s competitors

will not independently develop technologies that are substantially equivalent or superior to the Company’s technologies. It may be possible for unauthorized third parties to copy or reverse engineer portions of the Company’s products or otherwise obtain and use information that the Company regards as proprietary. Furthermore, the laws of certain foreign countries in which the Company’s products are or may be developed, manufactured or sold may not protect the Company’s products or intellectual property rights to the same extent as do the laws of the United States and thus make the possibility of unauthorized use of the Company’s technologies and products more likely. We also rely on confidentiality agreements with our collaborators, employees, and consultants to protect our trade secrets and proprietary know-how. These agreements may be breached and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by our competitors. In connection with the enforcement of our own intellectual property rights or in connection with disputes relating to the validity or alleged infringement of third-party rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation as part of our policy to vigorously defend our intellectual property rights, including rights derived from third-party licensors. Intellectual property disputes and litigation are typically very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. Adverse decisions in such litigation or disputes could have negative results, including subjecting us to significant liabilities, requiring us to seek licenses from others, preventing us from making, using, selling, distributing, or marketing our products and services in the United States or abroad, or causing severe disruptions to our operations or the markets in which we compete, any one of which could seriously harm our business. Additionally, although we actively pursue software pirates as part of our enforcement of our intellectual property rights, we do lose revenue due to illegal use of our software. If piracy activities increase, it may further harm our business.

The Company has previously experienced quarter-to-quarter fluctuations in its operating results as a result of a number of factors including the timing of new product introductions, announcements of new products by the Company, its competitors or its customers, slower-than-anticipated growth rates of emerging markets, slower adoption of new products and technologies into which the Company’s products are incorporated, delays in customer purchases in anticipation of industry developments, and gross margin fluctuations relating to variations in product mix. Furthermore, a significant portion of the Company’s expenses are relatively fixed in nature and the Company may not be able to reduce spending in response to shortfalls or delays in sales. Such shortfalls or delays may result in a material adverse effect on the Company’s business, financial condition and results of operations. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Moreover, the Company does not operate with a significant backlog and often tends to realize a disproportionate share of its revenues in the last few weeks of a fiscal quarter, thereby impairing the Company’s ability to accurately forecast quarter-to-quarter sales results. Due to the foregoing factors, it is likely that in one or more future fiscal quarters the Company’s operating results may be below the expectations of public market analysts and investors. Such an event could have a material adverse effect on the market price of the Company’s Class A Common Stock which could have a negative effect on the Company’s ability to obtain additional funding, if necessary, on terms favorable to the Company.

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. These principles are subject to interpretation by the American Institute of Certified Public Accountants (the “AICPA”), the Securities and Exchange Commission (the “SEC”) the Public Company Accounting Oversight Board (the “PCAOB”) and various bodies formed to interpret and create appropriate accounting policies. A change in these principles and policies could have a significant effect on our reported results and may even retroactively affect previously reported transactions. For example, a proposed change to the method for accounting for stock options, if adopted, could result in the Company recognizing additional expense upon the grant of such options, which, could have an adverse effect on the Company’s financial results. Additionally, to avoid the additional expense resulting from having to expense option grants, the Company may refrain from granting additional options, which may make it more difficult for the Company to attract and retain

skilled technical, managerial and marketing personnel. Changes to these rules may have a significant adverse effect on future financial results or in the way in which we conduct our business.

Unanticipated changes in tax rates could adversely affect our future results of operations. Increases in tax rates or changes in how taxes are assessed could increase the Company’s tax liabilities, which would negatively effect the Company’s business and financial results.

RESULTS OF OPERATIONS

Certain prior year account balances have been reclassified to be consistent with the current year’s presentation. The following table sets forth the percentage of revenue represented by certain items reflected in the Company’s Statements of Operations Data for the periods presented:

		Years Ended December 31,
		2005			2004			2003
Revenue
Software licenses		84.0	%		84.3	%		87.3	%
Services		16.0			15.7			12.7
Total revenue		100.0			100.0			100.0
Cost of revenue
Software licenses		27.6			27.5			25.5
Services		7.8			7.1			5.5
Total cost of revenue		35.4			34.6			31.0
Gross profit		64.6			65.4			69.0
Operating expenses:
Marketing and selling		18.8			22.7			27.3
Research and development		25.1			33.7			39.9
General and administrative		14.1			15.3			20.0
Total operating expenses		58.0			71.7			87.2
Operating income (loss)		6.6			(6.3	)		(18.2	)
Other income (expense), net		0.3			1.4			6.6
Benefit from (Provision for) income taxes		(0.3	)		(0.4	)		(0.8	)
Net income (loss)		6.6	%		(5.3	)%		(12.4	)%

YEAR ENDED DECEMBER 31, 20032005 COMPARED TO THE YEAR ENDED DECEMBER 31, 20022004

(in thousands, except percent amounts)

Consolidated Gross Profit:

The increase in revenue from software licenses for the year ended December 31, 20032005 as compared to the year ended December 31, 20022004 was attributable to an increaseincreases in font and font technology, and publishing product lines. License revenue in the Company’s MyFonts and Pageflex segments of $1,020 and $899, respectively, partially offset by a decrease in Type segment revenue of $660. Cost of revenuefrom direct sales, which include e-commerce sales, increased for the same periods due$2,564, or 40.6% to increased royalty expense for the Company’s MyFonts and Pageflex segments and increased service costs for the Type segment. Cost of revenue for the Company includes royalties and fees paid to third parties for the development or license of rights to technology and/or unique typeface designs, costs incurred in the fulfillment of custom orders, and costs associated with the duplication, packaging and shipping of product. Gross profit generated by each segment is discussed in more detail below.$8,874

Type Gross Profit:

The decrease in revenue for the year ended December 31, 20032005 as compared to $6,310 for the year ended December 31, 2002 was primarily2004. License revenue from resellers increased $344, or 32.4%, to $1,405 for the resultyear ended December 31, 2005 as compared to $1,061 for the year ended December 31, 2004. License revenue from OEMs and ISVs increased $443, or 18.2%, to $2,877 for the year ended December 31, 2005 as compared to $2,434 for the year ended December 31, 2004. The increases in direct and reseller revenue were due to increases in volume and variety of a decreasefonts and publishing products being licensed throughout 2005. The increase in OEM and ISV revenue was due to an increase in new licenses, as well as license renewals and royalties received under existing license agreements because of increases in reported unit shipments by certain OEM customers. We believe that new customer acquisition, current customers adding licenses for existing and new products and additional unit shipments reported by OEM customers will result in increased revenue of $489, a decrease in retail font product sales of $206 and a decreasefor 2006.

The increase in revenue from custom design services of $8, partially offset by an increase in retail ThunderHawk sales of $42. Retail sales of the Company’s Type products and custom design work have decreased during the past year because of consumer concerns about the economy and decreases in spending on

development efforts by high-technology customers. Cost of licenses for the same periods has decreased primarily because of the decrease in revenue, while cost of services increasedwas primarily due to costs incurred upon the establishment of a serviceincreases in maintenance and support structurecontracts associated with our publishing product line and increases in consulting services for both our publishing and font and font technology product lines. Service revenue from direct sales increased $513, or 46.3%, to $1,621 for the Company’s browser technologyyear ended December 31, 2005 as compared to $1,108 for the year ended December 31, 2004. Service revenue from resellers increased $118, or 56.7%, to $326 for the year ended December 31, 2005 as compared to $208 for the year ended December 31, 2004. Service revenue from OEMs and ISVs increased $39, or 7.6%, to $550 for the year ended December 31, 2005 as compared to $511 for the year ended December 31, 2004. These increases were primarily driven by increases in our customer base and customer demand for consulting and design services. We believe that our revenue from support and consulting will continue to grow during 2003.2006.

The Company’s Type business recognizes fontWe recognize license revenue from direct sales and licensing agreements of our products and products from third parties including e-commerce sales made via our websites, licensing agreements with OEMs and ISVs, and from the resale of its fontour products through various resellers. Resellers have an electronic digital format of the company’s font products available to them through the Bitstream Manufacturing System (“BMS”). This system is installed on their servers and allows them to “manufacture” a font for sale to a customer. The BMS system tracks the fonts sold and generates a monthly sales report, which is sent by theWe recognize reseller to Bitstream. Revenue is recognizedrevenue 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.

MyFonts Gross Profit:

MyFonts continued to be successful in increasing the number of fonts available on its Web site, the number of foundries participating, and the number of consumer accounts. Myfonts has attracted new purchasers while also retaining existing customers. Existing customers accounted for approximately 30% of orders during 2003 and 2002. Inter-company E-commerce sales which MyFonts generatedinclude revenue from the resalelicensing of Bitstream fonts and font technology, licensing of the ThunderHawk 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 been excluded. Cost of revenue increased primarily due to an increase in royalties and referrer fees due to increased revenue, and an increase in shipping, packaging and handling costs due toreferral agreements. Referral income for the increase in products sold that must be physically shipped. Cost of revenue as a percentage of sales, however has decreased as the Company has negotiated lower royalty percentages to be paid to third party foundries and because of a lower royalty paid on sales of CD products.

MyFonts currently recognizes revenue from referral agreements (Level 1 agreements) and resale agreements (Level 2 agreements). Referral revenue for yearyears ended December 31, 20032005 and 2004 was $14 versus$17 and $13, for the year ended December 31, 2002. All other revenue recognized by MyFonts resulted from Level 2 agreements under which MyFonts sells the fonts directly from its site(s).respectively. There are only minimal costs to the Level 1 program, whichassociated with referral revenue, and such costs primarily represent the time to load copies of the fonts provided by each participating foundry for addition to the MyFonts database, and the Company expensesMyFonts.com database. We expense those costs as incurred.

Pageflex Gross Profit:

The increase in Pageflexcost of license revenue for the year ended December 31, 20032005 as compared to the year ended December 31, 20022004 was due to increases in direct license sales and services of $845, and reseller license sales and services of $75, partially offset by decreases in OEM related sales and services of $21. The increase in cost of license revenue is primarily due to increased royalty, shipping, and credit card processing expenses of $1,080, or 42.2%, in connection with increased e-commerce sales. We expect the recordingcost of royalty expenses attributable to a pending settlement agreement with a Pageflex vendor. Cost of service revenue increased $17 but has decreasedlicenses as a percentage of service revenue as Pageflex’s existing infrastructure has been able to satisfysales for 2006 will approximate that of 2005, though the demandsquarterly results may vary based upon the mix of products sold during the increased customer base.

particular quarter.

The Company licenses its Pageflex products directly to Web-to-print providers, print service providers, major corporations and end users, and indirectly through resellers and strategic partners. During 2003,increases in costs of services revenue from direct sales and services was $2,849 and revenue from resellers and OEM relationships totaled $538.

Marketing and Selling:

Type marketing and selling expenses increased primarily due to the hiring of dedicated sales resources for ThunderHawk, participation in wireless tradeshows, and print advertising for ThunderHawk totaling $271 for the year ended December 31, 2003. This increase was partially offset by decreases in font and font technology sales and marketing expenses due to decreased participation in non-ThunderHawk trade shows and variable expenses such as commissions, which decreased as the sales volume for font products has decreased. Pageflex marketing and selling expenses increased primarily due to costs associated with the addition of three independent sales representatives engaged at the end of 2002, an increase in trade show participation, and an increase in travel-related expenses, which increased expenses $181 for the year ended December 31, 20032005 as compared to the year ended December 31, 2002. MyFonts sales2004 was primarily due to an increase in customer consulting resources and marketing activities and initiatives have remained relatively unchanged duringsupport personnel for the years ended December 31, 2002 and 2003.

Research and Development (“R&D”):

Type R&D expenses decreasedpublishing product line which increased $296, or 62.7%, to $769 for the year ended December 31, 20032005 and by a decrease in an internal allocation of resources to research and development projects from font and font technology support and consulting personnel. We expect the cost of services will increase as a percentage of sales during 2006 as we continue to invest in our infrastructure so as to be able to efficiently provide for these services.

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.

Operating Expenses:

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 increase in M&S expense was the result of a $187 increase in salaries and benefits due to an increase in headcount and commissions due to the increase in commissionable sales for the year ended December 31, 2005 as compared to the year ended December 31, 2002 primarily because of decreases2004, and a $111 increase in both internaladvertising and marketing activities including tradeshow participation during 2005. We expect that M&S expense will continue to increase during 2006 as we continue to increase sales personnel and outside contractormarketing activities.

Research and development on the Company’s font products totaling $127, a decrease in the use(“R&D”) expense consists primarily of customer support personnel for font R&D projects of $77, decreases in facilitysalary and depreciation charges due to the decrease in font personnel totaling $56 and from an increase in charges to the MyFonts and Pageflex segments for increased utilization of Type personnel of $25 and $35, respectively. This decrease in R&D expenses was partially offset by an increase inbenefit costs, contracted third-party development costs, for ThunderHawk of $27.and facility costs related to software developers and management. The increase in MyFonts R&D expense for the year ended December 31, 20032005 as compared to the year ended December 31, 20022004 was primarily due tothe result of an increase in employee-relatedpersonnel salary and benefit costs resulting from a higher utilizationand the use of Type resources of $25 and internet access at a co-location site of $18, combined with the non-recurrence of credits of $26 realized inthird-party developers totaling $168 during the year ended December 31, 20022005, partially offset by a decrease in the utilization of customer support and consulting personnel on internal R&D projects. We expect our development efforts to continue at a similar level during 2006 and expect our R&D expense to increase in absolute dollars but not as a percent of revenue.

General and administrative (“G&A”) expense consists primarily of salaries, benefits, and other related costs including travel and facility expenses for variablefinance, human resource, legal and executive personnel, legal and accounting treatment of stock options granted to non-employee consultants.professional services, provision for bad debts and director and officer insurance. The increase in Pageflex R&D expensesG&A for the year ended December 31, 20032005 as compared to the year ended December 31, 20022004 included $19 in increased personnel-related costs and $35 from a higher utilization of Type resources for internal Mpower development efforts, partially offset by a decrease in facility related expenses of $30.

General and Administrative (“G&A”):

Thean increase in G&A expenses for the year ended December 31, 2003 as compared to the year ended December 31, 2002 included approximately $72 in expenses incurred to relocate the Company’s offices, $260 in legal expensescosts including expenses incurredcosts to defend against certain trademark infringement lawsuits combined with the non-recurrence of a credit of $118 realized in the year ended December 31, 2002 for a change in an estimate associated with the Company’s sale of two product lines to Inso Corporation in August 1998. G&A expenses are primarily allocated to the business segments based on headcount. In addition, G&A expenses for MyFonts during the year ended December 31, 2003 included $82 in legal expenses incurred to defend against a trademark infringement lawsuit filed against MyFonts in 2003, which was settled in November 2003.

Gain on Investment in DiamondSoft, Inc.:

On March 13, 1998, the Company made a $500 or 25% equity investment, accounted for under the equity method, in DiamondSoft, Inc. (“DiamondSoft”), a California corporation primarily engaged in the business of developing, marketing and distributing software tools to a variety of professional markets. During the year ended December 31, 2001 the Company made additional investments totaling $410 in DiamondSoft, resulting in$154, an increase in Bitstream’s ownership percentageprofessional services for audit and accounting work and directors fees totaling $56, an increase in bad debts of $72, including a $60 write-off associated with a customer bankruptcy, a $47 increase in salary expense due to 31.7%an increase in headcount and salary increases, and an increase in employee benefit plan costs of $40, primarily due to an increase in insurance rates. We expect salaries, benefits, headcount, and related costs will increase at December 31, 2001, which remained unchanged until July 1, 2003. similar rates during 2006 and that our legal costs will decrease and partially offset such increases.

Other income and (expense), net;