UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Markmark one)

For the fiscal year ended December 31, 20042005

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, 20052006 was approximately $28.7$67 million.

On March 15, 2005,2006, there were 8,765,3969,006,613 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 20052006 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 2005. 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 makes 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, and customize documents over the Internet. Our core competencies include fonts and font technology, browsing technology, and publishing technology.

We maintain our executive offices at 245 First Street, 17^th Floor, Cambridge, Massachusetts 02142.02142-1270. Our telephone number is 617-497-6222(617) 497-6222 and we maintain Web siteswebsites 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

We categorize our products and technologies into three product lines: (1) fonts and font technology, (2) browsing technology, and (3) 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 computing environments. The evolution of real-time operating systems (RTOS), mobile phone operating systems, wireless devices, PDAs, set-top boxes, information appliances, and embedded systems in general require the transition from (a) the use of bitmaps to display text on these devices, 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 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. We have built substantial expertise in digital typeface design and production, technical font formats, and font portability and compaction software.

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 have beenare designed to support existing and new technological and typographic standards, such as Unicode, 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 haveare also been designed to function in multi-platform computing environments, including Windows, Macintosh, UNIX, Linux, Macintosh, RTOS, (real-time operating systems), and Java. We plan to continue to promote the use of our products in multi-vendor configurations.

We have a long history of working with standards’ organizations worldwide to enhance technological development. We created the portable font resource (PFR) as a highly compact, resolution independent representation of characters that can 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).

We also sell fonts and font-related products developed and designed by third party foundries and designers and wedesigners. We established our MyFonts.com Web site to becomewebsite as a universal source for fonts from a wide variety of international font vendors and 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.comMyFonts 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. We hopeOur goal is to provide access to fonts for all users, not just graphic arts professionals. CreatedMyFonts.com, created 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 March 15, 2005,2006, over 200250 foundries, large and small, domestic and international, participateparticipated as partners with MyFonts to offer their fonts for sale. This represents an aggregate collection of almost 40,000over 45,000 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; andweb; (6) the ability to collect fonts into one or more Font Albums for side-by-side comparison and collaborative decision making.making; and (7) the ability to access 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 having 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 (4) allows users to purchase and download the matching font.

OurMyFonts technology relies on computerized systems to organize fonts in 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 “More Fonts Like This” feature and through keyword searches. MyFonts technology also relies on computerized pattern matching for fonts, as accessed through the “WhatTheFont” feature. WhatTheFont is a font identifier 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 then displays the fonts on MyFonts.com that most closely match the font shapes captured in the image.

Bitstream font technology products include:

Our

Bitstream font products include:

BROWSING TECHNOLOGY

Today, nearly all information from enterprise datais web-enabled. Yet numerous analysts have found that mobile browsing at the consumer level has not 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 sales transactions toothers involved in disseminating news, commerce and entertainment data is Web-enabled. Inhow to effectively display this information on a mobile device in order to increasecreate a robust revenue stream in the wireless market.

Recognizing that mobile operators and improve productivity, corporations are lookingdevice manufacturers have a mandate to run mobile enterprise applicationsdevelop new revenue opportunities in a secure environment, while end users are accessing the Internet, Web-based e-mail, and other information on numerous mobile devices. To address thisdata services market the Companyin order to remain competitive, we developed ThunderHawk^™ThunderHawk™, a 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 handheld device.mobile phone or PDA. The server infrastructure provides many advantages, one of 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 over the Internet. At the enterprise level, ThunderHawk’s reliance on the server enables authorized corporate clientsfrom cell phones and employees to log into corporate intranet sites with theirother mobile devices, and access information behind the corporate firewall while maintaining the highest level of security.

devices.

The client/server architecture also gives ThunderHawk a high degree of compliance with open HTML standards, while providing the ability to transmit Web content in a more compact format to the device,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 Webweb browsing possible. Finally, unlike other browsers on the market, ThunderHawk does not rely on WAP (Wireless Application Protocol) or cHTML (Compact HyperText Markup Language). This removes, removing the need for Webto repurpose content developers to create separate,into simplified, Web sites“stripped down” websites optimized for small devices, or for companies to license separate software that converts Web sites into a format appropriate for wireless devices. Instead, ThunderHawk offers mobile subscribers a real Internet experience. With sharp text and clear graphics on full HTML web pages, ThunderHawk enables userssubscribers to seeview the real web on a Web pagemobile device, just as it appearsthe websites appear on the desktop.

The Company gained 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 Wireless Security Conference.

Currently, mobile operators, device manufacturers and corporations can license ThunderHawk technology for Windows Mobile 5.0, 2003 and 2002 Pocket PCs, Windows Mobile 2003 and 2002 Smartphones and Symbian Series60 phones. There are currently threefour editions of ThunderHawk, which are described in more detail below.

page. The upper half of the split screen shows the entire page, while the lower half displays the selected area at full size. Consumers can also work in full screen mode, which displays more of the Web page at once.

PUBLISHING TECHNOLOGIES

In the past several 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. To implement one-to-one communications, 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. 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 name, consist of:

They can also limit the editing capabilities made available to their end users and constrain portions of the document so that they cannot be modified.

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.

OurWe design our publishing products and technologies have been designed to support technological standards. We 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. We also participate 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. Our publishing software, since its inception, has sought to drive all brands of digital printers. With strong input from the Company, PPML has been adopted as a standard across the industry, and we continue to play a leading role in thethis standardization program.

SALES & MARKETING

SalesWe manage our sales and marketing efforts are managed from our corporate headquarters in Cambridge, Massachusetts. Sales personnel receive a base salary plus commissions, with additional commissions for sales in excess of annual targets. TheOur sales and marketing organization is focusedfocuses on direct sales and marketing activities and on maintaining and expanding reseller and OEM relationships. We also seek to enhance our relationships with existing and potential customers and have 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. We also have a sales agent based in Tokyo to facilitate OEM sales to Japanese hardware manufacturers.

We promote our products through (1) attendance and exhibition at major industry trade shows, and through(2) participation in booths sponsored by itsour strategic partners like EFI, Xerox, and Creo for itsour publishing technologies. We also participatetechnologies, (3) participation in several standards committees, such as digital television and promote our products through(4) advertising in industry publications, and through(5) engaging in direct marketing activities. We also promoteactivities, (6) our products on the Web through its various Web siteswebsites including,www.bitstream.com,,www.myfonts.com,, andwww.pageflex.com., and (7) through organic search engine optimization of Web sites.websites.

The principal objective of theour marketing strategy for fonts and font technology is to continue to expandincrease sales to OEMs and ISVs, who integrate theBitstream font technology software into our own products;their products, and to continue to expand the saleincrease sales of our 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. The principal objective of the marketing strategy for the ThunderHawk browsing technology is to expand awareness of itsour browsing technologies to wireless carriers, corporationswhile generating new business relationships with major mobile work forces,operators and end users.device manufacturers. The principal objective of marketing strategy for the publishing technologies 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. As new opportunities arise, we intend to evaluate otherSince 2002, marketing approaches.

Marketing activities for our e-commerce initiative have been focused on recruiting participation from font foundries, making Webweb users aware of our MyFonts.com Web site and attracting them to the Web site. Since 2002, we have focused marketing efforts for MyFonts.com on increasing awareness of, and sales on, the site.website. Marketing activities to increase awareness on the part of potential font buyers consists of efforts aimed at building Webweb links from search engines and other Internet sites, as well as referrals. To complement this presence,We plan to continue these marketing efforts in the future and, as new opportunities arise, we striveintend 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. We have worked and continue to work vigorously to develop and improve its ranking on search engines. In addition, we enter into referral agreements with selected Internet sites that refer new customers to us in return for a portion of the revenue generated and we have established relationships connecting font management software published by Corel Corporation and Extensis.

evaluate other marketing approaches.

CUSTOMERS

We license our font and font technology products to a variety of OEM and ISV customers worldwide. We also sell custom and other typeface products directly to corporate customers and individual end users through various means including sales to consumers worldwide through our e-commerce Web site.website. We license our ThunderHawk browsing technology to corporations, wireless carriers andmobile operators, device manufacturers, corporations and consumers. We also host ThunderHawk and license the browser directly to individual end users who purchase an annuala 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. We intend to continue to broaden our customer base through increased marketing efforts, by developing relationships with systems integrators, OEMs, and partners in 2005,2006, 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, 2003, or 2002.2003. From time to time, product sales to large customers during a single fiscal quarter may constitute more than 10% of our revenue for such quarter. We have broadened and intend to continue to broaden our customer base through expanded product offerings and increased marketing efforts. Revenue by geographic area is included in Footnote 9 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 are focusedfocus on (1) developing the best browsing experience on mobile devices, and improving the quality of(2) developing premier font technology solutions that render high-quality text rendering on a wide variety of hardware devices and in a wide variety of software applications. We are also committed toany language for any application or device, (3) developing leading-edge technology for our MyFonts.com, Web site, and to(4) advancing our publishing technologies so that they appeal to secure a broader range of markets.market appeal. To accomplish these goals, we have invested, and expect to continue to invest, significant resources in research and development.

During 2004,2005, 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

Our 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 our 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 our technology or products. The competition for our 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 our enablingfont rendering, font compression, and worldwide text layout technologies principally comes from Monotype Imaging with its iTypeCorp., Arphic, and Universal Font Scaling Technology (“UFST”). The competition for Font Fusion and TrueDoc consists primarily of software from Monotype Imaging, which includes a font rendering technology known as iType and a font compression technology known as MicroType Express. The competition for Bitstream Panorama consists primarily of Monotype Imaging’s modular software library for composing, positioning and rendering multilingual text known as WorldType Layout Engine. 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 Monotype Imaging can license TrueType hinting technology and fonts to developers. Competitors to our e-commerce initiative, MyFonts.com, include individual font foundry Web siteswebsites and other font-related Web siteswebsites that offer a variety of fonts for sale online, including fonts.com, owned and operated by Monotype Imaging Corp.

online.

Our 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 browsermobile browsing market. Although the wireless industry is the subject of intense activity, the market, and the browsing segment in particular, are still immature and changing. There are numerous browsing solutions that compete on operating platform or device. MobileOur mobile browser competitors include Pocket Internet Explorer from Microsoft Corporation; Opera for Smartphone/PDA fromCorp., Opera Software ASA;ASA, Access Co., Ltd., and NetFront from Access Co. Ltd. WhileNovarra Inc. ThunderHawk compares favorably against the competition on these fronts,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, we believe that the security provided by ThunderHawk’s client/server technology is especially advantageous at the enterprise level.

making fast and full-featured mobile web browsing possible.

Our 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 our customers. Mpower, .EDIT, and Storefront 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 Iway,PressSense, Printable, GMC, Objectif Lune, DeskNet, Saepio, XMPie, Quark DDS and Arbortext.XMPie. In addition, we may face new competition from emerging products and technologies. We believe our publishing products compete favorably based on rich feature sets, ease of use, stability, and scalability.

We believe that the principal competitive factors affecting all of our 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 we believe that we currently compete effectively with respect to such factors, there can be no assurance that we 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. We have entered intoare 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 our technologies or that our competitors will not independently develop non-infringing technologies that are substantially similar to or superior to our technology. The laws of certain foreign countries in which the our products are or may be developed, manufactured or licensed may not protect our 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 our technology and products more likely. We 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 our future success than the knowledge, ability and experience of our employees, the frequency of product enhancements and our ability to satisfy our 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”.

Our policy is to apply for U.S. patents with respect to itsour technology and seek copyright registration of our technology and trademark registration of our 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 seven 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 tofor our DocLock technology;technology, one of which is directed tofor our Font Fusion technology;technology one of which is directed tofor our Pageflex technology, this patent having been awarded in November 2004; and one of which is directed to thefor our technology behind theour MyFonts.com Web site, which was awarded in February 2005.website. Furthermore, multiple U.S., PCT, EPO, and Japanese applications are pending on some of the Company’s newer technologies. 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, 2005,2006, the Company employed 5562 persons, including 1416 in sales and marketing, 1015 in customer support and consulting, 2021 in research and development, and 1110 in general and administrative functions. Of our 5562 employees, 5158 are full time and 4 are part time. We also retain short-term consultants from time to time to assist itus with particular projects for limited periods of time.projects. We believe that our future success will depend in part on our ability to attract, motivate and retain highly qualified personnel. None of our employees is represented by a labor union and we have not experienced any work stoppages. We consider our employee relations to be good.

EXECUTIVE OFFICERS OF THE REGISTRANT

The Company’s executive officers and their ages as of March 15, 20052006 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. 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 fifteen15 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

Set 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 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 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 the 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 account for a significant 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 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 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 the summer closing or slowdown of several European customers. These seasonal factors have affected, and may continue to affect, our results of operations.

Failure to attract and retain talented employees would have a material adverse effect on our operations and financial results.Our performance depends to a significant extent on the continued service of our senior management and key technical employees. Our future results will depend upon our 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 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 proprietary and attempt 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 our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. It may be possible for unauthorized 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 which 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 United States and thus make the possibility of 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 we currently lease 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 Corporation) 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. We are contesting these claims.our operations, from this matter.

From time to time, in addition to the infringement case identified above, we are subject to legal proceedings and claims in the ordinary course of business, including claims of infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. In accordance with generally accepted accounting principles, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. This provision is reviewed at least quarterly. As of December 31, 2005 and 2004, no liability has beenwas recorded. Litigation is inherently unpredictable and it is possible that our financial position, cash flows, or results of operations could be materially affected in any particular period by the resolution of 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 year-fiscal year ended December 31, 2004.2005.

PART II

PART II

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

MARKET INFORMATION

The Class A Common Stock of the CompanyBitstream began trading publicly on the Nasdaq National Market tier of The Nasdaq Stock 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 toMarket under 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 to the NASDAQ Small Cap Market. Bitstream’s common stock continues to trade under its current 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 bid information for the Company’sour Class A Common Stock as reported on the NASDAQ Markets.Nasdaq Small Cap Market for the periods indicated. Such information reflects interdealer prices, without retail markup, markdown, or commission, and may not represent actual transactions.

As of March 15, 2005, 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, and 2002, the CompanyBitstream issued an aggregate of 45,002, 192,367, 97,904, and 46,83297,904 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, 2004.2005. 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, 20042005 and 2003,2004 and for the three years ended December 31, 20042005 have been derived from, and are qualified by reference to, the Company’s consolidated financial statements, which have been audited by an independent registered public accountant, whose reports thereon are included elsewhere in this Report.report. The selected consolidated financial data presented below as of December 31, 20012003, 2002 and 2000,2001, and for the two years ended December 31, 20012002 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 2000 and 2001 were audited by Arthur Andersen LLP, which has ceased operations.

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 our preparation of this Annual Report on Form 10-K requires us 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 we will 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 our decision to recognize revenue we must make a determination of the credit worthiness of our 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 our accounts receivable.

the section below entitled “Accounts Receivable”.

We 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. We 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. Our 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, for any reason, we wereare unable to continue to use the residual method, it could affect the timing of revenue recognition could be affected and, thusconsequently, the trends that we are currently experiencing.

ProfessionalOur professional services include custom font design, andconsulting services, development, and training. We 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. We had no long-term contracts in progress as of December 31, 2004.2005.

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. We estimate returns and allowances based on historical rates and as of December 31, 20042005, we dodid not have a reserve asbecause returns and allowances have been negligible. If and when a reserve is necessary we 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.

We generally warrant that our products will function substantially in accordance with documentation provided to customers for approximately 90 days following initial delivery. As of December 31, 2004,2005, we had not incurred any expense related to warranty claims. We 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 our 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, 20042005 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 we have included in Note 1(k) in the Notes to the Consolidated Financial Statements included herewith.

Accounts receivableReceivable

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from customers and maintain a provision for estimated credit losses based on itsour historical experience and any specific customer collection issues that we have identified.identify. While such credit losses have historically been within our expectations and appropriate reserves have been established, we cannot guarantee that we will continue to experience the same credit loss rates that we have experienced in the past.

Income taxesTaxes

As part of the process of preparing consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which 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. We must then assess the likelihood that we will recover our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely,unlikely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. Significant management judgment is required in determiningDetermination of our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets.assets requires significant management judgment. We have fully reserved against our tax assets. 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 our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. The determination of the valuation allowance requires us to make estimates, which we cannot guarantee will prove to be accurate.

OVERVIEW

Bitstream Inc. (“Bitstream”), together with its subsidiaries (collectively, the “Company”), is a software development company that makes communications compelling. We enable customers worldwide to render high-quality text, browse the Webweb on wireless devices, select from the largest collection of fonts online, and customize documents over the Internet. We classifycategorize our products and technologies into three product lines:lines consisting of (1) fonts and font technology, (2) browsing technology, and (3) publishing technology. In terms

Fonts and 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 TVs, printers, graphics and software applications, and embedded systems. Our solutions include Bitstream Panorama™ for text composition and Font Fusion^® for font rendering. Bitstream font technology supports all international languages. With our technology developers can render any scalable industry-standard and compact 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, we deliverand compact stroke-based Asian fonts. Bitstream also delivers high-quality font solutions for developers, ad agencies, graphic designers, desktop publishers, corporations, small businesses, and home office users. Our world-renowned library includes over 1,000 high-quality fonts in OpenType, TrueType, and PostScript Type 1 formats for Windows, the Macintosh, Unix, and Linux. We also sell our fonts and fonts from other foundries and designers on MyFonts.com^{™ SM}, 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 reference. In termsreference, 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 technology, we are a leading developer of font technology and custom font designs. With Panorama and Font Fusion, we deliver complete text composition and font rendering solutions for consumer electronics devices, mobile phones, PDAs, set-top boxes, digital TVs, printers, graphics applications, and embedded systems.shapes captured in the image.

Browsing technology. Our browsing technology, ThunderHawk^™ThunderHawk™, is a client-server technology that brings full-featured wireless Webweb browsing to mobile devices. It gives customersmobile subscribers complete Internet access to real Webweb pages while maintaining full text legibility. Both ThunderHawk SmartPhoneSmartphone Edition enables usersand ThunderHawk Symbian Series60 (S60) Edition enable subscribers to browse the Webweb on SmartPhones.high-end mobile phones. ThunderHawk PocketPC Edition allows consumersmobile subscribers to browse the Webweb on Pocket PC devices.PDAs. ThunderHawk Enterprise Server is a client-server technology for mobile operators, device manufacturers and corporations, allowing them to provide users with an easy-to-use, familiar interface that bridges the gap between mobile and telecommunications companies. Providing wireless Web browsing across networks, it gives a mobile workforce complete access to Internet and corporate intranet Web pages.desktop environments.

Publishing technology. Our publishing technology is the technology of choice for Web-to-printweb-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 been a technology innovator in the Web-to-printvariable output and web-to-print customization arena ever since. Our publishing technology powers online document customizationon demand marketing portals for printers, advertising agencies, marketing services companies and corporate marketing departments worldwide.

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 our 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 our judgment as of the date of this report, and we caution 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.

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 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 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 or may be able to devote greater resources to the promotion and sale of their products than us. 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 we will be able to compete successfully against these entities. To compete successfully, we 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 we 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 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 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 our 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 2005 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.

Sales to customers outside the United States represented 19.4% of our revenue for the year ended December 31, 2004. 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 our Myfonts.com Web site. We expect that its international business will continue to account for a significant 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 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 our future revenue and our results of operations. In addition, our 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, our quarterly results of operations.

Our performance depends to a significant extent on the continued service of our senior management and key technical employees. Our future results will depend upon our 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 we 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 our business, financial condition and results of operations.

We regard our software as proprietary and attempt 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 our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. It may be possible for unauthorized 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 which 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 United States and thus make the possibility of 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.

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.

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. Changes to these rules may have a significant adverse effect on future financial results or in the way in which we conduct our business. For example, in December 2004, the FASB issued SFAS 123R 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. The accounting provisions of SFAS 123R are effective for reporting periods beginning after June 15, 2005. We are required to adopt SFAS 123R in the third quarter of 2005. Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, it is evaluating the requirements under SFAS 123R and expects the adoption to have a significant adverse impact on our 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.

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 our tax liabilities, which would negatively affect our 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:

YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004

(in thousands, except percent amounts)

Gross Profit: