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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark one)

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

 

For the quarterly period ended September 30, 2004

 

or

 

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

 

For the transition period from              to             

 

COMMISSION FILE NUMBER: 0-21541

 


 

BITSTREAM INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   04-2744890

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

245 First Street, 17th Floor, Cambridge, Massachusetts 02142-1270
(Address of principal executive offices)

 

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

 


 

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 such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12B-2 of the Exchange Act).    Yes  ¨    No  x

 

On November 11, 2004, there were 8,735,521 shares of Class A Common Stock, par value $0.01 per share issued, including 125,809 issued and designated as treasury shares, and no shares of Class B Common Stock, par value $0.01 per share, issued or outstanding.

 



Table of Contents

INDEX

 

          PAGE
NUMBERS


PART I. FINANCIAL INFORMATION     

ITEM 1.

  

CONSOLIDATED FINANCIAL STATEMENTS

    
    

CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003

   2
    

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 and 2003

   3
    

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

   4
    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   5-12

ITEM 2.

  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   13-19

ITEM 3.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   20

ITEM 4.

  

CONTROLS AND PROCEDURES

   20
PART II. OTHER INFORMATION     

ITEM 1.

  

LEGAL PROCEEDINGS

   21

ITEM 2.

  

CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER REPURCHASES OF EQUITY SECURITIES

   21

ITEM 3.

  

DEFAULTS UPON SENIOR SECURITIES

   21

ITEM 4.

  

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   21

ITEM 5.

  

OTHER INFORMATION

   22

ITEM 6.

  

EXHIBITS AND REPORTS ON FORM 8-K

   22

SIGNATURES

   22

 

1


Table of Contents

BITSTREAM INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

 

    

September 30,

2004


   

December 31,

2003


 
    

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 4,253     $ 4,367  

Accounts receivable, net of allowance of $26 at September 30, 2004 and December 31, 2003

     679       1,016  

Prepaid expenses and other current assets

     183       61  
    


 


Total current assets

     5,115       5,444  
    


 


Property and equipment, net

     306       347  
    


 


Other assets:

                

Restricted cash

     250       250  

Goodwill

     727       727  

Intangible assets

     192       243  
    


 


Total other assets

     1,169       1,220  
    


 


Total assets

   $ 6,590     $ 7,011  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 232     $ 513  

Accrued expenses

     931       877  

Deferred revenue

     762       547  
    


 


Total current liabilities

     1,925       1,937  
    


 


Deferred rent

     202       135  
    


 


Total liabilities

     2,127       2,072  
    


 


Commitments and contingencies (Note 6)

                

Stockholders’ equity :

                

Preferred stock, $0.01 par value Authorized - 6,000 shares Issued and outstanding- 0 at September 30, 2004 and December 31, 2003

     —         —    

Common stock, $0.01 par value Authorized - 30,500 shares Issued and outstanding- 8,707 and 8,573 at September 30, 2004 and December 31, 2003, respectively

     87       86  

Additional paid-in capital

     32,729       32,551  

Accumulated deficit

     (27,993 )     (27,338 )

Treasury stock, at cost; 126 shares as of September 30, 2004 and December 31, 2003

     (360 )     (360 )
    


 


Total stockholders’ equity

     4,463       4,939  
    


 


Total liabilities and stockholders’ equity

   $ 6,590     $ 7,011  
    


 


 

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

 

2


Table of Contents

BITSTREAM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2004

    2003

    2004

    2003

 

Revenue:

                                

Software licenses

   $ 2,325     $ 1,975     $ 6,966     $ 6,205  

Services

     447       327       1,343       882  
    


 


 


 


Total revenue

     2,772       2,302       8,309       7,087  

Cost of revenue:

                                

Software licenses

     808       587       2,285       1,735  

Services

     222       145       597       396  
    


 


 


 


Total cost of revenue

     1,030       732       2,882       2,131  
    


 


 


 


Gross profit

     1,742       1,570       5,427       4,956  
    


 


 


 


Operating expenses:

                                

Marketing and selling

     590       730       1,965       2,055  

Research and development

     914       966       2,884       2,968  

General and administrative

     387       469       1,317       1,467  
    


 


 


 


Total operating expenses

     1,891       2,165       6,166       6,490  
    


 


 


 


Operating loss

     (149 )     (595 )     (739 )     (1,534 )
    


 


 


 


Gain on investment in DiamondSoft, Inc.

     —         399       91       591  

Interest and other income, net

     15       10       58       21  
    


 


 


 


Loss before provision for income taxes

     (134 )     (186 )     (590 )     (922 )

Provision for income taxes

     16       5       65       54  
    


 


 


 


Net loss

   $ (150 )   $ (191 )   $ (655 )   $ (976 )
    


 


 


 


Basic and diluted net loss per share

   $ (0.02 )   $ (0.02 )   $ (0.08 )   $ (0.12 )
    


 


 


 


Basic and diluted weighted average shares outstanding

     8,551       8,377       8,495       8,359  
    


 


 


 


 

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

 

3


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BITSTREAM INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

 

     Nine Months Ended
September 30,


 
     2004

    2003

 

CASH FLOWS FROM OPERATING ACTIVITIES:

                

Net loss

   $ (655 )   $ (976 )

Adjustments to reconcile net loss to net cash used in operating activities:

                

Depreciation

     131       145  

Amortization

     69       59  

Gain on investment in DiamondSoft, Inc.

     (91 )     (591 )

Loss on disposal of property and equipment

     —         20  

Changes in operating assets and liabilities:

                

Accounts receivable

     337       (230 )

Income tax receivable

     —         134  

Prepaid expenses and other assets

     (122 )     17  

Accounts payable

     (281 )     415  

Accrued expenses

     113       1  

Deferred revenue

     215       (118 )

Other long term liabilities

     67       —    
    


 


Net cash used in operating activities

     (217 )     (1,124 )
    


 


CASH FLOWS FROM INVESTING ACTIVITIES:

                

Proceeds from sale of DiamondSoft stock

     91       1,339  

Restricted Cash

     —         50  

Purchases of property and equipment, net

     (90 )     (249 )

Additions to intangible assets

     (18 )     (24 )
    


 


Net cash (used in) provided by investing

     (17 )     1,116  
    


 


CASH FLOWS FROM FINANCING ACTIVITIES:

                

Proceeds from exercise of stock options

     120       82  
    


 


Net cash provided by financing

     120       82  
    


 


Net (Decrease) increase in Cash and Cash Equivalents

     (114 )     74  

Cash and Cash Equivalents, beginning of period

     4,367       4,828  
    


 


Cash and Cash Equivalents, end of period

   $ 4,253     $ 4,902  
    


 


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

                

Cash paid for interest

   $ 1     $ 2  

Cash paid (received) for income taxes

   $ 52     $ (76 )

Stock option compensation reclassified from Accrued Expenses to Additional Paid-in Capital

   $ 58     $ —    

 

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

 

4


Table of Contents

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2004

 

(1) Significant Accounting Policies

 

Bitstream Inc. (“Bitstream”) together with its subsidiaries (collectively, the “Company”) enable customers worldwide to render high-quality text, browse the Web on wireless devices, select from the largest collection of fonts online, and customize documents over the Internet. Its core competencies include font technology, browsing technology, and publishing technology. Visit Bitstream on the Web at http://www.bitstream.com.

 

(a) Basis of Presentation

 

The consolidated financial statements of the Company presented herein, without audit, have been prepared pursuant to the rules of the Securities and Exchange Commission (the “SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnote disclosures required by generally accepted accounting principles. The balance sheet information at December 31, 2003 has been derived from the Company’s audited consolidated financial statements. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2003 included in the Company’s Annual Report on Form 10-K, which was filed by the Company with the SEC on March 30, 2004. The balance sheet as of September 30, 2004, the statements of operations for the three and nine month periods ended September 30, 2004 and 2003, the statements of cash flows for the nine months ended September 30, 2004 and 2003, and the notes to each are unaudited, but in the opinion of management include all adjustments necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows of the Company for these interim periods.

 

The results of operations for the nine months ended September 30, 2004 may not necessarily be indicative of the results to be expected for the year ending December 31, 2004.

 

(b) Disclosures about Segments of an Enterprise

 

During 2004, in connection with the reorganization of its sales and marketing forces and the elimination of the General Manager position for its Pageflex, Inc. subsidiary, the Company has changed the manner in which it measures and reports its financial results and reports to the Board of Directors. Prior to January 1, 2004 the Company’s CEO, its chief operating decision-maker, assessed individual performances based upon discreet financial information on three segments: Type, MyFonts, and Pageflex. Subsequent to January 1, 2004 the Company views its operations and manages its business as principally one segment with three major product lines: fonts and font technology, browsing, and publishing. In connection with this reorganization, the Company reassessed its segment disclosure requirements under SFAS No. 131 “Disclosure about Segments of an Enterprise and Related information” and as a result, during 2004, the Company is reporting its operations as one segment. Prior year segment disclosure has been modified to conform with the current year classification.

 

(c) Revenue Recognition (in thousands)

 

The Company derives revenues from the license of its software products, and from consulting and support and maintenance services. 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.

 

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Table of Contents

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

 

Sources of licensing fees and royalty revenue include: (1) Original Equipment Manufacturer (“OEM”) and Independent Software Vendor (“ISV”) customers for text imaging and page layout technologies; (2) direct and indirect licenses of software publishing applications for the creation, enhancement, management, transport, viewing and printing of electronic information; (3) direct sales of custom design and consulting services to end users such as graphic artists, desktop publishers and corporations; and (4) sales of fonts and page layout technologies to foreign customers primarily through distributors.

 

Certain OEM and ISV customers pay royalties only upon the sublicensing of the Company’s products to end-users. 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. Revenue from guaranteed minimum royalty licenses is recognized upon delivery of the software license when no further obligations of the Company exist, while revenue on pay-as-you-go licenses is recognized in the period when sublicenses to end users are reported to the Company by the OEM or ISV customer. In certain guaranteed minimum royalty licenses, the Company will enter into extended payment programs with creditworthy customers. Revenue related to extended payment programs is recognized when payment becomes due to the Company.

 

The Company recognizes license revenue from the resale of its products through various resellers. Resellers may sell the Company’s products in either an electronic format or CD format. Revenue is recognized if collection is probable, upon notification from the reseller that it has sold the product or if for a CD product, upon delivery of the software.

 

Revenue from end user product sales is recognized upon delivery of the software, net of estimated returns and allowances, and when collection is probable. Revenue related to extended payment programs is recognized when payment becomes due to the Company. End user sales include e-commerce revenue generated from the Company’s Web sites from the licensing of Bitstream fonts, font technology and the ThunderHawk browser, licensing of fonts and font technology developed by third parties and from fees received from referring customers to other sites for which we have referral agreements. Referral revenue is recognized at the net amount received by Bitstream and was $3 for both the three months ended September 30, 2004 and 2003. Referral income for the nine months ended September 30, 2004 and 2003 was $10 and $11, respectively. There are minimal costs associated with the Referral Fee program, and primarily represent the time to load copies of the fonts provided by each participating foundry for addition to the MyFonts.com database. The Company expenses those costs as incurred.

 

The Company recognizes revenue under multiple-element arrangements using the residual method when vendor-specific objective evidence of fair value exists for all of the undelivered elements under the arrangement. Under the residual method, the arrangement consideration is first allocated to undelivered elements based on vendor-specific objective evidence of the fair value for each element and the residual amount is allocated to the delivered elements. Arrangement consideration allocated to undelivered elements is deferred and recognized as revenue when the elements are delivered, if all other revenue recognition criteria are met. The Company has established sufficient vendor-specific objective evidence for the value of its consulting, training, and other services, based on the price charged when these elements are sold separately. Accordingly, software license revenue is recognized under the residual method in arrangements in which software is licensed with consulting, training or other services.

 

6


Table of Contents

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

Professional services include custom design and development and training. The Company recognizes 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 uncompleted contracts are made in the period in which such losses become probable.

 

The Company recognizes revenue from support and maintenance agreements ratably over the term of the agreement.

 

Deferred revenue includes unearned software maintenance revenue, certain prepaid royalties and advance billings under software development contracts and page layout technology licenses.

 

Cost of revenue from software licenses consists primarily of royalties paid to third party developers and foundries whose products the Company sells, and costs to distribute the product, including the cost of the media on which it is delivered. Cost of revenue from services consists primarily of costs associated with customer support, consulting and custom product development services.

 

The Company generally warrants that its products will function substantially in accordance with documentation provided to customers for approximately 90 days following initial delivery. The Company has not incurred any expenses related to warranty claims.

 

(d) Accounting For Stock-Based Compensation

 

The Company accounts for its employee stock plans using the intrinsic value method. The SFAS 123, “Accounting for Stock-Based Compensation”, as amended by SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment to Statement of Financial Accounting Standards No. 123.” disclosures include pro forma net income and earnings per share as if the fair value-based method of accounting had been used. Stock issued to non-employees is accounted for in accordance with SFAS 123 and related interpretations. The following table sets forth the pro forma amounts of net loss and net loss per share that would have resulted if the Company accounted for its employee stock plans under the fair value recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation” (in thousands, except per share amounts):

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2004

    2003

    2004

    2003

 

Net loss:

                                

As reported

   $ (150 )   $ (191 )   $ (655 )   $ (976 )

Deduct: Total stock based compensation expense determined under the fair value based method for all grants, net of related tax effects

     212       263       625       806  
    


 


 


 


Pro forma

   $ (362 )   $ (454 )   $ (1,280 )   $ (1,782 )
    


 


 


 


Basic and diluted net loss per share:

                                

As reported

   $ (0.02 )   $ (0.02 )   $ (0.08 )   $ (0.12 )

Pro forma

   $ (0.04 )   $ (0.05 )   $ (0.15 )   $ (0.21 )

 

7


Table of Contents

BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

For purposes of computing pro forma net loss, the Company estimates the fair value of all option or warrant grants to employees outstanding as of September 30, 2004 using the Black Scholes option pricing model prescribed by SFAS No. 123. Assumptions used are as follows:

 

    

Three Months Ended
September 30,


  

Nine Months Ended

September 30,


    

2004


  

2003*


  

2004


  

2003


Risk-free interest rates

   3.37% to 3.68%    —      3.37 to 3.87%    2.50% to 2.94%

Expected dividend yield

   —      —      —      —  

Expected lives

   5 Years    —      5 Years    5 Years

Expected volatility

   112.9%    —      112.9% to 116.1%    120.2% -120.5%

* No Grants were made during the third quarter of 2003.

 

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

 

Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable. The Company places a majority of its cash investments in one highly-rated financial institution. The Company has not experienced significant losses related to receivables from any individual customers or groups of customers in any specific industry or by geographic area. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by management to be inherent in the Company’s accounts receivable. At September 30, 2004, one customer accounted for 17% of the Company’s accounts receivable. The Company does not have any off-balance sheet risks as of September 30, 2004. At December 31, 2003 one customer accounted for 21% of the Company’s accounts receivable. No single customer accounted for 10% or more of the Company’s revenue for either the three or nine month periods ended September 30, 2004 or September 30, 2003.

 

(f) Goodwill and other intangible assets (in thousands)

 

Goodwill consists of the following:

 

    

September 30,

2004


  

December 31,

2003


Acquisition of Type Solutions, Inc.

   $ 228    $ 228

Acquisition of Alaras Corporation

     499      499
    

  

Total Goodwill

   $ 727    $ 727
    

  

 

The Company follows the accounting and reporting requirements for goodwill and other intangible assets as required by SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill and indefinite-lived intangible assets are not amortized, but are required to be reviewed annually for impairment, or more frequently if impairment indicators arise. Separable intangible assets that have finite lives are amortized over their useful lives. The Company has established and allocated goodwill to each of the following reporting units (product lines): Fonts and Font Technology and Publishing. The carrying amounts of goodwill attributable to each reporting unit are as follows:

 

    

September 30,

2004


  

December 31,

2003


Fonts and Font Technology

   $ 228    $ 228

Publishing

     499      499
    

  

     $ 727    $ 727
    

  

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

Amortization expense for finite-lived intangible assets for the three months ended September 30, 2004 and 2003 was $23 and $20, respectively. Amortization expense for finite-lived intangible assets for the nine months ended September 30, 2004 and 2003 was $69 and $59, respectively. Estimated amortization for the remainder of 2004 and the five succeeding years follows:

 

2004 (remainder)

   $ 21

2005

     74

2006

     50

2007

     29

2008

     17

2009

     1
    

     $ 192
    

 

(g) Recently Issued Accounting Standards

 

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities” and, in December 2003, issued a revision to that interpretation. FIN No. 46R replaces FIN No. 46 and addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. A variable interest entity (VIE) is defined as (a) an ownership, contractual or monetary interest in an entity where the ability to influence financial decisions is not proportional to the investment interest, or (b) an entity lacking the invested capital sufficient to fund future activities without the support of a third party. FIN No. 46R establishes standards for determining under what circumstances VIEs should be consolidated with their primary beneficiary, including those to which the usual condition for consolidation does not apply. The Company adopted FIN No. 46 in the year ended December 31, 2003, and FIN No. 46R in the first quarter of 2004 for non-special purpose entities created prior to February 1, 2003. The Company’s adoption of FIN No. 46 and FIN No. 46R has not had and is not expected to have, a significant effect on the Company’s financial position or its results of operations.

 

In December 2003, the SEC issued Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition”, which supersedes Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements.” The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of Emerging Issues Task Force 00-21 (“EITF 00-21”), “Accounting for Revenue Arrangements with Multiple Deliverables.” SAB 104 also incorporated certain sections of the SEC’s “Revenue Recognition in Financial Statements—Frequently Asked Questions and Answers” document. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

9


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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

(2) Income (Loss) Per Share (in thousands)

 

Basic earnings or loss per share is determined by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflect the effect of the conversion of potentially dilutive securities, such as stock options and warrants, based on the treasury stock method. In computing diluted earnings per share, common stock equivalents are not considered in periods in which a net loss is reported, as the inclusion of the common stock equivalents would be antidilutive. As a result there is no difference between the Company’s basic and diluted loss per share for the three month and nine month periods ended September 30, 2004 and 2003.

 

If the Company had reported a profit for these periods, potential common shares would have increased the weighted average shares outstanding by 1,800 and 1,238 shares for three months ended September 30, 2004 and 2003, respectively, and by 684 and 782 for the nine months ended September 30, 2004 and 2003, respectively. In addition, there were warrants and options outstanding to purchase 96 and 564 shares for the three months and nine month periods ended September 30, 2004 and 458 and 526 shares for the three and nine month periods ended September 30, 2003, respectively, that were not included in the potential common share computations because their exercise prices were greater than the market price of the Company’s common stock. These common stock equivalents are antidilutive even when a profit is reported in the numerator.

 

(3) Investment (in thousands, except percentages)

 

On March 13, 1998, the Company made a $500 or 25% equity investment, accounted for under the equity method, in DiamondSoft, Inc. (“DiamondSoft”), a California corporation primarily engaged in the business of developing, marketing and distributing software tools to a variety of professional markets. During the year ended December 31, 2001, the Company made additional investments totaling $410 in DiamondSoft, resulting in an increase in Bitstream’s ownership percentage to 31.7% at December 31, 2001, which remained unchanged until July 1, 2003 when in connection with the acquisition of DiamondSoft by Extensis, a wholly owned subsidiary of Celartem Technology USA, Inc., the Company sold its shares in DiamondSoft to Extensis in a cash transaction resulting in a realized and recognized gain on its investment of $399. The Company’s investment in DiamondSoft as of the June 30, 2003 Balance Sheet was $940 and the Company received $1,339 in cash from this transaction on July 1, 2003. In addition, the purchase agreement called for $300 of the purchase price to be placed in escrow to provide security for escrow and indemnification obligations as set forth in the purchase agreement. The Company deferred recognition of its $91 share of this escrow balance until June 30, 2004 when the amount to be received became fixed and determinable. The gain related to the Company’s investment in DiamondSoft for the three and nine month periods ended September 30, 2004 of $0 and $91, respectively, and for the three and nine month periods ended September 30, 2003 of $399 and $591, respectively, is included in the accompanying consolidated statements of operations.

 

10


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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

(4) Accrued Expenses, (in thousands)

 

    

September 30,

2004


  

December 31,

2003


     

Accrued expenses consist of the following:

             

Accrued royalties

   $ 333    $ 340

Payroll and other compensation

     391      320

Accrued professional and consulting services

     163      182

Other

     44      35
    

  

Total

   $ 931    $ 877
    

  

(5) Geographical Reporting (in thousands):

 

The Company attributes revenue to different geographical areas on the basis of the location of the customer. All of the Company’s product sales for the three and nine month periods ended September 30, 2004 and 2003 were shipped from its headquarters located in the United States or its office located in Cheltenham, England. The Cheltenham sales office was closed on March 31, 2003.

 

Revenue by geographic area is as follows:

 

     Three Months Ended
September 30,


   Nine Months Ended
September 30,


     2004

   2003

   2004

   2003

*Revenue:

                           

United States

   $ 2,323    $ 1,859    $ 6,762    $ 5,590

Japan

     132      87      448      478

United Kingdom

     69      64      299      378

Other (Countries less than 5% individually, by Region, excluding countries specifically listed above):

                           

Europe

     217      302      610      439

Asia

     15      17      97      20

Other, including Canada

     16      73      93      182
    

  

  

  

Total revenue

   $ 2,772    $ 2,302    $ 8,309    $ 7,087
    

  

  

  


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

 

All of the Company’s long-lived tangible assets are located in the United States of America. The Cheltenham sales office was closed on March 31, 2003 and all long-lived assets of that office were liquidated.

 

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BITSTREAM INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 

(6) Commitments and contingencies (in thousands):

 

Lease commitments

 

The Company conducts its operations in leased facilities. In August 2003, the Company entered into a six-year lease agreement and moved its corporate offices. The new lease agreement commenced on September 1, 2003 and obligated the Company to make minimum lease payments plus its pro-rata share of future real estate tax increases and certain operating expense increases above the base year. This lease agreement also required the Company to obtain a Letter of Credit in the amount of $250, which resulted in $250 in cash being classified as restricted on the Company’s Balance Sheet. The amount will be reduced to $200 on the second anniversary and further to $150 on the fourth anniversary of the lease.

 

Royalties

 

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

 

Guarantees

 

The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims based on these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal.

 

Legal Actions

 

On June 24, 2003, 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, through its TrueDoc software, infringes trademarks and copyrights and violates the Digital Millennium Copyright Act. The complaint fails to identify any of the plaintiffs’ trademarks or copyrights that have been allegedly infringed and does not specify any amount of monetary damages. The plaintiffs seek injunctive relief, but do not make any statement that any of the alleged acts have actually taken place. The Company is contesting these claims.

 

From time to time, in addition to the infringement case identified above, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of infringement of third-party patents and other intellectual property rights, commercial, employment and other matters.

 

In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. This provision is reviewed at least quarterly. As of September 30, 2004 no liability for legal claims has been recorded. Litigation is inherently unpredictable and it is possible that the Company’s financial position, cash flows, or results of operations could be affected in any particular period by the resolution of one or more of these contingencies.

 

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Table of Contents

PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

OVERVIEW

 

Bitstream Inc. (“Bitstream”) together with its subsidiaries (collectively, the “Company”) enable customers worldwide to render high-quality text, browse the Web on wireless devices, select from the largest collection of fonts online, and customize documents over the Internet. Its core competencies include font technology, browsing technology, and publishing technology.

 

During 2004, in connection with the reorganization of its sales and marketing forces and the elimination of the General Manager position for its Pageflex, Inc. subsidiary, the Company has changed the manner in which it measures and reports its financial results and reports to the Board of Directors. Prior to January 1, 2004 the Company’s CEO, its chief operating decision-maker, assessed individual performances based upon discreet financial information on three segments: Type, MyFonts, and Pageflex. Subsequent to January 1, 2004 the Company views its operations and manages its business as principally one segment with three major product lines: fonts and font technology, browsing, and publishing. In connection with this reorganization, the Company reassessed its segment disclosure requirements under SFAS No. 131 “Disclosure about Segments of an Enterprise and Related information” and as a result, during 2004, the Company is reporting its operations as one segment. Prior year segment disclosure has been modified to conform with the current year classification.

 

The Company maintains executive offices at 245 First Street, 17th Floor, Cambridge, Massachusetts 02142. Our telephone number is 617-497-6222. We maintain a Web site at www.bitstream.com. Investors can obtain copies of our SEC filings from this site free of charge, as well as from the SEC Web site at www.sec.gov.

 

CRITICAL ACCOUNTING POLICIES

 

We incorporate by reference the section “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Critical Accounting Policies” of our Annual Report on Form 10-K for the year ended December 31, 2003 filed on March 30, 2004. No changes have been made to these policies since December 31, 2003.

 

FORWARD LOOKING STATEMENTS

 

Except for the historical information contained herein, this Quarterly Report on Form 10-Q 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 filings with the Securities and Exchange Commission (“SEC”), including those risks and uncertainties discussed under the Forward Looking Statements section in the Company’s Annual Report filed with the SEC on Form 10-K on March 30, 2004. The forward-looking statements contained herein represent the Company’s judgment as of the date of this report, and the Company cautions readers not to place undue reliance on such statements. Management undertakes no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

 

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Table of Contents

PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)

 

RESULTS OF OPERATIONS (in thousands, except percentages)

 

Revenue and Gross Profit:

 

     Three Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

   Percent

 

Revenue

                                       

Software licenses

   $ 2,325    83.9 %   $ 1,975    85.8 %   $ 350    17.7 %

Services

     447    16.1       327    14.2       120    36.7  
    

  

 

  

 

  

Total revenue

     2,772    100.0       2,302    100.0       470    20.4  

Cost of Revenue

                                       

Software licenses

     808    34.8       587    29.7       221    37.6  

Services

     222    49.7       145    44.3       77    53.1  
    

  

 

  

 

  

Total cost of revenue

     1,030    37.2       732    31.8       298    40.7  
    

  

 

  

 

  

Gross Profit

   $ 1,742    62.8 %   $ 1,570    68.2 %   $ 172    11.0 %
    

  

 

  

 

  

     Nine Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

   Percent

 

Revenue

                                       

Software licenses

   $ 6,966    83.8 %   $ 6,205    87.6 %   $ 761    12.3 %

Services

     1,343    16.2       882    12.4       461    52.3  
    

  

 

  

 

  

Total revenue

     8,309    100.0       7,087    100.0       1,222    17.2  

Cost of Revenue

                                       

Software licenses

     2,285    32.8       1,735    28.0       550    31.7  

Services

     597    44.5       396    44.9       201    50.8  
    

  

 

  

 

  

Total cost of revenue

     2,882    34.7       2,131    30.1       751    35.2  
    

  

 

  

 

  

Gross Profit

   $ 5,427    65.3 %   $ 4,956    69.9 %   $ 471    9.5 %
    

  

 

  

 

  

 

The increase in revenue from software licenses and services for the three month and nine month periods ended September 30, 2004 as compared to the three month and nine month periods ended September 30, 2003 was attributable to increases across all of the Company’s product lines. The increase in revenue from services for the three and nine month periods was primarily due to increases in maintenance and support contracts associated with the Company’s publishing product line. License revenue from direct sales, which include e-commerce sales, increased $516 to $1,684 for the three months ended September 30, 2004 as compared to $1,168 for the three months ended September 30, 2003. License revenue from resellers increased $36 to $279 for the three months ended September 30, 2004 as compared to $243 for the three months ended September 30, 2003. These increases were partially offset by a decrease in license revenue from OEMs and ISVs of $202 to $362 for the three months ended September 30, 2004 as compared to $564 for the three months ended September 30, 2003. License revenue from direct sales, which include e-commerce sales, increased $1,058 to $4,733 for the nine months ended September 30, 2004 as compared to $3,675 for the nine months ended September 30, 2003. License revenue from resellers increased $236 to $724 for the nine months ended September 30, 2004 as compared to $488 for the nine months ended September 30, 2003. These increases were partially offset by a decrease in license revenue from OEMs and ISVs of $533 to $1,509 for the nine months ended September 30, 2004 as compared to $2,042 for the nine months ended September 30, 2003.

 

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Table of Contents

PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)

 

The Company recognizes license revenue from direct sales and licensing agreements of its products and products from third parties including e-commerce sales made via the Company’s Web sites, licensing agreements with OEMs and ISVs, and from the resale of its products through various resellers. Reseller revenue is recognized if collection is probable, upon notification from the reseller that it has sold the product or if for a physical product, upon delivery of the software. E-commerce sales include revenue from the licensing of Bitstream fonts and font technology, licensing the ThunderHawk browser, licensing of fonts and font technology developed by third parties and from fees received from referring customers to other sites for which we have referral agreements. Referral revenue is recognized at the net amount received by Bitstream and was $3 for each of the three month periods ended September 30, 2004 and 2003. Referral income for the nine months ended September 30, 2004 and 2003 was $10 and $11, respectively. There are minimal costs associated with the referral revenue, and primarily represent the time to load copies of the fonts provided by each participating foundry for addition to the MyFonts.com database. The Company expenses those costs as incurred.

 

The increases in cost of license revenue for the three and nine month periods ended September 30, 2004 as compared to the same periods ended September 30, 2003 were primarily due to increased royalty, shipping, and credit card processing expenses in connection with the Company’s increased e-commerce sales. The increases in costs of services revenue for the three and nine month periods ended September 30, 2004 as compared to the same periods ended September 30, 2003 were primarily due to an increase in customer consulting resources for the publishing product line. Cost of revenue for the Company includes royalties and fees paid to third parties for the development or license of rights to technology and/or unique typeface designs, costs incurred in the fulfillment of custom orders, costs incurred in providing customer support, maintenance, and training, and costs associated with the duplication, packaging and shipping of product.

 

Operating Expenses:

 

     Three Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

    Percent

 

Marketing and selling

   $ 590    21.3 %   $ 730    31.7 %   $ (140 )   (19.2 )%

Research and development

     914    33.0       966    42.0       (52 )   (5.4 )

General and administrative

     387    14.0       469    20.4       (82 )   (17.5 )
    

  

 

  

 


 

Total operating expenses

   $ 1,891    68.2 %   $ 2,165    94.0 %   $ (274 )   (12.7 )%
    

  

 

  

 


 

     Nine Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

    Percent

 

Marketing and selling

   $ 1,965    23.6 %   $ 2,055    29.0 %   $ (90 )   (4.4 )%

Research and development

     2,884    34.7       2,968    41.9       (84 )   (2.8 )

General and administrative

     1,317    15.9       1,467    20.7       (150 )   (10.2 )
    

  

 

  

 


 

Total operating expenses

   $ 6,166    74.2 %   $ 6,490    91.6 %   $ (324 )   (5.0 )%
    

  

 

  

 


 

 

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PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)

 

Marketing and selling (“M&S”) expense consist primarily of salaries and benefits, commissions, travel expenses and facilities costs related to sales and marketing personnel, as well as marketing program-related costs including trade shows and advertising. The decrease in M&S expense for the three month and nine month periods ended September 30, 2004 as compared to the three month and nine month periods ended September 30, 2003 was primarily the result of the non-recurrence of a one-time severance expense during the third quarter of 2003 of $75 associated with the elimination of the Pageflex General Manager position and a temporary decrease during the three months ended September 30, 2004 in sales salaries, the use of outside sales and marketing consultants, and personnel related allocations of $53.

 

Research and development (“R&D”) expense consist primarily of salary and benefit costs, contracted third-party development costs, and facility costs related to software developers and management. The decrease in R&D expense for the three months ended September 30, 2004 as compared to the three months ended September 30, 2003 was primarily the result of decreases in facility costs of $24 and a decrease in the utilization of customer consulting personnel on R&D projects of $22. The decrease for the nine months ended September 30, 2004 as compared to the nine months ended September 30, 2003 included additional savings of $45 from decreased facility related costs for the first six months of 2004 resulting in $69 in total facility related cost savings for the nine month period.

 

General and administrative (“G&A”) expense consists primarily of salaries, benefits, and other related costs including travel and facility expenses for finance, human resource, legal and executive personnel, legal and accounting professional services, provision for bad debts and director and officer insurance. G&A expenses decreased for the three months ended September 30, 2004 as compared to the three months ended September 30, 2003 primarily due to a decrease in legal costs including costs to defend against certain trademark infringement lawsuits of $58 and a $67 savings from the non-recurrence of costs incurred to relocate the Company’s offices, partially offset by increases in contracted financial and accounting related fees and personnel related allocations. G&A expense for the nine months ended September 30, 2004 as compared to the nine months ended September 30, 2003 included additional decreases during the first six months of 2004 in salaries of $94 and leased facility costs of $78, as well as, a decrease in non-recurring fees associated with the transfer of the Company’s stock from the NASDAQ/NM to the NASDAQ SmallCap Market of $46 incurred during the first quarter of 2003. These decreases were partially offset by increased legal costs during the first six months of 2004 of $149 primarily incurred to defend against certain trademark infringement lawsuits, which resulted in an increase in legal costs for the nine months ended September 30, 2004 of $91 as compared to the nine months ended September 30, 2003.

 

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Table of Contents

PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)

 

Other income and (expense), net;

 

     Three Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

    Percent

 

Gain on investment in DiamondSoft, Inc.

   $ —      —   %   $ 399    17.3 %   $ (399 )   (100.0 )%

Interest and other income, net

     15    0.5       10    0.5       5     50.0  
    

  

 

  

 


 

Total Other Income

   $ 15    0.5 %   $ 409    17.8 %   $ (394 )   (96.3 )%
    

  

 

  

 


 

     Nine Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

    Percent

 

Gain on investment in DiamondSoft, Inc.

   $ 91    1.1 %   $ 591    8.3 %   $ (500 )   (84.6 )%

Interest and other income, net

     58    0.7       21    0.3       37     176.2  
    

  

 

  

 


 

Total Other Income

   $ 149    1.8 %   $ 612    8.6 %   $ (463 )   (75.7 )%
    

  

 

  

 


 

 

On March 13, 1998, the Company made a $500 or 25% equity investment, accounted for under the equity method, in DiamondSoft, Inc. (“DiamondSoft. During the year ended December 31, 2001, the Company made additional investments totaling $410 in DiamondSoft, resulting in an increase in Bitstream’s ownership percentage to 31.7% at December 31, 2001, which remained unchanged through July 1, 2003 when the Company sold its shares in DiamondSoft to Extensis. The gain above represents the Company’s pro rata share of DiamondSoft’s net income through June 30, 2003 plus the gain on the sale of Bitstream’s investment in DiamondSoft. Further discussion can be found in Note 3 in the Notes to the Consolidated Financial Statements included herewith.

 

Other income for the three and nine month periods ended September 30, 2004 and 2003 includes interest income earned on cash and money market instruments net of interest expense. In addition, other income for the nine months ended September 30, 2003 consists of a loss on the disposition of assets related to the closure of the UK sales office of $(20).

 

Provision for income taxes:

 

     Three Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

   Percent

 

Provision for Income Taxes

   $ 16    0.6 %   $ 5    0.2 %   $ 11    220.0  %
    

  

 

  

 

  

     Nine Months Ended September 30,

 
     2004

   % of
Revenue


    2003

   % of
Revenue


    Change

 
             Dollars

   Percent

 

Provision for Income Taxes

   $ 65    0.8 %   $ 54    0.8 %   $ 11    20.4  %
    

  

 

  

 

  

 

The provision for income taxes consists primarily of foreign income taxes. Foreign taxes vary with Type OEM license royalties from customers in countries who have signed tax conventions with the United States including Japan, Korea, and Poland, and also with the results of operations from the Company’s location in the United Kingdom prior to its closure on March 31, 2003.

 

17


Table of Contents

PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)

 

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

 

The Company has funded its operations primarily through the public sale of equity securities, cash flows from operations, cash received from the sale of the Company’s MediaBank and InterSep OPI product lines to Inso Providence Corporation in August of 1998, and cash received from the sale of the Company’s investment in DiamondSoft to Extensis in July of 2003. As of September 30, 2004, the Company had net working capital of $3,190 as compared to $3,506 at December 31, 2003.

 

The Company used cash of approximately $217 and $1,124 to fund its operations during the nine months ended September 30, 2004 and 2003, respectively. This cash was used primarily to fund the Company’s net losses, which after adjustment for non-cash expenses used $546 and $1,343 in cash during the nine months ended September 30, 2004 and 2003, respectively. Changes in operating assets and liabilities resulted in cash savings of $329 and $219 for the nine months ended September 30, 2004 and 2003, respectively. The Company’s investing activities for the nine months ended September 30, 2004 and 2003 used cash to acquire additional property and equipment and intangible assets of $108 and $273, respectively. The Company’s investing activities related to its DiamondSoft investment provided cash of $91 and $1,389 for the nine months ended September 30, 2004 and 2003, respectively. The Company’s financing activities provided cash of $120 and $82 for the nine months ended September 30, 2004 and 2003, respectively, from the exercise of stock options.

 

The Company believes its current cash and cash equivalent balances will be sufficient to meet the Company’s operating and capital requirements for at least the next 12 months. There can be no assurance, however, that the Company will not require additional financing in the future. If the Company were required to obtain additional financing in the future, there can be no assurance that sources of capital will be available on terms favorable to the Company, if at all.

 

As of September 30, 2004, the Company had no material commitments for capital expenditures. From time to time, the Company evaluates potential acquisitions of products, businesses and technologies that may complement or expand the Company’s business. Any such transactions consummated may use a portion of the Company’s working capital or require the Company to issue additional equity securities or incur debt.

 

The Company conducts its operations in leased facilities. In August 2003, the Company entered into a six-year lease agreement and moved its corporate offices. The new lease agreement commenced on September 1, 2003 and obligated the Company to make minimum lease payments plus its pro-rata share of future real estate tax increases and certain operating expense increases above the base year. This lease agreement also required the Company to obtain a Letter of Credit in the amount of $250, which resulted in $250 in cash being classified as restricted on the Company’s Balance Sheet. The amount will be reduced to $200 on the second anniversary and further to $150 on the fourth anniversary of the lease.

 

The Company has entered into certain agreements to pay royalties based on the shipment and licensing of certain products. Royalty expense is primarily based on a dollar amount per unit shipped or a percentage of the underlying revenue. Royalty expense is recorded as cost of license revenue on our consolidated Statement of Operations.

 

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Table of Contents

PART 1, ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)

 

The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims based on these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities” and, in December 2003, issued a revision to that interpretation. FIN No. 46R replaces FIN No. 46 and addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. A variable interest entity (VIE) is defined as (a) an ownership, contractual or monetary interest in an entity where the ability to influence financial decisions is not proportional to the investment interest, or (b) an entity lacking the invested capital sufficient to fund future activities without the support of a third party. FIN No. 46R establishes standards for determining under what circumstances VIEs should be consolidated with their primary beneficiary, including those to which the usual condition for consolidation does not apply. The Company adopted FIN No. 46 in the year ended December 31, 2003, and FIN No. 46R in the first quarter of 2004 for non-special purpose entities created prior to February 1, 2003. The Company’s adoption of FIN No. 46 and FIN No. 46R has not had and is not expected to have, a significant effect on the Company’s financial position or its results of operations.

 

In December 2003, the SEC issued Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition”, which supercedes Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements.” The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superceded as a result of the issuance of Emerging Issues Task Force 00-21 (“EITF 00-21”), “Accounting for Revenue Arrangements with Multiple Deliverables.” SAB 104 also incorporated certain sections of the SEC’s “Revenue Recognition in Financial Statements—Frequently Asked Questions and Answers” document. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

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Table of Contents

PART I, ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

 

As of September 30, 2004 the Company did not participate in any derivative financial instruments or other financial and commodity instruments for which fair value disclosure would be required under SFAS No. 107. All of the Company’s investments are short-term, investment-grade commercial paper, and money market accounts that are carried on the Company’s books at amortized cost, which approximates fair market value. Accordingly, the Company has no quantitative information concerning the market risk of participating in such investments.

 

Primary Market Risk Exposures

 

The Company’s primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. The Company’s investment portfolio of cash equivalent and short-term investments is subject to interest rate fluctuations, but the Company believes this risk is immaterial due to the short-term nature of these investments. The Company’s exposure to currency exchange rate fluctuations has been, and is expected to continue to be, modest due to the fact that its international subsidiaries are inactive with the closing of the Company’s last foreign sales office on March 31, 2003. International subsidiary operating results are translated into U.S. dollars and consolidated for reporting purposes. Currently the Company does not engage in foreign currency hedging activities.

 

PART 1, ITEM 4. CONTROLS AND PROCEDURES

 

Based on the evaluation of the Company’s disclosure controls and procedures as of September 30, 2004, each of Anna Chagnon, Chief Executive Officer, and James Dore, the Chief Financial Officer of the Company have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were sufficiently effective to ensure that information required to be disclosed by the Company in this quarterly report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations.

 

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls during the quarter ended September 30, 2004, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

The Company’s management, including its Chief Executive Officer, and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures or its internal controls will prevent all error and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

 

20


Table of Contents

PART II — OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

On June 24, 2003, 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, through its TrueDoc software, infringes trademarks and copyrights and violates the Digital Millennium Copyright Act. The complaint fails to identify any of the plaintiffs’ trademarks or copyrights that have been allegedly infringed and does not specify any amount of monetary damages. The plaintiffs seek injunctive relief, but do not make any statement that any of the alleged acts have actually taken place. The Company is contesting these claims.

 

From time to time, in addition to the infringement case identified above, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of infringement of third-party patents and other intellectual property rights, commercial, employment and other matters.

 

In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. This provision is reviewed at least quarterly. As of September 30, 2004 no liability for legal claims has been recorded. Litigation is inherently unpredictable and it is possible that the Company’s Financial Position, cash flows, or results of operations could be affected in any particular period by the resolution of one or more of these contingencies.

 

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER REPURCHASES OF EQUITY SECURITIES

 

(a) Instruments defining the rights of the holders of any class of registered securities of the Company have not been materially modified during the three months ended September 30, 2004.

 

(b) Rights evidenced by any class of registered securities of the Company have not been materially limited or qualified by the issuance or modification of any other class of securities during the three months ended September 30, 2004.

 

(c) There were no unregistered securities sold by the Company during the three months ended September 30, 2004.

 

(d) There were no repurchases by the Company of its equity securities during the three months ended September 30, 2004.

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of security holders during the three months ended September 30, 2004.

 

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ITEM 5. OTHER INFORMATION

 

  (a) Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934 as added by Section 202 of the Sarbanes-Oxley Act of 2002, the Company is responsible for listing the non-audit services approved during any reporting period by its Audit Committee to be performed by PricewaterhouseCoopers LLP, the Company’s external auditor. All non-audit services are pre-approved by the Audit Committee or the Audit Committee’s Chairman pursuant to delegated authority by the Audit Committee. During the three months ended September 30, 2004, there were no matters brought forward to the Audit Committee for approval.

 

  (b) There have been no changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a) Exhibits

 

   

CERTIFICATIONS


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

 

(b) Reports on Form 8-K

 

        None

 

PART II - SIGNATURES

 

SIGNATURES

 

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

 

BITSTREAM INC.

(Registrant)

 

SIGNATURE


  

TITLE


   DATE

/s/ Anna M. Chagnon


Anna M. Chagnon

   President and Chief Executive Officer (Principal Executive Officer)    November 15, 2004
           

/s/ James P. Dore


James P. Dore

   Vice President and Chief Financial Officer (Principal Accounting Officer)    November 15, 2004
           

 

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