MARLBOROUGH SOFTWARE DEVELOPMENT HOLDINGS INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) All statements, trend analysis and other information contained in the following discussion relative to markets for our products and trends in revenue, gross margin and anticipated expense levels, as well as other statements, including words such as "may," "anticipate," "believe," "plan," "estimate," "expect," and "intend" and other similar expressions constitute forward-looking statements.

These forward-looking statements are subject to business and economic risks and uncertainties and our actual results of operations may differ materially from those contained in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under Item 1A Risk Factors in our Annual Report on Form 10-K, as may be supplemented from time to time in our quarterly reports on Form 10-Q, as well as other risks and uncertainties referenced in this report.

EXECUTIVE OVERVIEW Marlborough Software Development Holdings Inc. ("MSDH" or "We" or the "Company") was formed on July 18, 2011 in conjunction with our former parent company's, Bitstream Inc. ("Bitstream"), planned merger (the "Bitstream Merger") with and acquisition by Monotype Imaging Holdings Inc., a Delaware corporation ("Monotype") pursuant to an agreement and plan of merger (the "Bitstream Merger Agreement") entered into by and between Bitstream and Monotype on November 10, 2011 (the "Separation Date"). On the Separation Date, Bitstream transferred and assigned to MSDH all of the assets and liabilities relating to, arising from or in connection with Bitstream's Pageflex and BOLT product lines (the "Separation") pursuant to the terms and conditions of a Contribution Agreement dated November 10, 2011 by and between Bitstream and MSDH (the "Contribution Agreement"). On March 14, 2012, Bitstream distributed all of the shares of MSDH common stock to the stockholders of Bitstream on a pro rata basis (the "Distribution") pursuant to the terms and conditions of the Distribution Agreement dated November 10, 2011 between Bitstream and MSDH (the "Distribution Agreement"). On March 19, 2012, Bitstream completed the Bitstream Merger with Monotype.

MSDH is a software development company focused on bringing innovative and proprietary software products to a wide variety of markets. Our core software products include mobile browsing technologies and variable data publishing, Web-to-print, and multi-channel communications technologies.

Automated Marketing Communication and Print Production Variable Technologies.

The Pageflex product line enables companies across the globe to communicate their marketing messages more easily and effectively. It is the advanced technology for brand management, web-to-print applications, and sophisticated personalized communications based on customer information. We pioneered flexible variable data software in 1997 and have been a technology innovator in the document customization arena ever since. The platform produces rich, creative, award-winning document designs that look like they were given the individual attention of a graphic designer but were, in reality, created on-the-fly with Pageflex variable publishing technology. Print service providers, marketing service providers, corporate marketers, and publishers use Pageflex products to ensure design integrity and brand control while empowering local users to customize and personalize print collateral, email campaigns, and 1-to-1 marketing Web sites. Pageflex Persona is desktop software that produces personalized print and email documents using data from a database. Pageflex Studio ID is a plug-in to Adobe InDesign for producing personalized print pieces. Pageflex Storefront is a turnkey solution for producing web portals for document customization and online purchasing of print documents. Pageflex Server provides an enterprise solution for high-volume document customization driven by a database or requests from a web site. Pageflex iWay provides business flow automation for printing companies. Pageflex Campaign Manager lets companies develop personal conversations with their customers in print, email, and online.

And finally, Pageflex Chart works with these Pageflex products to add dynamic charts and graphs to print documents. Pageflex products enable companies worldwide to manage, streamline, and automate their document production processes, communicate more personally with their customers, and control their brand and market messaging while enabling their remote employees, franchises, and consumers to use a self-serve model to order customized communications.

Pageflex products are purchased by both corporations and the printing companies that support them, who also use the software to control and track production processes in order to improve their business ROI.

We market our products and acquire our customers through a variety of sources including participation in industry trade shows, trade association sponsorships, online marketing, including search engines and advertising on online networks and other websites, and other marketing efforts, relationships with our partners, referrals from our growing customer base, general brand awareness and the inclusion of a link to our website in the footer of the emails sent by our customers. Our business strategy focuses on expanding both our direct sales effort as well as expanding our relationships with our OEM and reseller channels. We are also focused on improving our product offerings and expanding our market share.

Mobile Browsing Technologies. BOLT provides a consistent, full desktop-style browsing experience on almost any handset. The BOLT mobile browser offers faithful rendering of web pages and it is the only browser for mobile phones of all types to support streaming video from popular media sharing sites such as YouTube and MySpace. Compatible with most handsets that support the 14-------------------------------------------------------------------------------- Table of Contents J2ME or BREW/BMP operating systems, BOLT's advanced features include W3C based widget support, direct Twitter integration, six levels of magnification, international localization, copy/paste, FOTA updates, and additional usability features such as auto-complete url, save page, secure browsing, patented split-screen minimap, password manager, rss subscriptions, automatic socket support, history and keypad shortcuts. BOLT is a WebKit based cloud computing mobile browser. We believe this cloud computing architecture is the key to BOLT's capabilities. Web pages are first loaded by the BOLT servers, then transcoded and sent to the BOLT mobile browser client on handsets. This client/server approach maintains the integrity of Web page layouts, reduces packet consumption on data networks, dramatically improves page load speeds, and enables advanced features such as video streaming. Currently, we are concentrating our resources and efforts on our automated marketing communications and print production variable technologies, and we do not expect sales of our mobile browsing products to contribute significant revenues in the short term.

Certain Financial and Operating Metrics In connection with the ongoing operation of our business, our management regularly reviews key financial and operating metrics, such as revenue, gross margin, expenses, and capital expenditures, among others. Management considers these financial and operating metrics critical to understanding and improving our business, reviewing our historical performance, comparing our performance versus other companies and identifying current and future trends, and for planning purposes.

Certain Trends and Uncertainties The following represents a summary of known trends and uncertainties which could have a significant impact on our financial condition and results of operations.

This summary should be considered along with the factors discussed under the headings "Risk Factors" and "Forward-Looking Statements" elsewhere in our Form 10-K filed with the SEC on March 30, 2012.

• Effective January 1, 2012 we completed the Separation from Bitstream and on March 14, 2012 Bitstream completed the Distribution, thereby resulting in MSDH becoming a separate, stand-alone public company. On March 19, 2012, Bitstream completed the Bitstream Merger with Monotype. We continue to experience disruption in our business related to the Separation and the Bitstream Merger, including, but not limited to, attention and time spent on the Separation, Distribution and transition services pursuant to the Bitstream Merger and the assignment of material contracts to us for which some of the parties may not consent to the assignment. If we experience significant disruption as a result of these or any other factors related to the Separation, Distribution and Bitstream Merger, our financial results could be adversely impacted.

• The Pageflex and Bolt product activities were conducted by Bitstream as a whole and integrated with the Fonts products activities. Our historical financial information may not be representative of our results as a separate company.

• We continue to closely monitor current economic conditions, particularly as they impact our customers. We believe that our customers continue to experience some amount of economic hardship. If this economic hardship continues or worsens, our financial results could be adversely impacted.

• We continue to develop new products and new versions of our existing product offerings. Failure to develop and launch new products and versions could negatively impact our financial results.

CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America consistently applied. The preparation of these unaudited condensed consolidated financial statements requires us to make significant estimates and judgments that affect the amounts reported in our unaudited condensed consolidated financial statements and the accompanying notes. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates.

While all of our accounting policies impact the unaudited condensed consolidated financial statements, certain policies are viewed to be critical. Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and that require management's most subjective or complex judgments and estimates. We consider the following accounting policies to be critical in fully understanding and evaluating our financial results: • Allocation Methodologies • Revenue Recognition • Stock-based Compensation 15 -------------------------------------------------------------------------------- Table of Contents • Impairment of Goodwill and Other Long-Lived Assets • Accounts Receivable • Software Development Costs • Income Taxes Please refer to the critical accounting policies set forth in our Annual Report on Form 10-K as of and for the fiscal year ended December 31, 2011, filed with the Securities and Exchange Commission, or the SEC, on March 30, 2012, for a description of all critical accounting policies.

The critical accounting policies included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 have not materially changed.

OVERVIEW RESULTS OF OPERATIONS (in thousands, except percentages and per share amounts) Revenue and Gross Profit: Three Months Ended September 30, Change % of % of 2012 Revenue 2011 Revenue Dollars Percent Revenue Software licenses $ 347 21.2 % $ 711 33.6 % $ (364 ) (51.2 )% Services 1,288 78.8 1,402 66.4 (114 ) (8.1 ) Total revenue 1,635 100.0 2,113 100.0 (478 ) (22.6 ) Cost of Revenue Software licenses 237 68.3 278 39.1 (41 ) (14.7 ) Services 629 48.8 539 38.4 90 16.7 Total cost of revenue 866 53.0 817 38.7 49 6.0 Gross Profit $ 769 47.0 % $ 1,296 61.3 % $ (527 ) (40.7 )% Nine Months Ended September 30, Change % of % of 2012 Revenue 2011 Revenue Dollars Percent Revenue Software licenses $ 1,391 25.9 % $ 2,078 32.2 % $ (687 ) (33.1 )% Services 3,977 74.1 4,379 67.8 (402 ) (9.2 ) Total revenue 5,368 100.0 6,457 100.0 (1,089 ) (16.9 ) Cost of Revenue Software licenses 700 50.3 859 41.3 (159 ) (18.5 ) Services 1,841 46.3 1,519 34.7 322 21.2 Total cost of revenue 2,541 47.3 2,378 36.8 163 6.9 Gross Profit $ 2,827 52.7 % $ 4,079 63.2 % $ (1,252 ) (30.7 )% License Revenue We recognize license revenue from direct sales and licensing agreements of our products and products from third parties, licensing agreements with OEMs, and from the resale of our products through various resellers. We recognize reseller revenue on a sell-in basis and bear no obligation after the license has been delivered to the reseller.

The decrease in revenue from software licenses for the three and nine month periods ended September 30, 2012 as compared to the three and nine month periods ended September 30, 2011 was due to decreases across all our sales channels.

During the first nine months of 2012, our sales continued to be affected by the global economic downturn. The decrease in OEM royalties is attributable primarily to reduced sales with certain of our OEMs and the delayed introductions of new versions of our solutions which were anticipated earlier in the year but which were not released until our third quarter of 2012.

16-------------------------------------------------------------------------------- Table of Contents Additionally, the decrease in direct sales during the first quarter was affected by the Separation of MSDH from Bitstream and activities related to the merger of Bitstream with Monotype Imaging. These activities began in 2011 and were completed during the first quarter of 2012. We expect with the release of new versions of our products, the stabilization of the iWay product, the localization of the Pageflex Storefront product and our increase in sales and marketing resources, that our revenue will begin to show improvement during the fourth quarter of 2012 and will continue to increase in 2013 as compared to levels achieved in 2012, though there can be no assurance that such revenue levels can be achieved.

Service Revenue Services revenue decreased for the three and nine month periods ended September 30, 2012 due primarily to a significant consulting agreement completed during the three months ended September 30, 2011. Services revenue also decreased for the nine month period ended September 30, 2012 primarily due to an end-of-life support contract which resulted in non-recurring support revenue for the nine month period ended September 30, 2011. These decreases were partially offset by the completion of a consulting engagement in the second quarter of 2012. Other product services revenue for customer support, consulting, custom design and training services were generally consistent period over period. We expect the revenue from support contracts to increase for the remainder of 2012, however there can be no assurance that this upward trend will be sustained.

Consulting, design and training services vary with specific requirements of customers and may be affected more by economic concerns as customers may delay design changes, custom development and training.

Cost of Revenue Cost of revenue includes hosting costs, royalties and fees paid to third parties for the license of rights to technology, 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 products. Cost of revenue also includes amortization of acquired-technology from the acquisition of assets from Press-Sense Ltd. and the amortization of capitalized internally developed software related to the translation of our products into multiple languages.

Cost of License Revenue The decrease in cost of license revenue for the three and nine month periods ended September 30, 2012 as compared to the same periods ended September 30, 2011 was primarily related to a decision to suspend the hosting of the BOLT browser free user base, partially offset by the first month of amortization of internally developed software related to the translation of Pageflex products into multiple languages. For the nine months ended September 30, 2012, these decreases were also partially offset by increased royalties related to increased sales of third party products during the second quarter.

Cost of Service Revenue The increase in cost of services revenue for the three and nine months ended September 30, 2012, as compared to the same period in 2011 was primarily due to increases in salary and related expenses for additional resources, contractor costs, expendable equipment purchases, and increased facilities costs resulting from added resources. The increase in contractor costs for the three and nine months ended September 30, 2012 resulted from costs to transfer our support services to an alternate system, as well as costs related to the setup of a new hosted product offering. Our cost of services infrastructure increased during the first nine months of 2012 and we expect these costs to decrease during the fourth quarter of this year with the reduction in workforce that we announced in August 2012. We do not expect our variable costs to continue to increase for the remainder of 2012.

17 -------------------------------------------------------------------------------- Table of Contents Operating Expenses: Three Months Ended September 30, % of % of Change 2012 Revenue 2011 Revenue Dollars Percent Marketing and selling $ 872 53.3 % $ 954 45.1 % $ (82 ) (8.6 )% Research and development 1,343 82.1 1,703 80.6 (360 ) (21.1 ) General and administrative 773 47.3 665 31.5 108 16.2 Total operating expenses $ 2,988 182.7 % $ 3,322 157.2 % $ (334 ) (10.1 )% Nine Months Ended September 30, % of % of Change 2012 Revenue 2011 Revenue Dollars Percent Marketing and selling $ 3,108 57.9 % $ 2,652 41.1 % $ 456 17.2 % Research and development 4,714 87.8 5,154 79.8 (440 ) (8.5 ) General and administrative 2,790 52.0 2,453 38.0 337 13.7 Total operating expenses $ 10,612 197.7 % $ 10,259 158.9 % $ 353 3.4 % Marketing and Selling ("M&S") Expense Marketing and selling ("M&S") expense consists primarily of salaries and benefits, commissions, travel expense and facilities costs related to sales and marketing personnel, as well as marketing program-related costs. The decrease in M&S for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 related primarily to decreases in salaries and benefits, as well as in tradeshow costs as a result of timing of the Graph Expo show which was held in the third quarter of 2011 but not until the fourth quarter of 2012. The increase in M&S for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 related primarily to increases in salary and benefit costs, employee travel, sales subcontractors including resources in Poland and Brazil, and facilities related expenses resulting from the increased resources. We expect that our M&S expense will increase in absolute dollars during the remainder of 2012, due to the timing of participation in marketing and tradeshow activities, as well as from increases in commissionable sales and as we invest in new sales and marketing resources.

Research and Development ("R&D") Expense Research and development ("R&D") expense consists primarily of salary and benefit costs, contracted third-party development costs, and facility costs related to software developers and management. R&D expense decreased for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011 primarily due to the reduction in R&D resources related to BOLT browser product development. The decrease reported for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 was primarily due to the reduction in R&D resources related to the BOLT browser product development, partially offset by an increase in stock compensation expense from the acceleration of Bitstream options and restricted stock awards caused by the merger of Bitstream on March 19, 2012. We expect our R&D costs to decrease during the fourth quarter of this year due to the reduction in workforce that we announced in August 2012.

18-------------------------------------------------------------------------------- Table of Contents General and Administrative ("G&A") Expense 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, directors fees and director and officer insurance. G&A expense increased for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011, consisting primarily of costs associated with public financial reporting, reduced allocation of facilities costs, and severance costs resulting from a workforce reduction in the US during the third quarter 2012. These increases were partially offset by a decrease in professional services costs.

G&A expense increased for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 due to increases from the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 as explained above, as well as from Bitstream stock compensation expense and G&A bonus and related tax expense, both related to the Bitstream merger with Monotype during the first quarter of 2012. These increases were partially offset by a management fee allocation to Bitstream in accordance with the management fee agreement between MSDH and Bitstream (see Note (2) Basis of Presentation and Allocation methodologies for details). In addition, the first quarter of 2012 included $2,250 of transaction costs related to the spinout of MSDH from Bitstream Inc. and the merger of Bitstream into Monotype Imaging Inc., which were fully allocated to Bitstream during the first quarter, resulting in a net effect of zero. We expect MSDH G&A expense to increase during the remainder of the year ended December 31, 2012 when compared to the "carve-out" expenses reported for 2011 as MSDH will bear the full costs of the previously shared expenditures and we expect the overall decrease in those costs to be less than the amount to be absorbed by MSDH.

Other Income, Net: Other income consists primarily of foreign currency transactions gains or losses.

Provision for Income Taxes: The provision for income taxes consists of foreign taxes in Israel and U.S.

federal tax expense related to the deferred tax liability created by the taxable amortization of Goodwill. There was no significant change in the provision for taxes for the three months ended September 30, 2012 and 2011, and for the nine months ended September 30, 2012 and 2011.

The Company accounts for income taxes in accordance with GAAP, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of the temporary differences between the book and tax basis of recorded assets and liabilities. The Company makes estimates and judgments with regard to the calculation of certain income tax assets and liabilities. GAAP requires that deferred tax assets be reduced by valuation allowances if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be objectively verified.

For purposes of the Company's historical financial statements prior to the Separation, income tax expense and deferred income tax balances were recorded as if the Company had filed tax returns on a separate return basis ("hypothetical carve-out basis") from Bitstream. After the completion of the Separation, income tax expense and deferred income tax balances are recorded in accordance with the Company's stand-alone income tax positions.

MSDH's operating results have been included in Bitstream's consolidated U.S.

federal and state income tax returns, as well as included in Bitstream's tax filings for non-U.S. jurisdictions. The Company's non-U.S. operations have primarily been conducted within Bitstream's non-U.S. subsidiaries which share operations with Bitstream's other businesses. For purposes of the Company's condensed consolidated financial statements, income tax expense and deferred tax balances have been recorded as if the Company had filed tax returns on a separate return basis from Bitstream. The Company's contribution to Bitstream's tax losses and tax credits on a separate return basis has been included in these condensed consolidated financial statements. The Company's separate return basis tax loss will not reflect the tax positions taken or to be taken by Bitstream.

In many cases tax losses and tax credits generated by the Company have been available for use by Bitstream and will largely remain with Bitstream after the completion of the Separation.

As the Company continues to incur cumulative taxable losses in the United States, the Company recorded a full valuation allowance against the Company's U.S. deferred tax assets, net of reversing taxable temporary differences.

We have made an indefinite reinvestment of earnings in our Israeli subsidiary and, therefore, we do not provide for U.S. income taxes applicable to its undistributed earnings.

19 -------------------------------------------------------------------------------- Table of Contents We have recorded a deferred tax liability and related income tax expense for the "naked credit" resulting from the amortization of goodwill for tax purposes. The total deferred liability at September 30, 2012 and December 31, 2011 was $174 and $115, respectively.

LIQUIDITY AND CAPITAL RESOURCES (dollar amounts in thousands) At September 30, 2012, our primary source of liquidity comes from our cash of $621. Our cash at September 30, 2012 of $621 includes $308 held by our Israeli subsidiary that is not available to fund domestic operations, unless the funds were repatriated. We do not intend to repatriate funds and if we do we will accrue and pay any applicable taxes on the repatriated funds, as required. The Pageflex and BOLT products historically have been funded directly through the conduct of our operations as a component of Bitstream. For the nine months ended September 30, 2012 and 2011, we incurred net losses of $7,957 and $6,305, respectively. Bitstream contributed capital of $9,005 and $5,434 for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, we had a working capital deficit of $2,234.

Our operating activities used cash during the nine months ended September 30, 2012 and 2011 of $8,060 and $4,579, respectively. The increased usage of cash during the nine months ended September 30, 2012 as compared to the same period in the prior year resulted primarily from an increased net loss of $1,652, a decrease in contributions from working capital accounts of $1,743, and a decrease in the add-backs of non-cash expense items of $86. Cash used in operating activities has historically been affected by the amount of net loss, changes in working capital accounts and add-backs of non-cash expense items such as depreciation and amortization and the expense associated with stock-based awards.

Cash used in investing activities during the nine months ended September 30, 2012 and 2011 was $875 and $786, respectively. Cash used in investing activities during the nine months ended September 30, 2012 and 2011 consisted of increases in restricted cash, the capitalization of internally developed software, and purchases of property and equipment.

Our financing activities for the nine months ended September 30, 2012 and 2011 provided cash of $9,005 and $5,434, respectively. Cash provided by financing activities consists entirely of contributions from Bitstream.

We are utilizing approximately 40% of the square footage of the Marlborough, Massachusetts headquarters after the decrease in personnel associated with the Bitstream Merger and a reduction in workforce during August 2012. Management anticipates a reduction in operating costs through the elimination of certain fixed costs, including, without limitation, the possible sub-letting or returning to the landlord of the unutilized space that currently exists.

However, there can be no assurance that management will be successful in implementing these cost-cutting plans or that such plans will be successful or, if successful, how long they will take to implement.

The unaudited condensed consolidated financial statements have been prepared on a basis that contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. MSDH's long-term viability is dependent on its ability to generate sufficient product revenue, net income and cash flows from operations to support its business as well as its ability to obtain additional financing. Management's plans also include reducing operating costs and delaying certain expenditures, if necessary, to maintain the Company's liquidity. The Separation from Bitstream Inc. has disrupted and may continue to disrupt our business and management, negatively affecting our business, operating results or financial condition and may cause other risks to the Company. MSDH has suffered recurring losses from operations, both before and after the Separation. For its liquidity, prior to Separation, the Company relied on contributions from Bitstream. As of March 19, 2012, MSDH had accumulated contributions of approximately $60,977 from its former Parent. After Separation, the Company has sought third party investors to reduce the Company's liquidity risks.

MSDH received an equity commitment from two investors on October 10, 2012, scheduled to occur in two tranches. The first in the aggregate amount of $2,000 in exchange for 597 shares of 6.5% redeemable preferred stock and 2,985 common stock warrants closed on October 11, 2012. A second tranche of $1,500 of the same securities shall occur in 2013 if certain performance criteria specified in the investment documents are achieved by the end of the second quarter of 2013.

In addition, the Company received commitments from certain customers with terms including the prepayment of software licenses in the aggregate amount of $850 payable over the course of the next three fiscal quarters, subject in each case to the Company continuing to provide service and support to these customers.

Additionally, MSDH announced on August 27, 2012 that it had restructured its global workforce eliminating 28 positions, including 7 contractors, a reduction in our workforce of approximately 26%.

Management believes that with its current operating plan, the additional funds received by the Company from the October 10, 2012 equity investment, and anticipated cash flows in the next year, cash will be sufficient to meet the Company's working capital and capital expenditure requirements through at least the next twelve months. There can be no assurance, however, that MSDH will not require additional financing in the future if funds from future operations or estimated expenses differ materially from those amounts estimated by management.

In October 2012, the Company engaged a financial advisory firm to assist the company with exploring its strategic alternatives. There can be no assurance that additional financing sources of capital would be available on terms favorable to us, if at all. In addition, MSDH and Bitstream have entered into certain ancillary agreements in connection with the Separation and Distribution that provide for indemnification of Bitstream with respect to certain liabilities of the Pageflex and BOLT products contributed to MSDH.

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

In connection with the Separation of MSDH from Bitstream and the Merger of Bitstream with Monotype, the Company entered into certain indemnification agreements with Monotype. A detailed discussion of these agreements is included in our Form 10-K filed with the SEC on March 30, 2012.

OFF-BALANCE SHEET ARRANGEMENTSWe do not have any off-balance sheet arrangements or unconsolidated special-purpose entities within the meaning of Item 303(a)(4) of Regulation S-K.

RECENT ACCOUNTING PRONOUNCEMENTSRecent Accounting Pronouncements Not Yet Adopted There has been one new accounting pronouncement during the three months ended September 30, 2012, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, that is of significance, or potential significance, to us.

In July 2012, the FASB issued ASU No. 2012-02, Intangibles - Goodwill and Other (Topic 350) - Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). This update amends existing guidance by giving an entity testing an indefinite-lived intangible asset for impairment the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If an entity determines that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, then the performance of the quantitative impairment test, as currently prescribed by ASC Topic 350, is required. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The adoption of this update did not have a significant effect on the Company's condensed consolidated financial statements and related disclosures.

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