Effective internal controls are necessary for us to provide reliable financial reports and effectively minimize the possibility of fraud and its impact on our company. If we cannot provide financial reports or effectively minimize the possibility of fraud, our business reputation and operating results could be harmed. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

In addition, we will be required to include the management and auditor reports on internal controls as part of our annual report for the fiscal year ending September 30, 2008, pursuant to SOX Section 404, which requires, among other things, that we maintain effective internal controls over financial reporting and effective disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404. Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management efforts.

We cannot be certain as to the timing of the completion of our evaluation and testing, the timing of any remediation actions that may be required or the impact these may have on our operations. Furthermore, there is no precedent available by which to measure compliance adequacy. If we are not able to implement the requirements relating to internal controls and all other provisions of Section 404 in a timely fashion or achieve adequate compliance with these requirements or other SOX requirements, we might become subject to sanctions or investigation by regulatory authorities such as the Securities and Exchange Commission or any securities exchange on which we may be trading at that time, which action may be injurious to our reputation and affect our financial condition and decrease the value and liquidity of our securities, including our common stock.

Risks Related to Our Industry

We face intense and growing competition, which could result in price reductions, reduced operating margins and loss of market share. 

We operate in a highly competitive marketplace and generally encounter intense competition to create and maintain demand for our services and to obtain service contracts. If we are unable to successfully compete for new business and license renewals, our revenue growth and operating margins may decline. The market for our products, i.e., Web development services, content management products, asset management products, e-Training products, foundations management products, and Web analytics are competitive and rapidly changing, and barriers to entry in such markets are relatively low. With the introduction of new technologies and market entrants, we expect competition to intensify in the future. Some of our principal competitors offer their products at a lower price, which may result in pricing pressures. Such pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our product and service offerings to achieve or maintain more widespread market acceptance.

The Web development/services market is highly fragmented with a large number of competitors and potential competitors. Our primary public company competitors are Website Pros, Filenet, aQuantive, Vignette and WebSideStory. We also face competition from customers and potential customers who develop their own applications internally. We also face competition from potential competitors that are substantially larger than we are and who have significantly greater financial, technical and marketing resources, and established, direct and indirect channels of distribution. As a result, they are able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share which could reduce our market share and decrease our revenues. See “Business - Competition” on page 53.

13

---

Increasing government regulation could affect our business. 

We are subject not only to regulations applicable to businesses generally, but also to laws and regulations directly applicable to electronic commerce. Although there are currently few such laws and regulations, state, federal and foreign governments may adopt laws and regulations applicable to our business. Any such legislation or regulation could dampen the growth of the Internet and decrease its acceptance. If such a decline occurs, companies may choose in the future not to use our products and services. Any new laws or regulations in the following areas could affect our business:

·	user privacy;

·	the pricing and taxation of goods and services offered over the Internet;

·	the content of Websites;

·	copyrights;

·	consumer protection, including the potential application of “do not call” registry requirements on customers and consumer backlash in general to direct marketing efforts of customers;

·	the online distribution of specific material or content over the Internet; or

·	the characteristics and quality of products and services offered over the Internet.

 

Because competition for highly qualified personnel is intense, we might not be able to attract and retain the employees we need to support our planned growth. 

We will need to increase the size and maintain the quality of our sales force, software development staff and professional services organization to execute our growth plans. To meet our objectives, we must attract and retain highly qualified personnel with specialized skill sets. Competition for qualified personnel can be intense, and we might not be successful in attracting and retaining them. Our ability to maintain and expand our sales, product development and professional services teams will depend on our ability to recruit, train and retain top quality people with advanced skills who understand sales to, and the specific needs of, our target customers. For these reasons, we have experienced, and we expect to again experience in the future, challenges in hiring and retaining highly skilled employees with appropriate qualifications for our business. In addition to hiring services personnel to meet our needs, we may also engage additional third-party consultants as contractors, which could have a negative impact on our financial results. If we are unable to hire or retain qualified personnel, or if newly hired personnel fail to develop the necessary skills or reach productivity slower than anticipated, it would be more difficult for us to sell our products and services, and we could experience a shortfall in revenue and not achieve our planned growth.

Risks Related to this Offering

There is no prior public market for our common stock and our stock price could be volatile and could decline following this offering, resulting in a substantial loss in your investment.

 

Prior to this offering, there has not been a public market for our common stock. An active trading market for our common stock may never develop or if it develops it may not be sustained, which could affect your ability to sell your shares and could depress the market price of your shares. In addition, the initial public offering price of the shares has been determined through negotiations between us and the representatives of the underwriters and may bear no relationship to the price at which the shares will trade upon completion of this offering. The stock market can be highly volatile. As a result, the market price of our common stock can be similarly volatile, and investors in our common stock may experience a decrease in the value of their stock, including decreases unrelated to our operating performance or prospects. The market price of our common stock after the offering will likely vary from the initial offering price and is likely to be highly volatile and subject to wide fluctuations in response to various factors, many of which are beyond our control. These factors include:

·	variations in our operating results;

·	changes in the general economy and in the local economies in which we operate;

·	the departure of any of our key executive officers and directors;

·	the level and quality of securities analysts’ coverage for our common stock;

·	announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or

 

14

---

capital commitments;

·	changes in the federal, state, and local laws and regulations to which we are subject; and

·	future sales of our common stock.

 

Shares of common stock that are issuable pursuant to our stock option plan and our outstanding warrants could result in dilution to existing shareholders and could cause the market price of our common stock to fall.

 

 

 

 

 

 

17

---

USE OF PROCEEDS 

Our net proceeds from the sale and issuance of 3,000,000 shares are estimated to be approximately $14,135,000 (approximately $16,610,000 if the underwriters’ over-allotment option is exercised in full), based upon an estimated initial public offering price of $5.50 per share and after deducting the estimated underwriting discount, the non-accountable expense allowance and the estimated offering expenses payable by us.

We intend to use the net proceeds of this offering as follows: 

Use		Amount (in thousands)				Percent
Repayment of indebtedness (approximate)		$	2,800			19.8	%
Payment of cash portion in connection with the acquisition of Objectware, together with expenses associated with that acquisition			2,955			20.9	%
General corporate purposes, including working capital			8,380			59.3	%
Total		$	14,135			100.0	%

     

 

Technology Development Expenses. Technology development expenses increased to $140, or 2% of revenues, in 2006 compared to $37, or 0.8% of revenues, in 2005. The increase resulted primarily from product enhancement activities for the netEDITOR content management product.

Comparison of Fiscal Years Ended September 30, 2005 and 2004

The following table sets forth certain Consolidated Statements of Operations data expressed as a percentage of revenue for the periods indicated:

 

		Fiscal Years Ended September. 30,
		2005			2004
Revenue			100	%		100	%
Cost of revenue			54			47
Gross profit			46			53
Operating expenses:
Sales and marketing			36			38
General and administrative			17			17
Technology development			1			1
Loss from operations			(8	)		(3	)
Interest income (expense), net			(1	)		(1	)
Net loss			(9	%)		(4	%)

Revenue, Cost of Revenue and Gross Profit

The following table presents revenue, cost of revenue and gross profit for the fiscal years ended September 30, 2005 and 2004:

 

								Net change 2005 vs. 2004
Fiscal Year Ended September 30,		2005			2004			$			%
Total revenue		$	5,769		$	4,888		$	881			18	%
Cost of revenue			3,113			2,290			823			36
Gross profit		$	2,656		$	2,598		$	58			2	%

 

Revenue. Our revenue is generated principally by fees paid for Web Services, Managed Services and Subscription Revenue. The following table presents revenue from each of our revenue streams and their respective contribution to the increase in revenue in the fiscal years ended September 30, 2005 and 2004:

33

---

 

								Net change 2005 vs. 2004
Fiscal Year Ended September 30,		2005			2004			$			%
Web Services		$	4,182		$	3,820		$	362			9	%
Managed Services			1,244			1,068			176			16
Subscription Revenue			343			—			343			343
Revenue		$	5,769		$	4,888		$	881			18	%

 

Web Services revenue consists primarily of revenue generated from architecture, design and development of our customers Web application projects. Depending on the nature of the contract, this revenue may have been accounted for utilizing the proportionate performance model or may be recognized as delivered. Revenue from Web services increased 9% to $4,182 in 2005 from $3,820 in 2004. This growth was primarily due to the ongoing signing of new or expanded customer accounts requiring Web services.

 

Managed Services revenue consists primarily of retained maintenance services agreements and Web maintenance and hosting arrangements. Revenues from managed services increased 16% to $1,244 in 2005 from $1,068 in 2004 primarily due to increased hosting and retained services revenue with three financial services customers.

Subscription Revenue consists primarily of on-demand license rentals of our Orgitecture product in the foundation and non-profit sector of our business. Revenues from Subscription Revenue increased $343,000 in 2005, primarily due to the acquisition of iapps in December 2004.

 

Cost of Revenues and Gross Profit. Cost of revenues increased to $3,113 in 2005 from $2,290 in 2004 primarily due to increases in staff related costs associated with the delivery of Web services. The cost of revenues also increased as a result of the iapps acquisition. Specifically, we recognized $94 and $30 in amortization of intangibles related to this acquisition for the years ended September 30, 2005 and 2004, respectively. Gross margin during 2005 of 46% of revenues decreased from 2004 gross margin of 53% driven primarily by the increased direct labor incurred and associated inefficiencies of ramping up sales resulting in lower billable utilization and overrun in costs on certain engagements.

 

Sales and Marketing Expenses. Sales and marketing expenses increased to $2,060 in 2005 from $1,874 in 2004, but as a percentage of revenue decreased from 38% in 2004 to 35% in 2005. The increase in selling and marketing expenses was primarily due to the costs associated with the additional personnel acquired in the iapps acquisition.

 

General and Administrative Expenses. General and administrative expenses increased to $1,014 in 2005 compared to $830 in 2004. The increase resulted primarily from an increase in headcount resulting from direct hires and acquisitions. We also had an increase in computer maintenance purchases and increased compensation levels.

Technology Development Expenses. Technology development expenses increased to $43, or 1% of revenues, in 2005 compared to $26, or 0.5% of revenues, in 2004. The total increase resulted primarily from product development enhancement activities for the netEDITOR content management product.

 

Liquidity and Capital Resources

We have historically funded our operations principally through issuances of short-term debt and private equity. In April 2006, we completed a private placement financing in the amount of $2,800 and received net proceeds of $2,433 after financing fees. In connection with this debt, we issued 280,000 warrants exercisable at $0.001 and 112,000 warrants exercisable at the initial public offering price of our shares in this offering. These warrants have been valued at $646 and are recorded as a debt discount and prepaid finance costs. This debt carries an interest rate of

34

---

10% per annum for the first six months and 12% per annum thereafter. The effective interest rate, considering the amortization of the debt discount and other debt issuance costs, is 47%. The debt was subordinated to certain debt that was retired in July 2006. The debt carries default provisions including: (1) failure to pay principal or accrued interest when due, (2) failure to observe or perform various positive and negative covenants as set forth in the loan document, (3) failure to expeditiously process our initial public offering and (4) the occurrence of a bankruptcy or similar event. In the event of loan default, the interest rate will increase to 15% per annum and in case of default in payment of the principal, the interest rate would increase to 18% per annum. This debt carries a one-year term and will be retired upon the successful completion of this offering. If this offering is not completed, we expect to request an extension on the payment date of the notes. If we are unable to extend the maturity of these obligations, we may be forced to raise additional funds to pay them, through the issuance of additional debt or equity securities.

 

Cash Flows

 

Operating Activities

 

Our net cash used in operating activities was $493 for the fiscal ten months ended July 31, 2006 compared to $661 for the fiscal ten months ended July 31, 2005. For the ten fiscal months ended July 31, 2006, the increase in revenue was the primary reason for the decrease in cash used in operating activities. We used cash in operating activities of $432 for the fiscal year ended September 30, 2005 as compared to $378 for the fiscal year ended September 30, 2004.

 

At July 31, 2006, we had a working capital deficit of $1,092 compared to a working capital deficit of $179 at September 30, 2005. This increase was primarily a result of the $2,800 private placement completed in April 2006 net of an increase in cash and accounts receivable resulting from an increase in revenue.

 

At July 31, 2006, we had trade accounts receivable of $1,073. This compares to $605 in trade accounts receivable at September 30, 2005. The level of trade accounts receivable at July 31, 2006 represented approximately 48 days of revenues as compared to 38 days at September 30, 2005. We typically require 30-day terms from our customers. Our receivables can vary dramatically due to overall sales volumes, the timing of implementation of services, receipts from large customers, and other contract payments.

 

Investing Activities

 

Net cash used in investing activities was $754 for the ten fiscal months ended July 31, 2006. This was primarily the result of the cash utilized in the purchase of New Tilt in April 2006 of $554. This compares to net cash used in investing activities in the ten fiscal months ended July 31, 2005 of $540 which included a cash payment of $308 used to acquire iapps in December 2004. We expect to incur more costs for future acquisitions and capital expenditures as well as contingent earn-out payments related to our prior acquisitions.

 

Financing Activities

 

During the fiscal ten months ended July 31, 2006 and the fiscal years ended September 30, 2005 and 2004, we financed our working capital requirements primarily through short-term debt. In March 2005, we entered into a short term credit facility with Sand Hill Finance, LLC whereby we pledged certain receivables and received an 80% advance against these receivables with the additional 20% being received upon collection of the receivable. This credit facility carried 1.7% interest per month and certain fees and was terminated subsequent to the successful completion of the April 2006 private placement financing.

 

Net cash provided by financing activities was $2,080 for the fiscal ten months ended July 31, 2006, which as stated above, was primarily provided by the private placement of short-term debt of $2,025 offset by $367 in associated fees. The net cash provided by financing activities in the ten months ended July 31, 2005 of $338 was primarily provided by the Sand Hill Finance LLC credit facility described above.

 

The short-term notes have a one-year term and are payable on April 20, 2007. If we are unsuccessful in completing this offering, and if we are unable to extend the maturity of these obligations, we may be forced to raise additional funds to pay them through the issuance of additional debt or equity securities. Particularly in light of our limited operating

35

---

history and losses incurred, there can be no assurance that we will be able to obtain the necessary additional capital on a timely basis, on acceptable terms or at all. In any of such events, our business prospects, financial condition and results of operations would be materially and adversely affected. As a result of any such financing, the holders of our common stock may experience substantial dilution.

 

If we are unable to increase our revenues and decrease our expenses, we will need to raise additional funds to finance our future capital needs. We may need additional financing earlier than we anticipate.

 

We currently do not have any variable interest entities. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Capital Resources and Liquidity Outlook

 

We have been dependent upon raising private capital for short and long-term cash needs. In March 2005, we obtained a $500 credit line under which we could borrow up to 80% of our eligible outstanding accounts receivable. In connection with this credit line, the lender obtained a first priority security interest in all of our assets. This line of credit was increased to $750 on September 12, 2005 and was terminated on June 30, 2006 with the proceeds of the April 2006 private placement financing described above.

 

Inflation

We believe that the relatively moderate rates of inflation in recent years have not had a significant impact on our operations.

 

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, financings or other relationships with unconsolidated entities or other persons.

 

Contractual Obligations

 

Certificate of Incorporation and By-laws

Our Amended and Restated Certificate of Incorporation and Amended and Restated By-laws will contain provisions that could have the effect of discouraging potential acquisition proposals or tender offers or delaying or preventing a change of control of our company. In particular, our Amended and Restated Certificate of Incorporation and Amended and Restated By-laws, as applicable, will, among other things:

 

·	provide that special meetings of the shareholders may be called only by our Chairman of the Board, our President or our Board of Directors;

·

establish procedures with respect to shareholder proposals and shareholder nominations, including requiring that advance written notice of proposals and nominations generally must be received at our principal executive offices not less than 90 days nor more than 120 days prior to the anniversary of the preceding annual meeting of shareholders;

·	provide that shareholders may not take actions by written consent in lieu of an annual or special meeting of shareholders;

72

---

·

do not include a provision for cumulative voting in the election of directors. Under cumulative voting, a minority shareholder holding a sufficient number of shares may be able to ensure the election of one or more directors. The absence of cumulative voting may have the effect of limiting the ability of minority shareholders to effect changes in the Board of Directors and, as a result, may have the effect of deterring a hostile takeover or delaying or preventing changes in control or management of our company;

·	provide that vacancies on our Board of Directors may be filled by a majority of directors in office, although less than a quorum, and not by the shareholders;

·

provide for staggered terms for the members of our Board of Directors. The Board of Directors is divided into three staggered classes, and each director serves a term of three years. At each annual shareholders’ meeting only those directors comprising one of the three classes will have completed their term and stand for re-election or replacement. In addition, our Amended and Restated Certificate of Incorporation contains a supermajority voting requirement for any amendments of the staggered Board provisions;

·	require an advance notice of any shareholder business before the annual meeting of our shareholders; and

·

allow us to issue without shareholder approval up to 1,000,000 shares of preferred stock that could adversely affect the rights and powers, including voting rights, of the holders of common stock. In some circumstances, this issuance could have the effect of decreasing the market price of the common stock as well as having the anti-takeover effect discussed above

These provisions are intended to enhance the likelihood of continuity and stability in the composition of our Board and in the policies formulated by them and to discourage certain types of transactions that may involve an actual or threatened change of control of our company. These provisions are designed to reduce our vulnerability to an unsolicited acquisition proposal and to discourage certain tactics that may be used in proxy fights. However, these provisions could have the effect of discouraging others from making tender offers for our shares that could result from actual or rumored takeover attempts. These provisions also may have the effect of preventing changes in our management.

Transfer Agent

 

SHARES ELIGIBLE FOR FUTURE SALE

All of our shareholders and our directors and officers who own any of our securities, including warrants and options, agreed in writing not to sell, transfer or otherwise dispose of our common stock or any securities exercisable for or convertible into our common stock owned by them for a period of one year after the effective date of the registration statement of which this prospectus is a part without prior written consent or waiver from the underwriters. As a result of these contractual restrictions, notwithstanding possible earlier eligibility for sale under the provisions of Rules 144, 144(k) and 701, shares subject to lock-up agreements may not be sold until such agreements expire or are waived by the underwriters.

 

Rule 144

In general, Rule 144 allows a shareholder (or shareholders whose shares are aggregated) who has beneficially owned our shares of common stock for at least one year and who files a Form 144 with the SEC to sell within any

73

---

three-month period commencing 90 days after the date of this prospectus a number of shares of our common stock that does not exceed the greater of: (i) 1% of the number of shares of our common stock then outstanding or (ii) the average weekly trading volume of the shares of our common stock during the four calendar weeks preceding the filing of the Form 144 with respect to such sale.

Sales under Rule 144, however, are subject to specific manner of sale provisions, notice requirements, and the availability of current public information about our company. We cannot estimate the number of shares our existing shareholders will sell under Rule 144, as this will depend on the market price for our shares, the personal circumstances of the shareholders, and other factors.

Rule 144(k)

Under Rule 144(k), in general, a shareholder who has beneficially owned shares of our common stock for at least two years and who is not deemed to have been an affiliate of ours at any time during the immediately preceding 90 days may sell such shares without complying with the manner of sale provisions, notice requirements, public information requirements, or volume limitations of Rule 144. Affiliates of our company, however, must always sell pursuant to Rule 144, even after the otherwise applicable Rule 144(k) holding periods have been satisfied.

Rule 701

Rule 701 generally allows a shareholder who purchased our securities pursuant to a written compensatory plan or contract and who is not deemed to have been an affiliate of our company during the immediately preceding 90 days to sell securities in reliance upon Rule 144, but without being required to comply with the public information, holding period, volume limitation, or notice provisions of Rule 144. Rule 701 also permits our affiliates to sell their Rule 701 securities under Rule 144 without complying with the holding period requirements of Rule 144.

Upon completion of this offering, we intend to file a registration statement on Form S-8 under the Securities Act to register shares of common stock reserved for issuance under our Amended and Restated Stock Incentive Plan. Persons who are not affiliates, and who receive shares that are registered under the Form S-8 registration statement, will be able to resell those shares in the public market without restriction under the Securities Act. Such registration statement will become effective immediately upon filing.

Prior to this offering, there has been no public market for our securities. Trading of our common stock is expected to commence following the completion of this offering. There can be no assurance that an active trading market will develop or continue after the completion of this offering or that the market price of our common stock will not decline below the initial public offering price. No prediction can be made as to the effect, if any, that future sales of shares of common stock, or the availability of shares for future sale, will have on the market price prevailing from time to time. Sales of substantial amounts of common stock in the public market, or the perception that such sales could occur, could adversely affect the prevailing market price of the common stock or our ability to raise capital through a public offering of our equity securities.

 

 

 

 

 

74

---

UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting agreement dated as of                     , 2006 (the “Underwriting Agreement”), the underwriters named below, for whom Joseph Gunnar & Co., LLC is acting as representative, have severally agreed to purchase, and we have agreed to sell to them, the number of shares of common stock set forth in the following table:

 

 

Name		Number of Shares
Joseph Gumnar & Co., LLC		[            ]
		[            ]
Total		3,000,000

The underwriters are offering the shares subject to their acceptance of shares from us and subject to prior sale. The Underwriting Agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares offered by this prospectus are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriters are obligated to take and pay for all of the shares offered by this prospectus, if any such shares are taken. However, the underwriters are not required to take or pay for the shares covered by the underwriters’ over-allotment option described below.

The underwriters propose to offer the shares offered hereby to the public at the public offering price set forth on the cover of this prospectus. That price should not be considered an indication of the actual value of the shares and is subject to change as a result of market conditions and other factors. The underwriters may offer the shares to securities dealers at the price to the public less a concession not in excess of $           per share. Securities dealers may re-allow a concession not in excess of $           per share to other dealers. After the shares are released for sale to the public, the underwriters may vary this offering price and other selling terms from time to time. No variation in those terms will change the amount of proceeds to be received by us as set forth on the cover page of this prospectus. The public offering price of the shares offered hereby was negotiated between us and the representatives.

We have granted to the underwriters an option, exercisable for 45 days from the date of this prospectus, to purchase up to an aggregate of 450,000 additional shares at the initial public offering price listed on the cover page of this prospectus, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares offered by this prospectus. To the extent this option is exercised, each underwriter will become obligated, subject to limited conditions, to purchase approximately the same percentage of additional shares as the number listed next to the underwriter’s name in the preceding table bears to the total number of shares listed next to the names of all underwriters in the preceding table. If the underwriters’ option is exercised in full, the total price to the public would be $          , the total underwriters’ discounts and commissions would be $          , and total proceeds to us would be $          .

Underwriting Compensation

We will sell to the managing underwriter in this offering or to its designees, at the closing of this offering, a warrant to purchase shares of our common stock in an amount equal to 10% of the number of shares of common stock issued in connection with this offering, not including the over-allotment option. The 5-year warrant is exercisable six months following this offering, and may be exercised on a cashless basis. The warrant is exercisable

 

75

---

at a price per share equal to 125% of the initial public offering price of our shares in this offering. The warrant will be issued pursuant to a definitive warrant agreement containing such provisions, including anti-dilution provisions, reasonably satisfactory to the managing underwriter in one warrant certificate or in such allocated portion certificates as may be requested in writing.

We have granted the representative of the underwriters the right to have a designee present at all meetings of our Board of Directors for a period of two years from the date of this prospectus. The designee will be entitled to the same notice and communications sent by us to our directors and to attend directors’ meetings but will not have voting rights. Stephan Stein, Chief Operating Officer of Joseph Gunnar & Co., LLC, the lead underwriter in this offering, has been appointed as such designee.

For a period of two years following the completion of the offering, the representative shall have a right of first refusal to serve as our placement agent or managing underwriter in future private or public financings.

Stabilization

The rules of the SEC generally prohibit the underwriters from trading in our securities on the open market during this offering. However, the underwriters are allowed to engage in certain open market transactions and other activities during this offering that may cause the market price of our shares to be above or below that which would otherwise prevail in the open market. These activities may include stabilization, short sales and over-allotments, syndicate covering transactions and penalty bids.

·	Stabilizing transactions consist of bids or purchases made by the representative for the purpose of preventing or slowing a decline in the market price of our securities while this offering is in progress.

·

Short sales and over-allotments occur when the representative, on behalf of the underwriters, sells more of our shares than it purchases from us in this offering. In order to cover the resulting short position, the representative may exercise the over-allotment option described above or may engage in syndicate covering transactions. There is no contractual limit on the size of any syndicate covering transaction. The underwriters will deliver a prospectus in connection with any such short sales. Purchasers of shares sold short by the underwriters are entitled to the same remedies under the federal securities laws as any other purchaser of shares covered by the registration statement.

·	Syndicate covering transactions are bids for or purchases of our securities on the open market by the representative on behalf of the underwriters in order to reduce a short position incurred by the representative on behalf of the underwriters.

·

A penalty bid is an arrangement permitting the representative to reclaim the selling concession that would otherwise accrue to an underwriter if the common stock originally sold by the underwriter was later repurchased by the representative and therefore was not effectively sold to the public by such underwriter.

If the underwriters commence these activities, they may discontinue them at any time without notice. The underwriters may carry out these transactions on Nasdaq or otherwise.

Indemnification

 

76

---

LEGAL MATTERS

 

EXPERTS

The consolidated financial statements of Bridgeline Software, Inc. at September 30, 2005 and 2004 and for the years then ended, the financial statements of Objectware, Inc. at September 30, 2005 and 2004 and for the years then ended, and the financial statements  of New Tilt, Inc. at April 24, 2006 and December 31, 2005 and for the period January 1, 2006 to April 24, 2006 and for the year ended December 31, 2005, included in this prospectus have been audited by UHY LLP, independent registered public accounting firm, as set forth in its reports thereon (which report for Bridgeline Software, Inc. includes an explanatory paragraph regarding substantial doubt about Bridgeline Software, Inc.’s ability to continue as a going concern) appearing elsewhere herein, and are included in reliance upon such reports given on the authority of said firm as experts in accounting and auditing.

ADDITIONAL INFORMATION

We have filed with the Securities and Exchange Commission a registration statement on Form SB-2 under the Securities Act for the shares offered hereby. This prospectus, which constitutes a part of the registration statement, does not contain all of the information set forth in the registration statement or the exhibits and schedules which are part of the registration statement. For additional information about us and our securities, we refer you to the registration statement and the accompanying exhibits and schedules. Statements contained in this prospectus regarding the contents of any contract or any other documents to which we refer are not necessarily complete. In each instance, reference is made to the copy of the contract or document filed as an exhibit to the registration statement, and each statement is qualified in all respects by that reference. Copies of the registration statement and the accompanying exhibits and schedules may be inspected without charge (and copies may be obtained at prescribed rates) at the public reference facility of the SEC at Room 1024, 100 F Street, NE, Washington, D.C. 20549.

You can request copies of these documents upon payment of a duplicating fee by writing to the Securities and Exchange Commission. You may call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of its public reference rooms. Our filings, including the registration statement, will also be available to you on the Internet Web site maintained by the Securities and Exchange Commission at http://www.sec.gov. We intend to furnish our shareholders with annual reports containing financial statements audited by our independent auditors, and make available to our shareholders quarterly reports for the first three quarters of each year containing unaudited interim financial statements.

Upon completion of this offering, we will become subject to the information and reporting requirements of the Exchange Act. As a result, we will file periodic reports, proxy statements and other information with the Securities and Exchange Commission. The periodic reports, proxy statements and other information we will file will be available for inspection and copying at the Securities and Exchange Commission’s public reference facilities and the Web site of the Commission referenced to above.

77

---

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

		Page
UNAUDITED COMBINED PRO FORMA CONDENSED FINANCIAL STATEMENTS OF BRIDGELINE SOFTWARE, INC., OBJECTWARE, INC., NEW TILT, INC., AND INTERACTIVE APPLICATIONS GROUP, INC.:
Introduction to Unaudited Combined Pro Forma Condensed Financial Statements		F - 3
Unaudited Combined Pro Forma Condensed Balance Sheet at July 31, 2006		F - 4
Unaudited Combined Pro Forma Condensed Statement of Operations for the ten months ended July 31, 2006		F - 6
Unaudited Combined Pro Forma Condensed Statement of Operations for the year ended September 30, 2005		F - 8
BRIDGELINE SOFTWARE, INC.:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		F - 10
Consolidated Balance Sheets of Bridgeline Software, Inc. at July 31, 2006 (Unaudited) and 2005 (Unaudited) and at September 30, 2005 and 2004		F - 11
Consolidated Statements of Operations for Bridgeline Software Inc. for the ten months ended July 31, 2006 (Unaudited) and 2005 (Unaudited) September 30, 2005 and 2004		F - 12
Consolidated Statements of Shareholder’s Equity for Bridgeline Software, Inc. for the ten months ended July 31, 2006 (Unaudited) and the years ended September 30, 2005 and 2004		F - 13
Consolidated Statements of Cash Flows for Bridgeline Software, Inc. for for the ten months ended July 31, 2006 (Unaudited) and 2005 (Unaudited) and the years ended September 30, 2005 and 2004		F - 14
Notes to Consolidated Financial Statements		F - 15

 

F - 1

---

BRIDGELINE SOFTWARE, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS  

OBJECTWARE, INC.:		Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		F-40
Balance Sheets for Objectware, Inc. at July 31, 2006 (Unaudited) and at September 30, 2005 and 2004		F-41
Statements of Operations for Objectware, Inc. for the ten months ended July 31, 2006 (Unaudited) and 2005 (Unaudited) and the years ended September 30, 2005 and 2004		F-42
Statements of Shareholder’s Equity for Objectware, Inc. for the ten months ended July 31, 2006 (Unaudited) and for the years ended September 30, 2005 and 2004		F-43
Statements of Cash Flows for Objectware, Inc. for the ten months ended July 31, 2006 (Unaudited) and for the years ended September 30, 2005 and 2004		F-44
Notes to Financial Statements		F-45
NEW TILT, INC.:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		F-57
Balance Sheets for New Tilt, Inc. at April 24, 2006 and at December 31, 2005		F-58
Statements of Operations for New Tilt, Inc. for the period of January 1, 2006 to April 24, 2006 and for the year ended December 31, 2005		F-59
Statements of Shareholder’s Equity for New Tilt, Inc. for the period of January 1, 2006 to April 24, 2006 and for the year ended December 31, 2005		F-60
Statements of Cash Flows for New Tilt, Inc. for the period of January 1, 2006 to April 24, 2006 and for the year ended December 31, 2005		F-61
Notes to Financial Statements		F-62

 

F - 2

---

UNAUDITED COMBINED PRO FORMA FINANCIAL STATEMENTS

INTRODUCTION

The following unaudited combined pro forma condensed financial statements reflect the impact of the following transactions:

 

1.	The offering of 3,000,000 shares of the Company’s common stock (the “Offering”). The net proceeds will be used, in part, to repay short-term Senior Notes Payable as described in “Use of Proceeds”;

2.	The probable acquisition of Objectware, Inc. (“Objectware”), expected to be consummated after the offering;

3.	The effect of the acquisition of New Tilt, Inc. (“New Tilt”) consummated on April 24, 2006; and

4.	The effect of the acquisition of Interactive Applications, Inc. (“iapps”) consummated on December 15, 2004.

A description of pro forma adjustments related to each transaction is presented in the notes to the unaudited combined pro forma condensed financial statements. The unaudited combined pro forma condensed financial statements and accompanying notes should be read in conjunction with the historical financial statements of the Company, New Tilt and Objectware included in this registration statement. The unaudited combined pro forma condensed financial statements are based on currently available information and certain assumptions that the Company believes are reasonable; however, the actual adjustments may materially differ from the pro forma adjustments presented.

A final determination of the purchase accounting adjustments, including the allocation of the purchase price of the assets acquired and liabilities assumed based on their fair values, has not been made with respect to the probable acquisition of Objectware. The purchase price accounting adjustments made in connection with the preparation of the unaudited combined pro forma condensed financial statements are preliminary and have been made solely for purposes of preparing such unaudited combined pro forma condensed financial statements.

The unaudited combined pro forma condensed financial statements do not purport to present the Company’s financial position or results of operations had the acquisition of Objectware, New Tilt and iapps actually been completed as of the dates indicated, and the unaudited combined pro forma condensed financial statements do not project the Company’s financial position or results of operations for any future date or period.

 

 

 

F - 3

---

BRIDGELINE SOFTWARE, INC.

UNAUDITED COMBINED PRO FORMA CONDENSED BALANCE SHEET

JULY 31, 2006

(Amounts in thousands)

The following unaudited combined pro forma condensed balance sheet reflects the effect of the Offering and the probable acquisition of Objectware as of July 31, 2006. The pro forma adjustments reflect the Use of Proceeds from the Offering as though it were completed on July 31, 2006 and the adjustments to Objectware’s historical balance sheet for the elimination of certain assets and liabilities that will not be acquired and to reflect the acquired assets and liabilities at estimated fair value as if they were acquired on July 31, 2006.

					Probable			Pro Forma
					Acquisition			Adjustments				Pro Forma
		Historical			(Note 1)			(Note 2)				Combined
ASSETS
Current assets:
Cash and cash equivalents		$	971		$	552		$	8,380	(a)		$	9,903
Accounts receivable and other current assets			1,408			906			(44	)(b)			2,270
Total current assets			2,379			1,458			8,336				12,173
Other assets			963			549			(303	)(c)			1,209
Intangible assets, net			325			—			409	(d)			734
Goodwill			6,310			—			4,130	(e)			10,440
Total assets		$	9,977		$	2,007		$	12,572			$	24,556
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current liabilities and accrued expenses		$	925		$	806		$	(271	)(f)		$	1,460
Short-term debt, net of discount			2,546			—			(2,546	)(g)			—
Total current liabilities			3,471			806			(2,817	)			1,460
Other liabilitlies			125			366			(347	)(h)			144
Total liabilities			3,596			1,172			(3,164	)			1,604
Shareholders’ equity:
Common stock			4			2			1	(i)			7
Additional paid-in capital			9,790			8			17,077	(j)			26,875
Accumulated earnings (deficit)			(3,413	)		825			(1,342	)(k)			(3,930	)
Total shareholders’ equity			6,381			835			15,736				22,952
Total liabilitiles and shareholders’ equity		$	9,977		$	2,007		$	12,572			$	24,556

 

 

The accompanying notes are an integral part of these unaudited combined pro forma condensed financial statements.

 

F - 4

---

BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED BALANCE SHEET

JULY 31, 2006

(Amounts in thousands)

1.	Probable Acquisition of Objectware

The unaudited combined pro forma condensed balance sheet combines the Company’s unaudited balance sheet with Objectware’s unaudited balance sheet as of July 31, 2006.

2.	Pro Forma Adjustments

(a)	$8,380 represents cash received in the Offering adjusted for the probable acquisition of Objectware and all other amounts paid as described in the Use of Proceeds.

(b)	$44 represents amounts receivable by Objectware from its shareholder that will not be purchased in the acquisition.

(c)

$303 represents the total of $263 of unamortized debt fees incurred in connection with issuance of the Senior Notes Payable that will be amortized when the notes are paid from the Proceeds of the Offering as discussed in the Use of Proceeds, and $40 of deferred costs associated with the Offering that will be charged to additional paid in capital when the Offering is completed.

(d)	$409 represents the estimated fair value of intangible assets that will be recognized as an asset by the Company after the acquisition of Objectware.

(e)	$4,130 represents the excess of the cost of the probable acquisition over the net amounts assigned to acquired assets and liabilities.

(f)	$271 represents the total of $209 of Objectware’s income taxes payable that will not be a liability of the Company after the acquisition, and $62 of current deferred revenue related to service arrangements of Objectware, the performance of which has been completed.

(g)	$2,546 represents the net of $2,800 Senior Notes Payable that will be paid with the proceeds of the Offering as discussed in Use of Proceeds, and $254 unamortized discount on debt that will be amortized in full when the notes are paid.

(h)	$347 represents non-current deferred revenue related to service arrangements of Objectware, the performance of which has been completed.

(i)	$1 represents the net affect of the elimination of Objectware’s common stock outstanding and the expected issuance of the Company’s common stock in connection with the Offering and acquisition.

(j)	$17,077 represents the effect of the Offering and the issuance of the Company’s common stock in connection with the probable acquisition of Objectware.

(k)	$1,342 represents the total of $825 for the elimination of Objectware’s accumulated earnings, and $263 and $254 of costs to be fully amortized as discussed above in (c) and (g), respectively.

 

F - 5

---

BRIDGELINE SOFTWARE, INC.

UNAUDITED COMBINED PRO FORMA CONDENSED STATEMENT OF OPERATIONS

FOR THE TEN MONTHS ENDED JULY 31, 2006

(Amounts in thousands, except per share amounts)

The following unaudited combined pro forma condensed statement of operations for the ten months ended July 31, 2006 reflects adjustments related to the effects of the Offering, the probable acquisition of Objectware, and the results of operations of New Tilt as if these events occurred as of the beginning of the period on October 1, 2005.

					Consummated			Probable			Pro Forma
					Acquisition			Acquisition			Adjustments			Pro Forma
		Historical			(Note 1)			(Note 2)			(Note 3)			Combined
Revenue:
Web services		$	5,355		$	919		$	2,578		$	—		$	8,852
Managed services			898			—			558			—			1,456
Subscriptions			350			—			—			—			350
Total revenue			6,603			919			3,136			—			10,658
Cost of revenue			2,924			851			1,440			60	(a)		5,275
Gross profit			3,679			68			1,696			(60	)		5,383
Operating expenses:
Sales and marketing			2,193			77			—						2,270
Technology development			140			—			—			—			140
General and administrative expenses			1,461			301			1,084			(239	)(b)		2,607
Total operating expenses			3,794			378			1,084			(239	)		5,017
Income (loss) from operations			(115	)		(310	)		612			179			366
Other income (expenses):
Other income (expense)			—			10			22			—			32
Interest expense			(583	)		(2	)		(1	)		573	(c)		(13	)
Income (loss) before income taxes			(698	)		(302	)		633			752			385
Provision (benefit) for income taxes (Note 4)			—			—			246			(200	)		46
Net income (loss)		$	(698	)	$	(302	)	$	387		$	952		$	339
Net income (loss) per share:
Basic		$	(0.17	)										$	0.05
Diluted		$	(0.17	)										$	0.04
Number of weighted average shares (Note 5):
Basic			4,007												7,135
Diluted (Note 5)			4,007												7,706

 

The accompanying notes are an integral part of these unaudited combined pro forma condensed financial statements.

F - 6

---

BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE TEN MONTHS ENDED JULY 31, 2006

(Amounts in thousands)

1.	Acquisition of New Tilt

The Company acquired New Tilt on April 24, 2006. The amounts represent the historical pre-acquisition operating results of New Tilt from the beginning of the period October 1, 2005 to December 31, 2005, which were derived from the results of operations included in New Tilt’s fiscal year ended December 31, 2005, combined with NewTilt’s results of operations from January 1, 2006 through the date of acquisition.

2.	Probable Acquisition of Objectware

The amounts represent the historical operating results of Objectware for the ten months ended July 31, 2006.

3.	Pro Forma Adjustments

The following adjustments assume the transactions described above occurred on October 1, 2005.

(a)

The $60 net increase in cost of revenues represents the effect of the following items:

i.

$79 increase in amortization and depreciation expense resulting from the values assigned to intangible assets and property and equipment of New Tilt and Objectware upon acquisition, and

ii.

$19 decrease in New Tilt’s stock-based compensation in order to conform to the Company’s accounting policy.

(b)

The $239 decrease in general and administrative expenses represents the effect of the following items:

i.

$180 decrease in salary for the owner of Objectware in order to reflect the salary at the expected contractual rate that will be in effect after the acquisition,

ii.

$38 decrease in amortization and depreciation expense resulting from the values assigned to intangible assets and property and equipment for New Tilt and Objectware, and

iii.

$21 decrease in New Tilt’s stock-based compensation in order to conform to the Company’s accounting policy.

(c)

The $573 decrease in interest expense related to indebtedness incurred to finance, in part, the acquisition of New Tilt, such indebtedness to be repaid with the proceeds of the Offering as described in the Use of Proceeds.

4.	Income Taxes

The $200 decrease in federal income tax expense is the result of combining Objectware as of the beginning of the period on October 1, 2005. The Company’s net operating loss carryforwards are sufficient to off-set the taxable income of Objectware such that no federal income tax expense would be incurred for the ten months ended July 31, 2006.

5.	Weighted Average Shares Outstanding

The shares issued in connection with the New Tilt acquisition and expected to be issued in connection with the probable acquisition of Objectware are included in the computation of weighted average shares outstanding as if these shares were issued as of the beginning of the period on October 1, 2005.

 

F - 7

---

BRIDGELINE SOFTWARE, INC.

UNAUDITED COMBINED PRO FORMA CONDENSED STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2005

(Amounts in thousands, except per share amounts)

The following unaudited combined pro forma condensed statement of operations combines the results of operations of Objectware, New Tilt and iapps with those of the Company and also reflects adjustments related to the Offering and the acquisition of Objectware, New Tilt and iapps as if these events occurred as of the beginning of the period on October 1, 2004.

					Consummated Acquisitions						Probable			Pro Forma
					New Tilt			iapps			Acquisition			Adjustments			Pro Forma
		Historical			(Note 1)			(Note 2)			(Note 3)			(Note 4)			Combined
Revenue:
Web services		$	4,182		$	2,304		$	181		$	2,288		$	—		$	8,955
Managed services and subscriptions			1,587			—			95			474			—			2,156
Total revenue			5,769			2,304			276			2,762			—			11,111
Cost of revenue			3,113			1,533			141			1,443			75	(a)		6,305
Gross profit			2,656			771			135			1,319			(75	)		4,806
Operating expenses:
Sales and marketing			2,060			—			137			—			—			2,197
Technology development			43			—			—			—			—			43
General and administrative expenses			1,014			635			37			784			(86	)(b)		2,384
Total operating expenses			3,117			635			174			784			(86	)		4,624
Income (loss) from operations			(461	)		136			(39	)		535			11			182
Other income (expenses):
Other income (expense)			—			4			—			(2	)		—			2
Interest expense, net			(56	)		(2	)		(3	)		(5	)		63	(c)		(3	)
Income (loss) before income taxes			(517	)		138			(42	)		528			74			181
Provision (benefit) for income taxes (Note 5)			—			—			—			156			(129	)		27
Net income (loss)		$	(517	)	$	138		$	(42	)	$	372		$	203		$	154
Net income (loss) per share:
Basic		$	(0.14	)													$	0.02
Diluted		$	(0.14	)													$	0.02
Number of weighted average shares:
Basic			3,804															7,614
Diluted (Note 6)			3,804															7,979

The accompanying notes are an integral part of these unaudited combined pro forma condensed financial statements.

 

F - 8

---

BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2005

(Amounts in thousands)

1.	Acquisition of New Tilt

The Company acquired New Tilt on April 24, 2006. The amounts represent the historical operating results of New Tilt for its fiscal year ended December 31, 2005.

2.	Acquisition of iapps

The Company acquired iapps on December 15, 2004. The amounts represent the historical operating results of iapps for the period October 1, 2004 to October 31, 2004, which were derived from its historical results of operations for its fiscal year ended October 31, 2004, combined with its historical results of operations for the period November 1, 2004 through the date of acquisition.

3.	Probable Acquisition of Objectware

The amounts represent the historical operating results of Objectware for its fiscal year ended September 30, 2005.

 

4.	Pro Forma Adjustments

The following adjustments assume the transactions described above occurred on October 1, 2004.

(a)

The $75 net increase in cost of revenues represents the effect of the following items:

i.

$134 increase in amortization and depreciation expense resulting from the values assigned to intangible assets and property and equipment upon acquisition as follows: $18 for New Tilt, $34 for iapps and $82 for Objectware, and

ii.

$59 decrease in New Tilt’s stock-based compensation in order to conform to the Company’s accounting policy.

 

(b)

The $86 decrease in general and administrative expenses represents the effects of the following items:

i.

$73 decrease in amortization and depreciation expense resulting from the values assigned to intangible assets and property and equipment upon acquisition as follows: $40 for New Tilt, $22 for iapps and $11 for Objectware, and

ii.

$13 decrease in New Tilt’s stock-based compensation in order to conform to the Company’s accounting policy.

 

(c)

The $63 decrease in interest expense relates to indebtedness incurred to finance, in part, the acquisition of New Tilt, such indebtedness to be repaid with the proceeds of the Offering as described in the Use of Proceeds.

5.	Income Taxes

The $129 decrease in federal income tax expense is the result of combining Objectware as of the beginning of the period on October 1, 2004. The Company’s net operating loss carryforwards are sufficient to off-set the taxable income of Objectware such that no federal income tax expense would be incurred for the year ended September 30, 2005.

6.	Weighted Average Shares Outstanding

The shares issued in connection with the New Tilt and iapps acquisitions and expected to be issued in connection with the probable acquisition of Objectware are included in the computation of weighted average shares outstanding as if these shares were issued as of the beginning of the period on October 1, 2004.

 

F - 9

---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors

Bridgeline Software, Inc.

We have audited the accompanying consolidated balance sheets of Bridgeline Software, Inc. as of September 30, 2005 and 2004 and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bridgeline Software, Inc. as of September 30, 2005 and 2004 and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 1 to the consolidated financial statements, the Company has incurred operating losses since inception, has a working capital deficit of approximately $179,000 and accumulated deficit of approximately $2,715,000 at September 30, 2005 and will need to repay its Senior Notes Payable of $2,800,000 and related interest no later than April 2007. These conditions raise substantial doubt about the ability of the Company to continue as a going concern. Management’s plans concerning these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ UHY LLP

 

Boston, Massachusetts

December 11, 2006

 

F - 10

---

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED BALANCE SHEETS

(Information as of July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

ASSETS		July 31,						September 30,
		2006			2005			2005			2004
Current assets:
Cash and cash equivalents		$	971		$	93		$	138		$	956
Accounts receivable (less allowance for doubtful accounts of
$52, 38, 58 and $27, respectively)			1,073			986			605			706
Unbilled receivables			253			170			167			210
Prepaid expenses and other current assets			82			20			25			6
Total current assets			2,379			1,269			935			1,878
Equipment and improvements, net			426			245			267			158
Definite-lived intangible assets, net			325			349			331			72
Goodwill			6,310			5,097			5,097			2,740
Deferred financing fees, net			263			—			—			—
Other assets			274			159			109			111
Total assets		$	9.977		$	7,119		$	6,739		$	4,959
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Senior notes payable		$	2,546		$	—		$	—		$	—
Financing agreement			—			474			292			—
Capital lease obligations - current			44			11			11			10
Notes payable to shareholders - current			—			45			85			110
Accounts payable			307			323			272			215
Deferred revenue			250			264			183			381
Accrued liabilities			324			276			271			264
Total current liabilities			3,471			1,393			1,114			980
Capital lease obligations, less current portion			125			31			33			44
Notes payable to shareholders, less current portion			—			—			—			61
Total liabilities			3,596			1,424			1,147			1,085
Commitments and Contingencies
Shareholders’ equity:
Common stock — $0.001 par value; 20,000,000 shares authorized: 4,233,833; 3,903,833; 3,903,833 and 3,427,166 shares issued and outstanding, respectively			4			4			4			3
Additional paid-in capital			9,790			8,302			8,303			6,069
Accumulated deficit			(3,413	)		(2,611	)		(2,715	)		(2,198	)
Total shareholders’ equity			6,381			5,695			5,592			3,874
Total liabilities and shareholders’ equity		$	9,977		$	7,119		$	6,739		$	4,959

 

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

 

F - 11

---

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Information for the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

		Ten Months Ended July 31,						Year Ended September 30,
		2006			2005			2005			2004
Revenue:
Web services		$	5,355		$	3,377		$	4,182		$	3,820
Managed services			898			989			1,244			1,068
Subscription			350			279			343			—
Total revenue			6,603			4,645			5,769			4,888
Cost of revenue			2,924			2,527			3,113			2,290
Gross profit			3,679			2,118			2,656			2,598
Operating expenses:
Sales and marketing			2,193			1,605			2,060			1,874
General and administrative			1,461			849			1,014			830
Technology development			140			37			43			26
Total operating expenses			3,794			2,491			3,117			2,730
Loss from operations			(115	)		(373	)		(461	)		(132	)
Interest expense			(583	)		(40	)		(56	)		(46	)
Loss before income taxes			(698	)		(413	)		(517	)		(178	)
Income taxes			—			—			—			—
Net loss		$	(698	)	$	(413	)	$	(517	)	$	(178	)
Net loss per share:
Basic and diluted		$	(0.17	)	$	(0.11	)	$	(0.14	)	$	(0.06	)
Number of weighted average shares:
Basic and diluted			4,007,499			3,786,255			3,804,527			3,026,163

 

 

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

 

F - 12

---

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Information as of July 31, 2006 and for the Ten Months Ended July 31, 2006 is Unaudited)

(Amounts in thousands, except share and per share data)

 

								Additional						Total
		Common Stock						Paid-in			Accumulated			Shareholders’
		Shares			Par Value			Capital			Deficit			Equity
Balance, September 30, 2003			2,887,880		$	3		$	4,427		$	(2,020	)	$	2,410
Issuance of stock for option exercises			22,222			—			—			—			—
Issuance of stock in private offering			517,064			—			1,640			—			1,640
Stock based compensation			—			—			2			—			2
Net loss			—			—						(178	)		(178	)
Balance, September 30, 2004			3,427,166			3			6,069			(2,198	)		3,874
Issuance of stock for acquisition			476,667			1			2,218			—			2,219
Issuance of common stock warrants
in connection with financing agreement			—			—			8			—			8
Stock based compensation			—			—			8			—			8
Net loss			—			—						(517	)		(517	)
Balance, September 30, 2005			3,903,833			4			8,303			(2,715	)		5,592
Issuance of stock for acquisition			320,000			—			837			—			837
Exercise of warrants			10,000			—			—			—			—
Issuance of common stock warrants			—			—						—			—
in private placement of debt			—			—			646			—			646
Stock based compensation			—			—			4			—			4
Net loss			—			—						(698	)		(698	)
Balance, July 31, 2006			4,233,833		$	4		$	9,790		$	(3,413	)	$	6,381

 

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

 

F - 13

---

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

 

		Ten Months Ended July 31,						Year Ended September 30,
Cash flows from operating activities:		2006			2005			2005			2004
Net loss		$	(698	)	$	(413	)	$	(517	)	$	(178	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			141			86			106			79
Amortization of intangible assets			97			76			94			30
Amortization of debt discount and deferred financing fees			419			7			7			—
Stock based compensation			4			7			8			2
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable and unbilled receivables			(382	)		(139	)		245			(437	)
Other assets			(151	)		(42	)		3			(48	)
Accounts payable and accrued liabilities			57			(84	)		(138	)		123
Deferred revenue			20			(159	)		(240	)		51
Total adjustments			205			(248	)		85			(200	)
Net cash (used in) operating activities			(493	)		(661	)		(432	)		(378	)
Cash flows from investing activities:
Acquisitions, net of cash acquired			(554	)		(308	)		(308	)		—
Contingent acquisition payments			(92	)		(113	)		(113	)		(150	)
Equipment and improvements expenditures			(108	)		(119	)		(122	)		(76	)
Net cash (used in) investing activities			(754	)		(540	)		(543	)		(226	)
Cash flows from financing activities:
Proceeds from issuance of senior notes payable, net of deferred costs			2,433			—			—			—
Proceeds from private stock offering, net			—			—			—			1,640
Proceeds from / payments on financing agreement, net			(259	)		474			292			—
Payments on capitalized leases			(9	)		(10	)		(49	)		(4	)
Payments on notes payable to shareholders			(85	)		(126	)		(86	)		(174	)
Net cash provided by financing activities			2,080			338			157			1,462
Net increase (decrease) in cash			833			(863	)		(818	)		858
Cash and cash equivalents at beginning of period			138			956			956			98
Cash and cash equivalents at end of period		$	971		$	93		$	138		$	956
Supplemental disclosures of cash flow information:
Cash paid for:
Interest		$	157		$	33		$	50		$	47
Non cash activities:
Issuance of common stock for acquisitions		$	837		$	2,218		$	2,218		$	—
Warrants issued in connection with equity and debt transactions		$	646		$	436		$	436		$	181
Purchase of capital equipment through capitalized leases		$	134		$	—		$	39		$	58

 

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

 

F - 14

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

1.  Description of Business and Basis of Presentation

 

Description of Business

 

Bridgeline Software, Inc. (“Bridgeline” or the “Company”), was incorporated in Delaware on August 28, 2000. Bridgeline is a developer of Web service applications. In providing these services the Company has developed the following software tools: (i) netEDITOR-pro^TM, its Web content management system, and (ii) Orgitecture^TM, its on-demand Web based platform, which provides expandable on-demand modules such as Relationship Management, eSurvey, eNewsletter, Content Management, eCommerce, Event Registration and Integrated Grants Management. The Company’s in-house team of Microsoft^®-certified developers specializes in information architecture, usability engineering, Web application development, rich media Web development, e-Commerce, e-Learning, and database development.

 

The Company’s principal executive offices are located at 10 Sixth Road, Woburn, Massachusetts, and it maintains offices in Cambridge, Massachusetts; in New York, New York; and in Washington, D.C. The Company also operates a wholly owned subsidiary, Bridgeline Software Enterprises, Pvt. Ltd, founded in 2003, as its software development center located in Bangalore, India. The Company maintains a website at www.bridgelinesw.com.

 

On April 7, 2006, the Company affected a 3 to 1 reverse stock split. The reduction in the number of shares as a result of the reverse stock split has been reflected retroactively for all periods presented.

 

Operating Matters and Going Concern

 

The Company has incurred annual losses since commencement of operations in 2000 and has used a significant amount of cash to fund its operations over the last several years. As a result, the Company has a working capital deficit of $179 and an accumulated deficit of $2,715 at September 30, 2005. Subsequently, the Company recognized a loss of $698 for the ten months ended July 31, 2006 resulting in a working capital deficit of $1,092 and an accumulated deficit of $3,413 at that date. The Company’s operating activities have not generated sufficient cash flows to maintain operations and, when required, the Company has issued various debt and equity securities. Management has taken significant steps to streamline its operations over the last several years and will continue to do so as circumstances warrant. To date, these steps have included reducing or maintaining headcount and limiting infrastructure, operating and capital expenditures where appropriate. The Company must maintain or increase revenue from current levels to achieve profitability and generate future positive cash flow. Long-term cash requirements, other than for normal operating expenses and for commitments described in Note 8, will be required for the development of new software products, enhancements of existing products, and the possible acquisition of other companies, products, or technologies complementary to the Company’s business.

Delays in the timing of future revenues or revenue levels below management’s expectations may cause the Company to re-evaluate its cash position, adjust its operations, and/or take other possible actions. In the event the planned public offering described in Note 11 is not completed by April 7, 2007, the Company would need to seek additional financing to repay the senior notes payable described in Note 7 and related interest. There can be no assurances that the Company would be able at that time to obtain the necessary financing under acceptable terms and conditions, or at all.

The circumstances discussed above raise substantial doubt about the Company’s ability to continue as a going concern in the normal course of business. The recovery of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheets are dependent upon the continued operations of the Company, which in turn are dependent upon its ability to maintain or increase revenue, succeed in its future operations, and complete its planned public offering or obtain other sources of cash to repay the secured senior notes payable. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the classifications and amount of liabilities that might be necessary should the Company be unable to continue operations.

 

F - 15

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

Unaudited Interim Financial Information

 

The accompanying interim consolidated balance sheets as of July 31, 2006 and 2005, the consolidated statements of operations and cash flows for the ten months ended July 31, 2006 and 2005, and the consolidated statement of shareholders’ equity for the ten months ended July 31, 2006 are unaudited. The unaudited interim consolidated statements have been prepared in accordance with accounting principles generally accepted in the United States of America and in the opinion of the Company’s management have been prepared on the same basis as the audited consolidated financial statements as of and for the years ended September 30, 2005 and 2004 and include all adjustments, consisting of normal recurring adjustments and accruals, necessary for the fair presentation of the Company’s financial position at July 31, 2006 and 2005 and its results of operations and its cash flows for the ten months ended July 31, 2006 and 2005. The results for the ten months ended July 31, 2006 are not necessarily indicative of the results to be expected for the year ending September 30, 2006.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its subsidiary. All significant inter-company accounts and transactions have been eliminated.

 

2.  Summary of Significant Accounting Policies

 

Revenue Recognition

 

Substantially all of the Company’s revenue is generated from four activities: Web Services, Managed Services, Software Licenses and Subscriptions. The Company enters into arrangements to sell services, software licenses or combinations thereof. The Company recognizes revenue in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition in Financial Statements, Emerging Issues Task Force (“EITF”) Issue No. 00-21, Accounting For Revenue Arrangements with Multiple Deliverables, and American Institute of Certified Public Accountant’s Statement of Position No. 97-2, Software Revenue Recognition (“SOP 97-2”). Revenue is recognized when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the services have been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of the fees is probable. Billings made or payments received in advance of providing services are deferred until the period these services are provided.

Web Services and Managed Services include consulting services that are related to specific customer needs such as information architecture and usability engineering, interface configuration, Web application development and hosting, rich media, e-Commerce, e-Learning and e-Training, search engine optimization, and content management. Such services typically do not involve significant production, modification, or customization of the Company’s licensed software products.

Managed Services also include on-going retained professional services and hosting arrangements. On-going retained professional services are either contracted for on an “on-call” basis or for a certain amount of hours each month. Such arrangements generally provide for a guaranteed availability of a number of hours each month on a “use it or lose it” basis. These arrangements do not require formal customer acceptance and do not grant any future right to labor hours contracted for but not used.

In determining whether Web Services can be accounted for separately from other elements in multi-element arrangements, the Company considers the following factors for each agreement: availability of the Web Services from other vendors, whether objective and reliable evidence of fair value exists for the undelivered elements, and whether delivery of any undelivered elements is probable and can be controlled by the Company. The amount of revenue recognized for Web Services in multi-element arrangements is

 

F - 16

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

determined by use of the residual method.

Revenue for Web Services and Managed Services is recognized when the services are performed or when they are complete. The Company uses the proportionate performance model in the determination of when delivery has occurred in relation to the extent of progress toward completion. When allocating revenue between reporting periods, the Company considers the actual labor dollars incurred each period in proportion to total estimated labor dollars necessary to deliver the services under the arrangement.

 

The Company’s software licenses include fixed-term and perpetual license agreements. Revenue for perpetual licenses is included in Web Services and is generally recognized upon delivery of the software in accordance with SOP 97-2. Revenue for licensed subscription agreements is included in Subscription revenue and is generally recognized over the term of the agreements. The Company provides maintenance and post contract support (“PCS”), however the revenues from PCS are not material to all periods presented.

Subscription Services often include hosting and other support services such as help desk, site or solution usage reporting.

Certain arrangements include a warranty period generally between 30 to 90 days from the completion of work. In hosting arrangements, the Company may provide warranties of up-time reliability. To date, few warranty claims have been received. The Company continues to monitor the conditions that are subject to the warranties to identify if a warranty claim may arise. If the Company determines that a warranty claim is probable, then any such estimable cost would be recognized to comply with the warranty requirements.

In connection with certain arrangements, reimbursable expenses are incurred and billed to customers and such amounts are recognized as both revenue and cost of revenue.

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. The most significant estimates included in these financial statements are the valuation of accounts receivable and long-term assets, including intangibles, goodwill and deferred tax assets, stock-based compensation, amounts of revenue to be recognized on service contracts in progress, unbilled receivables, and deferred revenue. Actual results could differ from these estimates under different assumptions or conditions.

Concentration of Credit Risk and Significant Customers

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents to the extent these exceed federal insurance limits and accounts receivable. Risks associated with cash and cash equivalents are mitigated by the Company’s investment policy, which limits the Company’s investing of excess cash into only money market mutual funds. The Company limits its exposure to credit loss by placing its cash and cash equivalents and investments with high credit quality financial institutions. In general, the Company does not require collateral on its arrangements with customers. The Company has accounts receivable related to monthly fees as well as service and licensing fees, which typically provide for credit terms of 30-60 days.

F - 17

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

The Company had certain customers that individually represented 10% or more of the Company’s total revenue, as follows:

 

		Ten Months Ended July 31,						Year Ended September 30,
		2006			2005			2005			2004
Customer #1			23	%		11	%		12	%		11	%
Customer #2			*			21	%		19	%		32	%
Customer #3			*			10	%		*			13	%
* Represents less than 10%

 

The Company had certain customers with balances that individually represented 10% or more of the Company’s total accounts receivable, as follows:

		July 31,						September 30,
		2006			2005			2005			2004
Customer #1			20	%		*			12	%		10	%
Customer #2			10	%		13	%		17	%		39	%
Customer #3			20			*			18	%		*
Customer #4			*			19	%		11	%		12	%
* Represents less than 10%

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments with original maturity of three months or less from the date of purchase to be cash equivalents. Cash equivalents primarily consist of money market mutual funds.

 

Fair Value of Financial Instruments

 

The carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximate their fair value because of the short-term maturity of these instruments. Based on rates available to the Company at September 30, 2005 and 2004 for loans with similar terms, the carrying values of short-term debt and capital lease obligations approximate their fair value.

 

Impairment of Long-Lived and Intangible Assets

 

Long-lived assets to be held and used, which primarily consist of equipment and improvements and intangible assets with finite lives, are recorded at cost. Management reviews long-lived assets (other than goodwill) for impairment whenever events or changes in circumstances indicate the carrying amount of such assets is less than the undiscounted expected cash flows from such assets, or whenever changes or business circumstances indicate that the carrying value of the assets may not be fully recoverable or that the useful lives of those assets are no longer appropriate. Recoverability of theses assets is assessed using a number of factors including operating results, business plans, budgets, economic projections and undiscounted cash flows. In addition, the Company’s evaluation considers non-financial data such as

 

F - 18

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

market trends, product development cycles and changes in management’s market emphasis. There has been no impairment loss recorded for long-lived and intangible assets to date.

 

Allowance for Doubtful Accounts

 

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. For all customers, the Company recognizes allowances for doubtful accounts based on the length of time that the receivables are past due, current business environment and its historical experience. If the financial condition of the Company’s customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.

 

Technology Development Costs

 

Research and development expenditures for technology development are charged to operations as incurred. Software development costs subsequent to the establishment of technological feasibility are capitalized and amortized to cost of software and included in cost of sales. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. Costs incurred between completion of a working model and the point at which the product is ready for general release are capitalized if significant. No software development costs have been capitalized to date as a result of the Company’s development process.

 

Equipment and Improvements

 

The components of equipment and improvement are stated at cost. The Company provides for depreciation by use of the straight-line method over the estimated useful lives of the related assets (three to five years). Leasehold improvements are amortized by use of the straight-line method over the lesser of the estimated useful life of the asset or the lease term. Repairs and maintenance costs are expensed as incurred.

 

Definite Lived Intangible Assets

 

Definite-lived intangible assets are amortized over their useful lives and are subject to impairment tests as previously described under Impairment of Long-Lived and Intangible Assets.

 

Deferred Financing Fees

The Company incurred $367 of direct costs in connection with the issuance of $2,800 in Senior Notes Payable (See Note 7). These costs are being amortized using the interest method over the one year term of the notes.

 

Deferred Offering Costs

 

As of July 31, 2006, the Company incurred and included in other assets $42 of direct costs in connection with the anticipated initial public offering of its common stock as described in Note 11. These costs will be charged to additional paid in capital upon a successful conclusion of the initial public offering as a direct cost of raising capital.

 

Contingent Consideration

 

In accordance with EITF Issue No. 95-8, Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination, consideration is recorded as additional purchase price if the consideration is unrelated to continuing employment with the Company. Such consideration is paid when the contingency is resolved subsequent to acquisition and is recorded as additional goodwill resulting from the business combination.

 

F - 19

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

Goodwill

 

The excess of the cost of an acquired entity over the amounts assigned to acquired assets and liabilities is recognized as goodwill. Goodwill is tested annually for impairment and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the fair value calculated at a reporting unit level. The Company has determined that its operating locations can be aggregated as a single reporting unit due to their similar economic characteristics. For goodwill, the impairment determination is made at the reporting unit level and consists of two steps. First, the Company estimates the fair value of the reporting unit and compares it to its carrying amount. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is estimated by allocating the estimated fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”). The residual estimated fair value after this allocation is the implied fair value of the reporting unit’s goodwill. The Company’s policy is to perform its annual impairment testing in the fourth quarter of each fiscal year. 

 

The factors the Company considers important that could indicate impairment include significant under performance relative to prior operating results, change in projections, significant changes in the manner of the Company’s use of assets or the strategy for the Company’s overall business, and significant negative industry or economic trends.

 

In evaluating the impairment of goodwill, the Company considers a number of factors such as discounted cash flow projections, market capitalization value and third party sales transactions of comparable companies. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis, especially with regard to the future cash flows of the Company. In estimating fair value of such, management makes estimates and judgments about the future cash flows of the Company.

 

As a result of management’s evaluation, the Company concluded there was no impairment of goodwill based upon its annual assessments in 2005 and 2004.

 

Advertising Costs

 

All advertising costs are expensed when incurred. Advertising costs were $111, $103, $118 and $116 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively.

 

Stock-Based Compensation

 

At July 31, 2006, the Company had two stock-based employee compensation plans which are more fully described in Note 9. The Company accounts for its stock compensation awards using the intrinsic value method under the provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (“SFAS 148”). As permitted by SFAS 123, the Company measures compensation cost in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations using the intrinsic value method.

Under the intrinsic value method, compensation expense is measured as of the grant date as the excess of the estimated fair value of the Company’s common stock (the “Stock Price”) and the exercise price, if any, multiplied by the number of options granted. Generally, the Company grants stock options with exercise prices equal to the Stock Price; however, to the extent that the Stock Price exceeds the exercise price of stock options on the date of grant, the Company records stock-based compensation expense using the graded vested attribution method over the vesting schedule of the options, which is generally three years.

 

F - 20

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

The Company recognized $4, $7, $8 and $2 in stock-based compensation expense for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively, under the intrinsic value method.

 

Since inception, there has been no public market for the Company’s common stock to observe its Stock Price on award grant dates. Therefore, for purposes of applying the intrinsic value method, management estimated the stock price based on the American Institute of Certified Public Accountants Practice Alert No. 00-1, Accounting for Certain Equity Transactions. The estimated fair value of the common stock on the date of grant was based on weighing a variety of different quantitative and qualitative factors including, but not limited to, the Company’s financial position, an evaluation of the Company’s competition, the economic climate in the marketplace, the illiquid nature of the common stock, contemporaneous and anticipated private sales of the common stock, and the Company’s analysis of a peer group of comparable public companies trading prices. For periods prior to August 1, 2005, the Company estimated the fair value of common stock based on contemporaneous transactions included in private placement sales of common stock for cash that were executed at or near the grant dates. Since August 1, 2005, the Company has estimated the fair value of common stock based on valuations analyses performed for applicable periods which consider several factors including discounted cash flows, the average trading multiples of comparable peer group public companies and the multiples derived from recent purchase and sales transactions of comparable companies in the industry. The Company believes its approach results in a reasonable application of its valuation methodology for all periods.

 

The Company granted the following stock options during the ten months ended July 31, 2006, and the years ended September 30, 2005 and 2004;

					Weighted Average
								Estimated			Intrinsic
								Fair Value			Value
		Options			Exercise			at Grant			at Grant
		Granted			Prices			Date			Date
Ten Months Ended July 31, 2006			154,920		$	3.75		$	2.17		$	—
Year Ended September 30, 2005			429,616		$	3.74		$	3.75		$	0.01
Year Ended September 30, 2004			109,067		$	3.00		$	3.15		$	0.15

The following disclosure, required by SFAS 148, illustrates the pro forma effect on net loss and net loss per share that would have been recognized in the statement of operations if the fair-value-based method had been applied to all awards in accordance with SFAS 123. Under the fair value-based-method, the Company must measure the estimated fair value of equity instruments awarded to employees at the grant date for which the Company is obligated to issue when employees have rendered the requisite service and satisfied any other conditions necessary to earn the right to benefit from the instruments (for example, to exercise the share options). That estimate is not re-measured in subsequent periods.

The Company estimated the fair value of stock options issued to employees using the Black-Scholes-Merton option-pricing model (the “Model”). The Model requires assumptions be made by management including the economic life of the option, expected volatility, expected dividends and risk-free interest rates. For purposes of calculating the pro forma compensation expense illustrated below, the Company used its cumulative actual forfeiture rate of 11.5% for all awards. The Company believes that the Model

 

F - 21

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

provides a fair value estimate that is consistent with the measurement objective and the fair-value-based method of SFAS 123.

 

The following table illustrates the pro forma effect on net loss per share as if the Company had applied the fair value recognition provisions of SFAS 123:

		Ten Months Ended July 31,						Years Ended September 30,
		2006			2005			2005			2004
Net loss		$	(698	)	$	(413	)	$	(517	)	$	(178	)
Deduct: Stock based employee
compensation determined under
the fair value based method
for all awards, net of tax effect			(439	)		(336	)		(405	)		(335	)
Pro forma net loss		$	(1,137	)	$	(749	)	$	(922	)	$	(513	)
Pro forma net loss per share:
Basic and diluted		$	(0.28	)	$	(0.20	)	$	(0.24	)	$	(0.15	)
As reported net loss per share:
Basic and diluted		$	(0.17	)	$	(0.11	)	$	(0.14	)	$	(0.06	)
Weighted average shares outstanding:
Basic and diluted			4,007,499			3,786,255			3,804,527			3,026,163

Certain assumptions used by the Company in the application of the Model were used to estimate the fair value of all stock options issued to employees on the grant date. The risk-free interest rate for all stock option grants is based on the treasury instrument whose term is consistent with the expected life of the stock options. The expected life of such options has been estimated to equal the average of the contractual term and the vesting term. The Company anticipates paying no cash dividends for its common stock; therefore, the expected dividend yield is assumed to be zero. As there was no public market for its common stock prior to July 31, 2006, the Company estimated the volatility for options granted based on an analysis of reported data for a peer group of publicly traded companies that issued options with substantially similar terms.

 

The following table illustrates the assumptions used by the Company in the application of the Model to calculate the pro forma compensation expense in accordance with SFAS 123 for stock options granted to employees and directors:

		Fair Value												Expected			Option
		of Stock			Stock			Risk Free			Dividend			Option Life			Exercise
		Prices			Volatility			Rate of Return			Rate			in Years			Prices
Ten Months Ended July 31,
2006		$ 2.07 - $ 2.37				70%			4.31% - 4.90%			0%			6.5		$ 3.75
Years Ended September 30,
2005		$ 3.75				70% - 90%			3.26% - 4.13%			0%			6.5		$ 3.00 - $ 3.75
2004		$ 3.00 - $ 3.75				90% - 100%			2.96% - 4.10%			0%			6.5		$ 3.00 - $ 3.75

 

As stock options vest over several years, additional stock option grants are made and employees terminate each year, the above pro forma disclosures and related assumptions used in the Model are not necessarily

 

F - 22

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

representative of pro forma effects on operations for future periods.

 

On December 12, 2004, the FASB issued SFAS No, 123R, Share-Based Payments (“SFAS 123R”), which is a revision of SFAS 123. SFAS 123R superseded APB 25. Generally, the approach under SFAS 123R is similar to the approach described in SFAS 123. SFAS 123R requires companies to utilize an estimated forfeiture rate when calculating the expense for the period, whereas SFAS 123 permitted companies to record forfeitures based on actual forfeitures. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure will no longer be an acceptable alternative. SFAS 123R must be adopted for fiscal years starting after October 1, 2006 and the Company expects to adopt the modified prospective method described therein.

 

Valuation of Other Options and Warrants Issued

 

The Company measures expense for non-employee stock-based compensation and the estimated fair value of options exchanged in business combinations and warrants issued for services using the fair value method for services received or the equity instruments issued, whichever is more readily measured in accordance with SFAS 123 and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling Goods or Services. The Company estimated the fair value of stock options and warrants issued to non-employees using the Model as described more fully above. The following table illustrates the inputs and assumptions used by the Company in the application of the Model to estimate the fair value for fully vested stock options granted to non-employees as follows:

		Ten Months
		Ended July 31,			Years Ended September 30,
		2006			2005			2004
Options granted to non-emplyees			9,227			—			—
Warrants granted to non-employees			464,527			93,740			36,667
Contractual lives in years			5 - 10			5			5
Estimated combined fair value		$	656		$	436		$	181
Estimated fair value of common stock		$	2.07 - $ 2.37		$	3.75		$	3.00 - $ 3.75
Exercise prices		$	0.001 - $ 4.68		$	4.68		$	3.75
Estimated stock volatility			70	%		70% - 90	%		90% - 100	%
Risk free rate of return			3.48% to 4.86	%		3.36% to 3.48	%		3.36	%
Dividend Rate			0	%		0	%		0	%

 

Employee Benefits

 

As of January 1, 2002, the Company adopted a contributory 401(k) plan covering all full-time employees who meet prescribed service requirements. The Company is not required to make matching contributions, although the plan provides for discretionary contributions by the Company. The Company has not made any contributions since inception.

 

Income Taxes

 

Deferred income taxes are recognized, based on temporary differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. Valuation allowances are provided if, based upon the weight of

 

F - 23

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

 

The Company does not provide for U.S. income taxes on the undistributed earnings of foreign subsidiaries, which the Company considers to be permanent investments.

 

Net Loss Per Share of Common Stock

Basic loss per common share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding. Diluted loss per common share is computed similarly to basic loss per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were not anti-dilutive. The Company has excluded all outstanding options, warrants and convertible debt from the calculation of diluted weighted average shares outstanding because these securities were anti-dilutive for all periods presented. Weighted average shares of these equity instruments were 1,232,647, 836,021, 816,749 and 731,560 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively.

 

Recent Accounting Pronouncements

 

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, (“SAB 108”). SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement — including the reversing effect of prior year misstatements — but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of a company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods. Management of the Company has evaluated SFAS 108 and believes its adoption will not materially impact the consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United State of America, and expands disclosures about fair value measurements. SFAS 157 prioritizes the inputs to valuation techniques used to measure fair value into a hierarchy containing three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined on the lowest level input that is significant to the fair value measurement in its entirety. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability. SFAS No. 157 is effective for interim and annual financial statements for fiscal years beginning after November 15, 2007. Upon initial adoption of SFAS 157, differences between the carrying value and the fair value of those instruments shall be recognized as a cumulative-effect adjustment to the opening balance of retained earnings for that fiscal year, and the effect of subsequent adjustments resulting from recurring fair measurements shall be recognized in earnings for the period. The Company has yet not adopted SFAS 157. As a result, the consolidated financial statements do not include any adjustments relating to any potential adjustments to

 

F - 24

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

the carrying value of assets and liabilities. Management of the Company has not completed its evaluation of SFAS 157.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that the Company recognize the impact of a tax position in the financial statements, if that position is more likely than not to be sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings.  Management of the Company has evaluated FIN 48 and believes its adoption will not materially impact the consolidated financial statements.

 

3.  Acquisitions

 

The Company completed the acquisition of New Tilt, Inc. (“New Tilt”) on April 24, 2006 and the Interactive Applications Group, Inc. (“iapps”) on December 15, 2004. The following table summarizes the estimated fair values of the assets acquired at the date of each acquisition as described further below:

		New Tilt			iapps
Net assets acquired;
Cash		$	159		$	77
Other current assets			181			104
Equipment			58			54
Other assets			59			202
Intangible assets			91			353
Goodwill			1,121			2,244
Total assets			1,669			3,034
Current liabilities			70			247
Deferred tax liabilities			49			182
Total liabilities			119			429
Net assets acquired		$	1,550		$	2,605
Purchase price;
Cash paid		$	550		$	355
Equity exchanged			717			1,788
Warrants issued and options exchanged			120			432
Closing costs and fees			163			30
Total purchase price		$	1,550		$	2,605

Unaudited Pro Forma Information

The following unaudited pro forma information reflects the results of operations of the Company and the pre-acquisition results of operations of New Tilt and iapps as noted below:

F - 25

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

		Pro Forma Combined (Unaudited)
		Ten Months Ended July 31,						Years Ended September 30,
		2006			2005			2005			2004
Revenue		$	7,522		$	6,753		$	8,349		$	8,113
Net (loss)		$	(1,090	)	$	(515	)	$	(621	)	$	(191	)
Net (loss) per share:
Basic and diluted		$	(0.26	)	$	(0.12	)	$	(0.15	)	$	(0.05	)
Number of weighted average shares:
Basic and diluted			4,226,166			4,152,227			4,223,833			3,822,830

The results above give effect to the following pro forma adjustments related to New Tilt and iapps:

 

·	Reduction in depreciation resulting from the new accounting basis of equipment and improvements of $(12) and $(22) for New Tilt for the ten months ended July, 31, 2006 and the year ended September 30, 2005, respectively.

·	Increase in amortization of the new accounting basis of assets, including intangible assets of $12 and $12 for iapps for the ten months ended July 31, 2005 and year ended September 30, 2005, respectively.

·	Reduction in stock-compensation expense of $(41) and $(72) for New Tilt for the ten months ended July, 31, 2006 and the year ended September 30, 2005, respectively, to conform to the Company’s accounting policy of using the intrinsic value method.

·	The effect of additional interest expense that would have been incurred to finance a portion of the purchase price for New Tilt in the amount of $142 and $282 for the ten months ended July 31, 2006 and year ended September 30, 2005, respectively.

The common stock used as consideration for the acquisitions is presented as being outstanding during the entire period for the computation of weighted average shares outstanding used in the computation of net loss per share for all periods above.

 

The results presented above for the ten months ended July 31, 2006 include the results of the Company for that period combined with the pre-acquisition results of New Tilt from October 1, 2005 through April 24, 2006.

The results presented above for the ten months ended July 31, 2005 include the results of the Company for that period combined with the pre-acquisition results of iapps from October 1, 2004 through the day before acquisition on December 15, 2004.

The results presented above for the year ended September 30, 2005 include the results of the Company for that period combined with the pre-acquisition results of New Tilt for its fiscal year ended December 31, 2005 and iapps from October 1, 2004 through the day before acquisition on December 15, 2004.

The results presented above for the year ended September 30, 2004 include the results of the Company for that period combined with the pre-acquisition results of New Tilt for its fiscal year ended December 31, 2004 and iapps for its fiscal year ended October 31, 2004.

See Note 2 regarding the accounting policy related to the measurement, recognition and allocation of contingent consideration and intangible assets acquired in business combinations.

F - 26

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

New Tilt, Inc.

 

On April 24, 2006, the Company acquired New Tilt, a privately held provider of Web services. New Tilt’s results of operations have been included in the consolidated financial statements since the date of acquisition. As a result of the acquisition, the Company is expected to expand its services in the health care and insurance industries. The aggregate current consideration of approximately $1,550 consisted of $550 in cash, common stock valued at $717, and other costs of $283. Additional consideration of up to approximately $750 may be paid over a three-year period in cash as additional consideration.

 

The additional consideration described above is based upon the attainment by the acquired entity of defined operating objectives. No additional consideration has been paid to date.

Acquired intangible assets of $91 were assigned as follows: $29 was assigned to the customer relationships and $62 was assigned to non-compete agreements. The estimated value for customer relationships was based on using discounted cash flows. The estimated value for non-compete agreements was based on probability-weighted future discounted cash flows with and without certain key members of New Tilt that have critical relationships with certain customers for which future competition may arise if the key executives were to leave and compete directly with the Company.

The acquisition has been treated as a non-taxable transaction; therefore, the intangible assets, including goodwill, are not tax deductible for the Company.

Interactive Applications Group, Inc.

On December 15, 2004, the Company acquired iapps, a privately-held provider of Web services. Iapps’ results of operations have been included in the consolidated financial statements since the date of acquisition. As a result of the acquisition, the Company is expected to expand its services to not-for-profit organizations.

 

The aggregate current consideration of approximately $2,605 consisted of $355 in cash, common stock valued at $1,788 and other costs of $462 (including $269 paid to an investment advisor as equity equivalents). Additional consideration of $300 may be paid over a three-year period in cash as additional consideration.

 

The additional consideration described above is based upon the attainment by the acquired entity of defined operating objectives. At July 31, 2006, the maximum potential future consideration pursuant to such arrangements during the three years subsequent to acquisition is approximately $176.  To date $124 was recorded as an increase to goodwill under these arrangements.

Acquired intangible assets of $353 were assigned as follows: $180 was assigned to the customer relationships, $58 was assigned to non-compete agreements, $95 was assigned to the Orgitecture platform, $10 was assigned to domain names and $10 was assigned to trademarks. The estimated value for customer relationships was based on using discounted cash flows. The estimated value for non-compete agreements was based on probability-weighted future cash flows with and without certain key members of iapps that have critical relationships with certain customers for which future competition may arise if the key executives were to leave and compete directly with the Company. The estimated value assigned to the Orgitecture platform and domain and trade names was based on estimates of the replacement costs for each of the items.

The acquisition has been treated as a non-taxable transaction, therefore the intangible assets, including

 

F - 27

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

goodwill, are not tax deductible for the Company.

4.  Equipment and Improvements

Equipment and improvements, net consisted of the following:

		As of July 31,						As of September 30,
		2006			2005			2005			2004
Furniture and fixtures		$	113		$	110		$	111		$	75
Acquired software			91			58			75			20
Computers and peripherals			632			344			365			250
Leasehold improvements			43			25			28			19
			879			537			579			364
Less accumulated depreciation			453			292			312			206
		$	426		$	245		$	267		$	158

Included above are assets acquired under capitalized leases of $231, $58, $97, and $58 as of July 31, 2006 and 2005 and September 30, 2005 and 2004, respectively, with accumulated depreciation thereon of $81, $35, $41 and $19, respectively.

The Company has $96 and $39 of net property and equipment at September 30, 2005 and 2004, respectively, available for lease as a component of hosting arrangements as described in Note 2.

 

5.  Definite Lived Intangible Assets and Goodwill

 

Definite lived intangible assets and goodwill consisted of the following;

 

		Useful			As of July 31, 2006									As of July 31, 2005
		Lives in			Gross			Accumulated			Net			Gross			Accumulated			Net
		Years			Asset			Amortization			Amount			Asset			Amortization			Amount
Intangible assets;
Domain and trade names			10		$	29		$	(11	)	$	18		$	29		$	(10	)	$	19
Customer related			5			478			(214	)		264			387			(132	)		255
Acquired software			3			95			(52	)		43			95			(20	)		75
Total intangible assets					$	602		$	(277	)	$	325		$	511		$	(162	)	$	349
Goodwill					$	6,310		$	—		$	6,310		$	5,097		$	—		$	5,097
						As of September 30, 2005									As of September 30, 2004
					Gross			Accumulated			Net			Gross			Accumulated			Net
					Asset			Amortization			Amount			Asset			Amortization			Amount
Intangible assets;
Domain and trade names			10		$	29		$	(10	)	$	19		$	9		$	(9	)	$	—
Customer related			5			387			(145	)		242			149			(77	)		72
Acquired software			3			95			(25	)		70			—			—			—
Total intangible assets					$	511		$	(180	)	$	331		$	158		$	(86	)	$	72
Goodwill					$	5,097		$	—		$	5,097		$	2,740		$	—		$	2,740

 

The aggregate amortization expense for the ten months ended July 31, 2006 and 2004 and for the years ended September 30, 2005 and 2004 is as follows:

 

F - 28

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

		Total			Expense Charge To
		Amortization			Cost of
		Expense			Revenue			Operations
Ten Months Ended July 31, 2006		$	97		$	95		$	2
Ten Months Ended July 31, 2005		$	76		$	74		$	2
Year Ended September 30, 2005		$	94		$	92		$	2
Year Ended September 30, 2004		$	30		$	30		$	-

The estimated amortization expense for the fiscal years 2006, 2007, 2008, 2009, 2010 and thereafter is $111, $90, $52, $46, $18 and $14, respectively.

 

As discussed more fully in Note 3, goodwill increased $2,244 in the year ended September 30, 2005 as a result of the acquisition of iapps, and $1,121 in the ten months ended July 31, 2006 as a result of the acquisition of New Tilt. In addition to the acquisitions, goodwill increased $113 and $92 in the year ended September 30, 2005 and in the ten months ended July 31, 2006, respectively, due to contingent consideration earned under acquisition agreements with Lead Dog Digital, Inc. (“Lead Dog”) and iapps.

 

6.  Accrued Liabilities

 

Accrued liabilities consisted of the following:

		As of July 31,						As of September 30,
		2006			2005			2005			2004
Compensation and benefits		$	139		$	98		$	144		$	179
Subcontractors			89			22			31			17
Deferred rent			32			56			44			36
Other			64			100			52			32
		$	324		$	276		$	271		$	264

 

7.  Indebtedness

 

The Company’s indebtedness consisted of the following:

 

Senior Notes Payable

		As of July 31,						As of September 30,
		2006			2005			2005			2004
Senior notes payable		$	2,800		$	—		$	—		$	—
Discount on senior notes payable			(254	)		—			—			—
		$	2,546		$	—		$	—		$	—

 

In 2006, the Company entered into an agreement with an underwriter to execute a private placement of $2.8 million of senior secured notes payable and related security agreement (the “Senior Notes”) and to underwrite an initial public offering of the Company’s common stock.

 

F - 29

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

The terms of the Senior Notes include various covenants and are secured by all assets of the Company. The Senior Notes were subordinated to other creditors at issuance; however, those debts were fully paid by the Company as of July 1, 2006. The principal amount of the Senior Notes is payable in full at the earlier of April 2007 or the closing date of an initial public offering of the Company’s securities pursuant to a registration statement filed by the Company under the Securities Act of 1933 (the “Maturity Date”).

Under the terms of the Senior Notes, the Company agreed to comply with certain restrictive covenants so long as the notes remain outstanding, which include; (a) not to liquidate, dissolve or merge with another entity, excluding its wholly-owned subsidiaries, (b) not to sell assets other than in the ordinary course of business, (c) not to redeem or repurchase equity securities of the Company other than from employees or consultants to the Company, (d) not to declare dividends, pay any cash dividends or make distributions to the Company’s outstanding shareholders and (e) not to engage in a merger, acquisition, reorganization, declaration of bankruptcy or sell substantially all of its assets that would result in a change in voting control of the Company from its current shareholders.

 

In connection with the issuance of the Senior Notes, the Company issued 280,000 warrants to the note holders (the “Debt Warrants”) and 112,000 warrants to the underwriter for services rendered in connection with the private placement (the “Underwriter’s Debt Warrants”). These Warrants are exercisable into shares of the Company’s common stock. The Debt Warrants are exercisable at $0.001 per share at any time within five years from the date of grant. The Underwriter’s Debt Warrants are exercisable at any time within five years from the grant date provided, however, that no such exercise shall take place prior to the earlier of the date of an initial public offering or April 21, 2008. The Underwriter’s Debt Warrants are exercisable at $4.68 or, in the case of an initial public offering, an amount equal to the first offering price on the first day of an offering.

 

Under the terms of the Senior Notes, the Company is not obligated to make principal payments until the Maturity Date, nor are there any penalties should the notes be repaid prior to the Maturity Date. Interest on the Senior Notes accrues at a rate of 10% per annum through October 27, 2006 and at the rate of 12% from October 27, 2006 thereafter as defined in the note agreement and is payable quarterly commencing June 30, 2006. Interest expense related to this debt including amortization of the deferred financing fees for the ten months ended July 31, 2006 was $185, which when aggregated with the amortization of the Debt Warrants and the Underwriter’s Debt Warrants described above, yields an effective interest rate of 47%.

 

Financing Agreement

 

		As of July 31,						As of September 30,
		2006			2005			2005			2004
Financing agreement		$	—		$	474		$	292		$	—

 

Commencing March 2005, the Company entered into a financing agreement (the “Agreement”) with a private commercial lender (the “Lender”) providing the Company up to $500 of credit availability which was increased to $750 on September 12, 2005. Under the terms of the Agreement, the Company chose to deliver certain accounts receivable to the Lender, subject to acceptance. Upon acceptance, the Lender advanced to the Company up to 80% of the face amount of the receivable, and the remaining 20% was remitted to the Company when paid by the customer. In this Agreement, the Company assigned its right of

 

F - 30

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

collection to the Lender with full recourse rights against the Company in the event the receivable was never paid to the Company or the Lender directly.

The fees charged under the Agreement for the aggregate amounts advanced by the Lender included a monthly commitment fee of 1.7%, which the Company recorded as interest expense. The total interest expense was $57, $22, $37, and $0 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively. The weighted average interest rate incurred by the Company on this arrangement was 21%, 24%, 22% and 0% on weighted average borrowings of $370, $266, $319, and $0 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively. The Company terminated the Agreement in June 2006.

 

Capitalized Lease Obligations

 

		As of July 31,						As of September 30,
		2006			2005			2005			2004
Capital lease obligations		$	169		$	42		$	44		$	54

 

As of September 30, 2005, the Company had remaining the following minimum lease payments under capitalized lease obligations:

Year Ending September 30,
2006		$	16
2007			16
2008			16
2009			8
Totals			56
Less imputed interest (9.06%)			12
Total capitalized lease obligations		$	44

 

During the ten months ended July 31, 2006, the Company leased additional equipment with a cost of $134 under capitalized leases.

 

Notes Payable to Shareholders

		As of July 31,						As of September 30,
		2006			2005			2005			2004
Notes payable to shareholders		$	—		$	45		$	85		$	171

In connection with the acquisition of Lead Dog Digital, Inc. (“Lead Dog”) in 2002, the Company issued notes payable to the former shareholders of Lead Dog totaling $58. These notes carried an interest rate of 10% maturing on August 31, 2005 and were convertible into the Company’s common stock at $3.00 per share. The Company was unable to fully repay the principal and one of the note holders instituted the default interest rate of 15% for the period subsequent to August 31, 2005. Interest incurred under the notes was $5, $5, $6 and $6 for the

 

F - 31

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

ten month periods ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively. The amounts outstanding under these notes were $0, $45, $45 and $58 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively. These notes were subsequently paid in April 2006 and July 2006.

 

In September 2002, the Company entered into two notes payable with its Chief Executive Officer in the amounts of $200 and $112. The $200 was secured by all assets of the Company and the $112 was an unsecured note. Both notes carried a 10% interest rate and were convertible into the Company’s common stock at $3.00 per share. The balances on these notes were $0, $0, $40 and $113 for the ten months ended July 31, 2006 and 2005, and the years ended September 30, 2005 and 2004, respectively. Both of these notes matured on September 7, 2006 and were paid on October 12, 2004 with no advance payment penalty. Interest under these notes was $0, $0, $0 and $5 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively.

In September 2005, the Company received an interest free advance from its Chief Executive Officer in the amount of $40 and the advance was repaid on November 9, 2005.

 

8.  Commitments and Contingencies

 

Guarantees and Indemnifications

 

Certain software licenses granted by the Company contain provisions that indemnify licensees from damages and costs resulting from claims alleging that the Company’s software infringes the intellectual property rights of a third party. The Company has indemnification provisions in its articles of incorporation whereby no director or officer will be liable to the Company or its shareholders for monetary damages for breach of certain fiduciary duties as a director or officer. The Company has received no requests for indemnification under these provisions, and has not been required to make material payments pursuant to these provisions. Accordingly, the Company has not recorded a liability related to these indemnification provisions.

Litigation

 

In the normal course of business, the Company is subject to ordinary routine litigation and claims incidental to its business. The Company monitors and assesses the merits and risks of pending legal proceedings. While the results of litigation and claims cannot be predicted with certainty, based upon its current assessment, the Company believes that the final outcome of any existing legal proceeding will not have a materially adverse effect, individually or in the aggregate, on its consolidated results of operations or financial condition.

 

Operating Lease Commitments

 

The Company maintains its executive offices in Woburn, Massachusetts and operating offices in several locations throughout the United States and abroad. Future minimum rental commitments under non-cancelable operating leases with initial or remaining terms in excess of one year at September 30, 2005 were as follows:

Year Ending September 30,
2006		$	475
2007			259

 

F - 32

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

2008			234
2009			237
2010			239
Thereafter			230
Total		$	1,674

     

Rent expense for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004 was approximately $495, $432, $501 and $278, respectively.

 

Other Commitments

 

On October 1, 2005, the Company entered into a Business Combination Services Agreement with Joseph Gunnar & Co., LLC (“Gunnar”), pursuant to which Gunnar provides us with certain advisory services concerning potential acquisitions and transactions. The term of the agreement is for one year with automatic one-year renewals until either party elects not to renew and provides 90 days’ written notice prior to the commencement of the next renewal period or after the consummation of two business combinations during any term. During the term and any renewal periods, the Company is required to pay cash advances against success fees in the initial amount of $7 per month, which amount increased to $10 per month in May 2006, and will increase to $15 per month upon a public stock offering. As compensation for its services, the Company is obligated to pay Gunnar, at the closing of a business combination (i.e., a merger, acquisition, sale or joint venture), a success fee equal to six percent of the total value of all cash, securities or other property paid in connection with the transaction. The success fee for each business combination consummated during the initial term or a renewal period is a minimum of $125 and a maximum of $375, net of the cash advances paid to Gunnar during the applicable period. Success fees, less amounts paid in advance, are included in the total purchase price of the related acquisition. Amounts paid in advance are expensed as paid. The Company is also obligated to reimburse Gunnar for reasonable expenses incurred in connection with providing the advisory services. This agreement also contains exclusivity, indemnification and other terms and provisions customary for agreements of this nature.

The Company frequently warrants that the technology solutions it develops for its clients will operate in accordance with the project specifications without defects for a specified warranty period, subject to certain limitations that the Company believes are standard in the industry. In the event that defects are discovered during the warranty period, and none of the limitations apply, the Company is obligated to remedy the defects until the solution that the Company provided operates within the project specifications. The Company is not typically obligated by contract to provide its clients with any refunds of the fees they have paid, although a small number of its contracts provide for the payment of liquidated damages upon default. The Company has purchased insurance policies covering professional errors and omissions, property damage and general liability that reduce its monetary exposure for warranty-related claims and enable it to recover a portion of any future amounts paid. The Company typically provides in its contracts for testing and client acceptance procedures that are designed to mitigate the likelihood of warranty-related claims, although there can be no assurance that such procedures will be effective for each project. The Company has never paid any material amounts with respect to the warranties for its solutions. The Company sometimes commits unanticipated levels of effort to projects to remedy defects covered by its warranties. The Company’s estimate of its exposure related to warranties on contracts is immaterial as of July 31, 2006 and 2005 and September 30, 2005 and 2004.

F - 33

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

9.  Shareholder’s Equity

 

Estimated Fair Value of Common Stock

Since its inception in 2000, the Company has granted common stock, common stock warrants, and common stock option awards (the “Equity Awards”) to employees, consultants, advisors and debt holders of the Company and to former owners and employees of acquired companies that become employees of the Company. The following is a summary of the common stock reserved for issuance for stock option and warrant activity:

Common Stock Warrants

During 2001 through 2004, the Company issued to certain investment advisors warrants to purchase 128,874 shares of common stock for services rendered in connection with private placement sales of common stock with aggregate proceeds of approximately $4,700. The warrants are exercisable at $3.75 and $4.68 per share at any time within five years from the grant date. The Company valued the warrants at a combined amount of $341 using the Model as described in Note 2.

In connection with the December 2004 acquisition of iapps described in Note 3, the Company issued 104,193 warrants to its investment advisor for services rendered in connection with the acquisition. The warrants are exercisable at $3.75 and $4.68 per share at any time within five years from the grant date. The Company valued the warrants at $269 using the Model as described in Note 2, which the Company recorded as a direct cost of the acquisition.

In March 2005, the Company issued 3,200 warrants in connection with the $500 financing agreement described in Note 7. The warrants are exercisable at $4.68 per share at any time within five years from the date of grant. The Company valued the warrants at $8 using the Model as described in Note 2, which the Company charged to deferred financing fees and amortized the cost over the expected life of the agreement. The fees were fully amortized when the financing agreement was terminated in 2006.

The Debt Warrants issued in connection with the Senior Notes described in Note 7 are exercisable at $0.001 per share at any time within five years from the date of grant. For the ten months ending July 31, 2006, 10,000 Debt Warrants have been exercised by one Senior Note holder. The Underwriter’s Debt Warrants issued in connection with the Senior Notes described in Note 7 are exercisable at any time within five years from the grant date provided, however, that no such exercise shall take place prior to the earlier of the date of an initial public offering or April 21, 2008. The Underwriter’s Debt Warrants are exercisable at $4.68 or, in the case of an initial public offering, an amount equal to the first offering price on the first day of an offering. The Company valued the Debt Warrants at $531 and the Underwriter’s Debt Warrants at $115 using the Model as described in Note 2, which the Company charged to deferred financing costs and amortized over the expected life of the Senior Notes of one year.

Upon successful completion of an initial public offering, the exercise price of the Underwriter’s Debt Warrants will be modified to an amount equal to the first offering price on the first day of an offering in accordance with the Agreement. As such, the modification will require the Company to re-measure the value assigned to the warrants using the Model (as more fully described in Note 2). The effect of the modification, if any, will be charged to earnings at that time.

2000 Stock Incentive Plan

During 2000, the Company adopted the 2000 Stock Incentive Plan (the “Plan”) and reserved 1.0 million

 

F - 34

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

shares of common stock for issuance thereunder. On June 24, 2005 the Board of Directors increased the reserve for common stock issued under the Plan to 1.2 million. The Plan authorized the award of incentive stock options, non-statutory stock options, restricted stock, unrestricted stock, performance shares, stock appreciation rights and any combination thereof to employees, officers, directors, consultants, independent contractors and advisors of the Company. During 2006, the Company amended and restated the Plan to conform to current tax laws and to increase the number of common shares reserved for issuance under the plan to 1.4 million. Options granted under the Plan may be granted with contractual lives of up to ten years. There were 366,427 options reserved for issuance under the Plan as of September 30, 2005.

2001 Lead Dog Stock Option Plan

In connection with the Company’s merger with Lead Dog Digital, Inc. (“Lead Dog”) in February 2002, the Company acquired Lead Dog’s 2001 Stock Option Plan (the “Lead Dog Plan”). Options under the Lead Dog Plan may be granted for periods of up to ten years and at prices no less than the fair market value of the shares on the date of grant. Under the terms of the Agreement and Plan of Merger with Lead Dog, 98,731 options of the Lead Dog Plan were reserved for issuance to former Lead Dog employees that remained with the Company based on achievement of certain contingent objectives subsequent to the merger. During 2002, the Company issued 66,851 options with exercise prices of between $0.36 and $1.07 as the contingent objectives were met and during 2006, the Company issued 31,880 of its options with exercise prices of $3.75 as the contingent objectives were met.

A summary of combined option activity is as follows:

		Stock Options						Stock Warrants
					Weighted						Weighted
					Average						Average
					Exercise						Exercise
		Options			Price			Warrants			Price
Outstanding, October 1, 2003			582,587		$	2.376			33,333		$	3.750
Granted			109,067		$	3.002			36,667		$	3.750
Exercised			(22,222	)	$	0.003			—			—
Cancelled or expired			(58,710	)	$	1.688			—			—
Outstanding, September 30, 2004			610,722		$	2.579			70,000		$	3.778
Granted			429,616		$	3.439			93,740		$	4.349
Exercised			—			—			—			—
Cancelled or expired			(206,765	)	$	2.852			—			—
Outstanding, September 30, 2005			833,573		$	2.955			163,740		$	4.093
Granted			154,920		$	3.750			464,527		$	1.860
Exercised			—			—			—			—
Cancelled or expired			(62,662	)	$	3.348			—			—
Outstanding, July 31, 2006			925,831		$	3.055			628,267		$	2.442

F - 35

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

A summary of options outstanding and options exercisable at September 30, 2005:

 

			Options Outstanding									Options Exercisable
						Weighted
						Average
						Remaining			Aggregate			Number of			Aggregate
	Exercise		Number of			Contractual			Intrinsic			Options			Intrinsic
	Price		Options			Life in Years			Value			Exercisable			Value
	$ 0.003			24,167			7.00		$	49,953			24,167		$	49,953
	$ 0.357			15,397			5.06		$	26,371			15,397		$	26,371
	$ 1.072			63,374			6.51		$	63,272			63,374		$	63,272
	$ 1.200			43,764			9.21		$	38,075			43,764		$	38,075
	$ 3.000			568,038			8.00		$	—			197,379		$	—
	$ 3.750			118,833			9.17		$	—			4,389		$	—

 

The aggregate intrinsic value in the table above represents the total intrinsic value, based on the Company’s estimate of fair value of $1.94 at September 30, 2005 which would have been received by the option holders had all option holders exercised their options as of those dates.

10.  Income Taxes

The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The sources and tax effects of the differences are as follows:

 

		Fiscal Year Ended September 30,
		2005			2004
Income tax benefit at the
federal statutory rate of 34%		$	(175	)	$	(61	)
Permanent differences, net			45			15
State income benefit,
net of federal benefit			(20	)		(9	)
Change in valuation allowance			150			55
		$	—		$	—

 

As of September 30, 2005, the Company has net operating loss carryforwards (“NOLs”) of approximately $3,000 for federal purposes and $2,900 for state purposes, which will be available to offset future taxable income. If not used, the federal carryforwards will expire between 2020 and 2025 and the state carryforwards will expire between 2006 and 2025.

The Company’s income tax provision was computed based on the federal statutory rate and average state statutory rates, net of the related federal benefit.

F - 36

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

Significant components of the Company’s deferred tax assets and liabilities are as follows:

		As of September 30,
		2005			2004
Deferred tax assets:
Long-term
Net operating loss carry forwards		$	1,186		$	1,024
Deferred tax liabilities:
Current:
Other			(3	)		(5	)
Long-term:
Intangibles			(132	)		(30	)
Depreciation			(57	)		(11	)
			994			978
Valuation allowance			994			978
		$	-0-		$	-0-

The valuation allowance for deferred tax assets increased by $16 and $56 in the years ended September 30, 2005 and 2004, respectively. These increases were mainly due to the losses incurred during those years and the acquisition of iapps in December 2004. The Company has NOLs and other deferred tax benefits that are available to offset future taxable income. When realization of the deferred tax asset is more likely than not to occur, the Company establishes a valuation allowance to the extent that this realization is not probable; accordingly, the Company has established a full valuation allowance against its net deferred tax asset at July 31, 2006 and 2005 and September 30, 2005 and 2004, respectively.

In January 2005, the Company established Bridgeline Software Enterprises Pvt Ltd in Bangalore India under the Software Technology Parks of India law. This law establishes a tax holiday for the first ten years of operations; therefore the Company has not incurred any foreign taxes.

Undistributed earnings of the Company’s foreign subsidiary amounted to approximately $28 at September 30, 2005. These earnings are considered to be indefinitely reinvested; accordingly, no provision for US federal and state income taxes has been provided thereon. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to both US income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the applicable foreign tax authority. Determination of the amount of unrecognized deferred US income tax liability is not material and detailed calculations have not been performed. As of September 30, 2005, there would be minimal withholding taxes upon remittance of all previously unremitted earnings.

11.  Subsequent Events

Probable Acquisition of Objectware, Inc.

 

On December 7, 2006, the Company signed a definitive agreement to acquire Objectware, Inc. (“OW”) effective immediately following a successful initial public offering, and no later than May 15, 2007. OW is an Atlanta, Georgia-based company that specializes in Web application development, Web design, wireless application development, search engine optimization and providing managed Web services to

 

F - 37

---

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of July 31, 2006 and 2005 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Amounts in thousands, except share and per share data)

 

customers. The proposed consideration for the acquisition of OW will consist of (i) $2,500 in cash, (ii) shares of its common stock having a value (based on the initial public offering price of its shares in this offering) of $2,700 and (iii) a deferred, contingent purchase price of up to $1,800, payable in cash and stock quarterly over the three years after the acquisition, contingent upon OW attaining certain operational performance benchmarks.

Initial Public Offering of Common Stock

In December 2006, the Company expects to file an initial public offering with the Securities and Exchange Commission for the sale of 3,000,000 of the Company’s common stock and to register 3,612,000 shares and warrants. The initial public offering price for the shares offered hereby is estimated to be between $5.00 and $6.00 per share. The underwriter has a 45-day option to purchase up to an additional 450,000 shares to cover over-allotments. The shares are being offered by the underwriter, Joseph Gunnar & Co., LLC, subject to prior sale, when, as and if accepted by them and subject to certain conditions.

Amendment of Warrant Agreements

 

In November 2006, the terms of Debt Warrants described in Note 7 were amended to eliminate a certain provision, included in the Debt Warrants in error during the drafting of the Debt Warrant documents, which provision resulted in a contingent obligation of the Company to redeem the Debt Warrants in the event that an initial public offering of the Company’s common stock does not occur prior to the April 2011 expiration date of the Debt Warrants. As a result of the amendment correcting this error, the Company has accounted for the warrants in shareholder’s equity as additional paid in capital since the date of issuance.

 

 

 

 

F - 38

---

Objectware, Inc.

 

 

Report of Independent Certified Public Accountants	F-40
Balance Sheets as of July 31, 2006 (unaudited) and September 30, 2005 and 2004	F-41
Statements of Operations for the ten months ended July 31, 2006 (unaudited)      and 2005 (unaudited) and the years ended September 30, 2005 and 2004	F-42
Statements of Shareholder’s Equity for the ten months ended July 31, 2006 (unaudited)       and the years ended September 30, 2005 and 2004	F-43
Statements of Cash Flows for the ten months ended July 31, 2006 (unaudited)       and the years ended September 30, 2005 and 2004	F-44
Notes to Financial Statements	F-45

 

 

 

 

 

F - 39

---

Report of Independent Certified Public Accountants

To the Shareholders of

Bridgeline Software, Inc.

and Objectware, Inc.

We have audited the accompanying balance sheets of Objectware, Inc. (the “Company”) as of September 30, 2005 and 2004, and the related statements of operations, shareholder’s equity, and cash flows for the years ended September 30, 2005 and 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Objectware, Inc. as of September 30, 2005 and 2004, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ UHY LLP

Boston, Massachusetts

December 11, 2006

F - 40

---

Objectware, Inc.

BALANCE SHEETS

(Amounts in thousands, except share amounts)

		(Unaudited)
		July 31,			September 30,
ASSETS		2006			2005			2004
Current assets:
Cash and cash equivalents		$	552		$	530		$	211
Accounts receivable, net			366			180			138
Current portion of long-term receivable			62			37			—
Marketable securities - available for sale			363			—			—
Due from shareholder			44			27			—
Deferred tax asset			48			48			—
Other current assets			23			19			7
Total current assets			1,458			841			356
Equipment and improvements, net			190			134			87
Long-term receivable, net of current portion			347			226			—
Other assets			12			11			12
Total assets		$	2,007		$	1,212		$	455
LIABILITIES AND SHAREHOLDER’S EQUITY
Current liabilities:
Accounts payable		$	52		$	24		$	30
Income taxes payable			209			184			5
Accrued liabilities			93			81			55
Deferred revenue			452			238			221
Due to shareholder			—			—			76
Total current liabilities			806			527			387
Deferred tax liability			19			19			—
Long-term deferred revenue			347			226			—
Total liabilities			1,172			772			387
Commitments (Note 9)			—			—			—
Shareholder’s equity:
Common stock — $0.001 par value; 5,000,000 shares authorized; 1,600,000 shares issued and outstanding			2			2			2
Accumulated other comprehensive income, net of taxes			8			—			—
Retained earnings			825			438			66
Total shareholder’s equity			835			440			68
Total liabilities and shareholder’s equity		$	2,007		$	1,212		$	455

 

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

 

F - 41

---

Objectware, Inc.

STATEMENTS OF OPERATIONS

(Amounts in thousands)

		For the Ten Months Ended						For the Year Ended
		(Unaudited)			(Unaudited)			September 30,
		July 31, 2006			July 31, 2005			2005			2004
Revenue:
Web services		$	2,560		$	1,816		$	2,265		$	1,334
Managed services			558			404			474			336
Reimbursable expense			18			19			23			2
Total revenue			3,136			2,239			2,762			1,672
Cost of revenue			1,440			1,200			1,443			1,141
Gross profit			1,696			1,039			1,319			531
Operating Expenses:
Selling, general and administrative			1,041			631			743			586
Depreciation			43			34			41			32
Total operating expenses			1,084			665			784			618
Income (loss) from operations			612			374			535			(87	)
Other income (expense), net			22			—			(2	)		—
Interest income (expense), net			(1	)		(4	)		(5	)		(6	)
Income (loss) before provision for income taxes			633			370			528			(93	)
Provision for income taxes			246			110			156			5
Net income (loss)		$	387		$	260		$	372		$	(98	)

 

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

 

F - 42

---

Objectware, Inc.

STATEMENTS OF SHAREHOLDER’S EQUITY

(Amounts in thousands except share amounts)

 

		Common Stock						Retained			Accumulated Other Comprehensive			Total Shareholder’s			Comprehensive
		Shares			Amount			Earnings			Income			Equity			Income
Balance, September 30, 2003			1,600,000		$	2		$	164		$	—		$	166
Net loss			—			—			(98	)		—			(98	)
Balance, September 30, 2004			1,600,000			2			66			—			68
Net income			—			—			372			—			372
Balance, September 30, 2005			1,600,000			2			438			—			440
Net income (unaudited)			—			—			387			—			387		$	387
Other comprehensive income:
Unrealized gain in fair market value of   marketable securities, net of tax of $5 (unaudited)												8			8			8
Total comprehensive income (unaudited)			—			—			—			—			—		$	395
Balance, July 31, 2006 (unaudited)			1,600,000		$	2		$	825		$	8		$	835

 

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

F - 43

---

Objectware, Inc.

STATEMENTS OF CASH FLOWS

(Amounts in thousands)

		For the Ten Months Ended						For the Year Ended
		(Unaudited)			(Unaudited)			September 30,
		July 31, 2006			July 31, 2005			2005			2004
Cash flows from operating activities:
Net income (loss)		$	387		$	260		$	372		$	(98	)
Adjustments to reconcile income (loss) from operations to net cash provided by operating activities:
Depreciation			43			39			40			32
Loss on disposal of fixed assets			—			—			2			—
Gain on sale of marketable securities			(5	)		—			—			—
Changes in operating assets and liabilities:
Accounts receivable			(185	)		(56	)		(42	)		(20	)
Long term receivable			(146	)		(206	)		(263	)		—
Prepaid expenses			(4	)		—			(12	)		(7	)
Other current assets			—			—			—			(3	)
Deferred tax assets			—			—			(48	)		—
Accounts payable			28			(15	)		(6	)		21
Income taxes payable			25			105			179			5
Accrued liabilities			12			40			26			13
Deferred revenue			335			132			243			192
Deferred tax liability			—			—			19			—
Net cash provided by operating activities			490			299			510			135
Cash flows from investing activities:
Capital expenditures			(98	)		(62	)		(88	)		(43	)
Purchases of investments			(458	)		—			—			—
Proceeds from the sale of investments			105			—			—			—
Net cash used in investing activities			(451	)		(62	)		(88	)		(43	)
Cash flows from financing activities:
Advances (to) from shareholder, net			(17	)		(96	)		(103	)		(26	)
Net cash used in financing activities			(17	)		(96	)		(103	)		(26	)
Net increase in cash and cash equivalents			22			141			319			66
Cash and cash equivalents, beginning of period			530			211			211			145
Cash and cash equivalents, end of period		$	552		$	352		$	530		$	211
Supplemental cash flow information:
Cash paid for interest		$	1		$	4		$	5		$	6
Cash paid for income taxes		$	221		$	6		$	6		$	—

 

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

 

F - 44

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

1.

Business Description:

Objectware, Inc. (the “Company”), a Georgia corporation, is a software company specializing in the development and hosting of custom Web, mobile and wireless applications. The Company is headquartered in Atlanta, Georgia. The Company’s customers are primarily located in the Southeastern and Eastern United States.

The Company’s operations are subject to certain risks and uncertainties, including the susceptibility of the Company’s services to rapid technological change, increased competition from existing service providers and new entrants, and dependence upon key members of the management team.

 

Unaudited Interim Financial Information

 

 

The accompanying balance sheet as of July 31, 2006, the statements of operations and cash flows for the ten months ended July 31, 2006 and 2005, and the statement of stockholder’s equity for the ten months ended July 31, 2006 are unaudited. The unaudited interim statements have been prepared in accordance with accounting principles generally accepted in the United States of America and in the opinion of the Company’s management have been prepared on the same basis as the accompanying audited financial statements and include all adjustments, consisting of normal recurring adjustments and accruals, necessary for the fair presentation of the Company’s financial position at July 31, 2006 and its results of operations and its cash flows for the ten months ended July 31, 2006 and 2005. The results for the ten months ended July 31, 2006 are not necessarily indicative of the results to be expected for the year ending September 30, 2006.

 

2.

Summary of Significant Accounting Policies:

 

Revenue Recognition

 

Substantially all of the Company’s revenue is generated from Web Services and Managed Services. The Company recognizes revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the services have been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of the fees is probable. Billings made or payments received in advance of providing services are deferred until the period these services are provided.

Web Services and Managed Services include consulting services that are related to specific customer needs such as information architecture and usability engineering, interface configuration, Web application development and hosting, rich media, e-Commerce,

 

F - 45

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

2.

Summary of Significant Accounting Policies (Continued):

e-Training, search engine optimization, and content management.

Revenue for Web Services and Managed Services is recognized when the services are performed or when they are complete. The Company uses the proportionate performance model in the determination of when delivery has occurred in relation to the extent of progress toward completion. When allocating revenue between reporting periods, the Company considers the actual labor hours incurred each period in proportion to total estimated labor hours necessary to deliver the services under the arrangement.

Managed Services also include on-going retained professional services and hosting arrangements. On-going retained professional services are either contracted for on an “on-call” basis or for a certain amount of hours each month. Such arrangements generally provide for a guaranteed availability of a number of hours each month on a “use it or lose it” basis. These arrangements do not require formal customer acceptance and do not grant any future right to labor hours contracted for but not used.

In determining whether Web Services can be accounted for separately from other elements in multi-element arrangements, the Company considers the following factors for each agreement: availability of the Web Services from other vendors, whether objective and reliable evidence of fair value exists for the undelivered elements, and whether delivery of any undelivered elements is probable and can be controlled by the Company. The amount of revenue recognized for Web Services in multi-element arrangements is determined by use of the residual method.

 

Certain arrangements include a warranty period generally 60 days from the completion of work. In hosting arrangements, the Company may provide warranties of up-time reliability. To date, few warranty claims have been received. The Company continues to monitor the conditions that are subject to the warranties to identify if a warranty claim may arise. If the Company determines that a warranty claim is probable, then any such estimable cost would be recognized to comply with the warranty requirements.

In connection with certain arrangements, reimbursable expenses are incurred and billed to customers and such amounts are recognized as both revenue and cost of revenue.

 

Concentration of Credit Risk and Significant Customers

 

Financial instruments, which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, to the extent these exceed federal insurance limits, short-term investments and accounts receivable. Risks associated with cash and cash equivalents are mitigated by investing excess cash in money market funds with high credit quality financial institutions. In general the Company does not require collateral on its arrangements with customers. The Company has accounts receivable related to upfront fees which typically provide for credit terms of 30-60 days. The Company provides reserves against accounts receivables for estimated losses that may result from customers’ inability to pay. The amount of the reserve is determined by analyzing known uncollectible accounts, aged receivables, the economic conditions in the customers’ industry, historical losses and changes in customer creditworthiness.

The Company had one customer who individually represented 18% of the Company’s total revenue for the ten months ended July 31, 2006 and no other customers representing 10% or more of the Company’s total revenue in all other periods presented.

 

F - 46

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

2.

Summary of Significant Accounting Policies (Continued):

 

The Company had certain customers whose balances individually represented 10% or more of the total accounts receivable (excluding the long term receivable discussed in Note 7), as follows:

				September 30,
		July 31, 2006		2005		2004
Customer #1		25%		*		*
Customer #2		*		25%		*
Customer #3		*		24%		*
Customer #4		*		11%		*
Customer #5		*		*		26%
Customer #6		*		*		17%
* Represents less than 10%

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. The most significant estimates included in these financial statements are the valuation of accounts receivable and deferred tax assets, proportionate performance estimates, unbilled receivables and deferred revenue. Actual results could differ from these estimates under different assumptions or conditions.

The complexity of the estimation process and factors relating to assumptions, risks and uncertainties inherent with the use of the proportionate performance model affect the amounts of revenues and related expenses reported in our financial statements. A number of internal and external factors can affect our estimates including efficiency variances and specification and test requirement changes.

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments with original maturity of three months or less from the date of purchase to be cash equivalents. Cash equivalents primarily consist of money market mutual funds.

Fair Value of Financial Instruments

The carrying amounts of financial instruments, which include cash and cash equivalents, accounts receivable and accounts payable approximates their fair value because of the short-term maturity of these instruments.

 

F - 47

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

2.

Summary of Significant Accounting Policies (Continued):

 

Marketable Securities - Available for Sale

Investments in marketable equity securities are classified as available for sale and are recorded at fair value.  Unrealized gains and losses on these securities, net of income taxes, are included in shareholder’s equity as a component of accumulated other comprehensive income.

Equipment and Improvements

The components of equipment and improvements are stated at cost. The Company provides for depreciation and amortization using the straight-line method over the estimated useful lives of the individual assets as follows: software, three years; furniture and fixtures, five to ten years; and computers and equipment, three to ten years. Leasehold improvements are amortized by use of the straight-line method over the lesser of the estimated useful life of the asset or the lease term.

 

Maintenance and repair costs are charged to expense as incurred. Major renewals, betterments, and additions are capitalized.

 

Advertising Costs

 

All advertising costs are expensed when incurred. Advertising costs were $2, $0, $3, and $11 for the ten months ended July 31, 2006 and 2005 and for years ended September 30, 2005 and 2004, respectively.

 

Stock-Based Compensation

 

The Company has a stock-based employee compensation plan that is described more fully in Note 10. Prior to the effective date of Statement of Fnancial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” the Company has elected under the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), to account for employee stock options in accordance with Accounting Principle Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), using the intrinsic value approach to measure compensation expense, if any. Companies that account for stock-based compensation arrangements under APB No. 25 are required by SFAS No. 123 to disclose the pro forma effect on net income (loss) as if the fair value based method prescribed by SFAS No. 123 had been applied. The Company has not granted any options since 2001 and all options were fully vested in 2002, therefore no pro forma disclosure of the effect of SFAS No. 123 is required.

 

F - 48

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

2.

Summary of Significant Accounting Policies (Continued):

 

Income Taxes

 

Deferred income taxes are recognized based on temporary differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

 

Recent Accounting Pronouncements

 

In September 2006, the SEC staff issued Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement — including the reversing effect of prior year misstatements — but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods. Management of the Company has evaluated SAB 108 and believes its adoption will not materially impact the financial statements.

 

In September 2006, the FASB issued Statement of financial Accounting Standard 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States and expands disclosures about fair value measurements. SFAS 157 prioritizes the inputs to valuation techniques used to measure fair value into a hierarchy containing three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined on the lowest level input that is significant to the fair value measurement in its entirety. Assessing the

 

F - 49

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

2.

Summary of Significant Accounting Policies (Continued):

 

significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability. SFAS 157 is effective for interim and annual financial statements for years beginning after November 15, 2007. Upon initial adoption of SFAS 157, differences between the carrying value and the fair value of those instruments shall be recognized as a cumulative-effect adjustment to the opening balance of retained earnings for that year, and the effect of subsequent adjustments resulting from recurring fair measurements shall be recognized in earnings for the period. The Company has yet not adopted SFAS 157. As a result, the financial statements do not include any adjustments relating to any potential adjustments to the carrying value of assets and liabilities. Management of the Company has not completed its evaluation of SFAS 157.

 

In June 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize the impact of a tax position in the financial statements if that position is more likely than not to be reversed on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for years beginning after December 15, 2006, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings.  Management of the Company has evaluated SFAS 48 and believes its adoption will not materially impact the financial statements.

3.

Related-Party Transactions:

The Company’s sole shareholder has from time to time advanced funds to the Company for working capital purposes and has received funds as advances from the Company. Outstanding balances are due on demand. As of September 30, 2004, the balance of advances from the shareholder was approximately $76 and the amount due from the shareholder was $44 and $27 as of July 31, 2006 and September 30, 2005, respectively. Interest paid in relation to advances from the shareholder totaled $1, $5, $5 and $6 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively.

 

F - 50

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

4.

Accounts Receivable:

Accounts receivable consisted of the following as of July 31, 2006 and September 30, 2005 and 2004:

					September 30,
		July 31, 2006			2005			2004
Accounts receivable		$	409		$	195		$	116
Unbilled accounts receivable			—			15			22
Allowance for doubtful accounts			(43	)		(30	)		—
Accounts receivable, net		$	366		$	180		$	138

5.

Marketable Securities - Available for Sale:

Marketable securities consist of the following at July 31, 2006:

		Cost			Unrealized Gain			Unrealized (Loss)			Estimated Fair Value
Current:
Common stocks		$	300		$	14		$	—		$	314
Mutual funds			50			—			(1	)		49
Totals		$	350		$	14		$	(1	)	$	363

6.

Equipment and Improvements:

Equipment and improvements, net consisted of the following as of July 31, 2006 and September 30, 2005 and 2004:

 

					September 30,
		July 31, 2006			2005			2004
Computers, software and equipment		$	391		$	296		$	209
Furniture and fixtures			37			34			34
Leasehold improvements			20			20			20
			448			350			263
Less: Accumulated depreciation and  amortization			258			216			176
Equipment and improvements, net		$	190		$	134		$	87

 

7.

Long Term Receivable:

Commencing in the year ended September 30, 2005, the Company granted to a certain customer extended payment term which provided for monthly payments of interest and principal. Prior to August 11, 2006, the payments were $3 monthly plus interest at a rate of 7%. Effective August 11, 2006, the principal payments were increased to $5 per month and the interest rate remained at 7%. The balance of the outstanding principal and interest

 

F - 51

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

7.

Long Term Receivable (Continued):

becomes due and payable on August 31, 2010. The Company has determined that, in accordance with its revenue recognition policy, revenue for the arrangement should be deferred and is recognizing revenue as payments are received. During the ten months ended July 31, 2006 and the year ended September 30, 2005, the Company recognized revenue of $203 and $166, respectively, under this arrangement.

8.

Accrued Liabilities:

Accrued liabilities consisted of the following as of July 31, 2006 and September 30, 2005 and 2004:

 

					September 30,
		July 31, 2006			2005			2004
Deferred rent		$	22		$	44		$	48
Accrued payroll			66			37			7
Other accruals			5			—			—
Total accrued liabilities		$	93		$	81		$	55

 

9.

Commitments:

Revolving Line of Credit

On January 9, 2002, the Company entered into a revolving line of credit with a commercial lender, First Union National Bank and its successor, Wachovia National Bank (the “Facility”). The Facility provides borrowings of up to $250 and bears interest at the Wall Street Journal’s prime rate plus 5% (8.25% at July 31, 2006 and 6.75% at September 30, 2005). There was no balance outstanding under the Facility for any of the periods presented and the Company has never had any substantial borrowings under this arrangement. The Facility, which is guaranteed by the Company’s sole shareholder, is renewable annually.

Operating Leases

The Company leases office space under non-cancelable operating leases with various expirations through 2008. Future minimum lease payments under all operating leases at September 30, 2005 were as follows:

Year Ended September 30,:
2006		$	159
2007			164
2008			35

 

F - 52

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

9.

Commitments (Continued):

Rent expense under all operating leases was approximately $100, $123, $135 and $129 for the ten months ended July 31, 2006 and 2005 and the years ended September 30, 2005 and 2004, respectively.

10.

Shareholder’s Equity:

The Company has a stock option plan (the “Option Plan”) under which officers and key employees may be granted options to purchase shares of the Company’s authorized but unissued common stock. The maximum number of shares of the Company’s common stock available for issuance under the Option Plan is 400,000 shares. Under the Option Plan, the exercise price is equal to the estimated fair market value of the Company’s common stock at the date of grant as estimated by management. Options currently expire no later than 10 years from the grant date and generally vest within three months. Additional information with respect to the Option Plan’s stock option activity is as follows:

		Options			Weighted Average Exercise    Price
Options outstanding at September 30, 2003			52,500		$	1.00
Granted			—
Cancelled			(10,000	)		1.00
Exercised			—
Options outstanding at September 30, 2004			42,500			1.00
Granted			—
Cancelled			—
Exercised			—
Options outstanding at September 30, 2005			42,500			1.00
Granted			—
Cancelled			—
Exercised			—
Options outstanding at July 31, 2006			42,500			1.00

Summarized information about stock options outstanding at September 30, 2005 is as follows:

								Exercisable
Range of Exercise Prices		Number of Options Outstanding		Weighted Average Remaining Contractual Life		Weighted Average Exercise Price		Number of Options Outstanding		Weighted Average Remaining Contractual Life
$1.00		42,500		5.4		$1.00		42,500		5.4

 

F - 53

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

 

11.

Retirement Plan:

The Company has established a 401(k) employee savings and profit sharing plan (the “401(k) Plan”) for the benefit of employees. Under the 401(k) Plan, employees can contribute and defer taxes on a portion of their compensation. The Company has not made any contributions to the plan since its inception.

 

12.

Income Taxes:

Deferred tax assets or liabilities at the end of each period are determined using the currently enacted tax rates applied to taxable income in the period in which the deferred tax asset or liability is expected to be settled or realized. Realization of deferred tax assets is dependent on future earnings, if any, the timing and amount of which is uncertain. Accordingly, a valuation allowance in an amount equal to the net deferred tax asset as of September 30, 2004 has been established to reflect these uncertainties. As a result of improved operating results, a valuation allowance as of September 30, 2005 was not deemed necessary by the Company.

The components of net deferred tax assets at September 30, 2005 and 2004 are as follows:

		September 30,
		2005			2004
Deferred tax assets:
Deferred revenues		$	77		$	84
Accounts payable and accrued liabilities			40			32
Less: Deferred tax liabilities:
Accounts receivable, net			(69	)		(53	)
Tax over book depreciation			(19	)		(5	)
Valuation allowance			—			(58	)
Net deferred taxes		$	29		$	—
Current		$	48		$	—
Long-term		$	(19	)	$	—

The components of the provision for income taxes for the years ended September 30, 2005 and 2004 are as follows:

 

		For the Year Ended September 30,
		2005			2004
Federal and state taxes:
Current:
Federal		$	158		$	—
State			27			5
Deferred			(29	)		—
Provision for income taxes		$	156		$	5

 

F - 54

---

Objectware, Inc.

NOTES TO FINANCIAL STATEMENTS

(Information as of July 31, 2006 and for

the Ten Months Ended July 31, 2006 and 2005 is Unaudited)

(Dollars in thousands, except share and per share data)

12.

Income Taxes (Continued):

The provision for income taxes differs from the amount computed by applying the statutory federal income tax to income before provision for income taxes. The sources and tax effects of the differences are as follows:

		Fiscal Year Ended September 30,
		2005			2004
Income tax (benefit) provision at the
federal statutory rate of 34%		$	180		$	(32	)
State income expense,
net of federal benefit			21			5
Change in valuation allowance			(58	)		32
Other			13			—
		$	156		$	5

 

13.

Subsequent Event:

 

On December 7, 2006, the shareholder of the Company entered into a definitive agreement to sell the Company to Bridgeline Software, Inc. (“Bridgeline”). The sale is contingent on Bridgeline’s successful completion of an initial public offering (“IPO”) and the receipt of proceeds from the IPO of at least $10,000. The Company plans to complete the sale concurrent with, or shortly after Bridgeline’s IPO.

 

 

F - 55

---

 

New Tilt, Inc.

 

Report of Independent Certified Public Accountants		F-57
Balance Sheets as of April 24, 2006 and December 31, 2005		F-58
Statements of Operations for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005		F-59
Statements of Shareholders’ Equity for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005		F-60
Statements of Cash Flows for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005		F-61
Notes to Financial Statements		F-62

 

F - 56

---

Report of Independent Certified Public Accountants

To the Shareholders

Bridgeline Software, Inc.

We have audited the accompanying balance sheets of New Tilt, Inc. (the “Company”) as of April 24, 2006 and December 31, 2005, and the related statements of operations, shareholders’ equity, and cash flows for the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of New Tilt, Inc. as of April 24, 2006 and December 31, 2005, and the results of its operations and its cash flows for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.

/s/ UHY LLP

Boston, Massachusetts

December 11, 2006

F - 57

---

New Tilt, Inc.

BALANCE SHEETS

(Amounts in thousands, except share amounts)

 

ASSETS		April 24, 2006			December 31, 2005
Current assets:
Cash and cash equivalents		$	159		$	148
Accounts receivable			173			465
Prepaid expenses			8			13
Total current assets			340			626
Equipment and improvements, net			61			73
Other assets			11			15
Total assets		$	412		$	714
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Line of credit and other debt		$	—		$	54
Accounts payable			19			23
Deferred revenue			48			58
Accrued liabilities			31			77
Total current liabilities			98			212
Commitments (Note 9)			—			—
Shareholders’ equity:
Common stock — $0.001 par value; 2,000,000 shares authorized; 1,200,000 shares issued and outstanding			1			1
Additional paid-in capital			182			160
Retained earnings			131			341
Total shareholders’ equity			314			502
Total liabilities and shareholders’ equity		$	412		$	714

 

 

 

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

 

F - 58

---

New Tilt, Inc.

STATEMENTS OF OPERATIONS

(Amounts in thousands)

 

 

		Period from January 1, 2006 thru April 24, 2006			For the Year Ended December 31, 2005
Revenue		$	404		$	2,304
Cost of revenue			392			1,533
Gross profit			12			771
Operating expenses:
General and administrative expenses			199			593
Depreciation			12			42
Income (loss) from operations			(199	)		136
Other income (expenses):
Interest expense			(2	)		(2	)
Miscellaneous			10			4
Net income (loss)		$	(191	)	$	138

 

 

 

 

 

 

 

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

 

F - 59

---

New Tilt, Inc.

STATEMENTS OF SHAREHOLDERS’ EQUITY

(Amounts in thousands, except share amounts)

 

 

								Additional						Total
		Common Stock						Paid-in			Retained			Shareholders’
		Shares			Amount			Capital			Earnings			Equity
Balance, December 31, 2004			1,200,000		$	1		$	88		$	260		$	349
Distributions to shareholders			—			—			—			(57	)		(57	)
Stock based compensation expense			—			—			72			—			72
Net income			—			—			—			138			138
Balance, December 31, 2005			1,200,000			1			160			341			502
Distributions to shareholders			—			—			—			(19	)		(19	)
Stock based compensation expense			—			—			22			—			22
Net loss			—			—			—			(191	)		(191	)
Balance, April 24, 2006			1,200,000		$	1		$	182		$	131		$	314

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

F - 60

---

New Tilt, Inc.

STATEMENTS OF CASH FLOWS

(Amounts in thousands)

 

		Period from January 1, 2006 thru April 24, 2006			For the Year Ended December 31, 2005
Cash flows from operating activities:
Net income (loss)		$	(191	)	$	138
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation			12			42
Stock based compensation expense			22			72
Gain on sale of assets			(9	)		—
Changes in operating assets and liabilities:
Accounts receivable			292			(51	)
Prepaid expenses			5			3
Other assets			4			4
Accounts payable			(4	)		(35	)
Deferred revenue			(10	)		(38	)
Accrued liabilities			(46	)		(7	)
Total adjustments			266			(10	)
Net cash provided by operating activities			75			128
Cash flows from investing activities:
Proceeds from sale of property			3			—
Equipment and improvements expenditures			(3	)		(60	)
Net cash provided by (used in) investing activities			—			(60	)
Cash flows from financing activities:
Proceeds from issuance of long term debt			—			50
Payments on debt			(54	)		(5	)
Cash distributions to shareholders			(10	)		(57	)
Net cash used in financing activities			(64	)		(12	)
Net increase in cash and cash equivalents			11			56
Cash and cash equivalents at beginning of period			148			92
Cash and cash equivalents at end of period		$	159		$	148
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	2		$	2
Additional distribution to shareholders (see Note 3)		$	9		$	—

 

 

 

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

 

F - 61

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

1.     Business Description:

New Tilt, Inc. (the “Company”), a Massachusetts Subchapter S corporation, is an internet strategy firm that architects, designs and delivers an internet based business platform for competitive advantage. The Company is headquartered in Cambridge, Massachusetts. The Company’s customers are primarily located in the Northeastern United States. The Company was acquired by Bridgeline Software, Inc. (“Bridgeline”) on April 24, 2006 (See Note 12).

The results of operations for the period January 1, 2006 thru April 24, 2006 are not necessarily indicative of the results to be expected for a full year.

 

2.     Summary of Significant Accounting Policies:

 

Revenue Recognition

 

Substantially all of the Company’s revenue is generated from Web services. The Company recognizes revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the services have been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of the fees is probable. The Company recognizes revenue using the proportional performance model. Certain arrangements include a warranty period of between 30 to 60 days from the completion of work. To date, few warranty claims have been received. Billings made or payments received in advance of providing services are deferred until the period these services are provided.

Web Services include consulting services that are related to specific customer needs such as information architecture and usability engineering, interface configuration, Web application development and database and content management.

 

Concentration of Credit Risk and Significant Customers

 

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents to the extent these exceed federal insurance limits, short-term investments and accounts receivable. Risks associated with cash and cash equivalents are mitigated by investing in money market funds with high credit quality financial institutions. In general, the Company does not require collateral on its arrangements with customers and typically provides for credit terms of 30-60 days. The Company has not provided an allowance for doubtful accounts since its customers have a good credit rating and the Company has experienced minimal write-offs of its receivables in the past and continues to believe that its customers pose no significant risk of non-payment.

 

F - 62

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

 

2.     Summary of Significant Accounting Policies -- (Continued):

 

The Company’s customers who comprised at least 10% of the Company’s revenue for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005 or who comprised of at least 10% of the Company’s accounts receivable at April 24, 2006 or December 31, 2005 are as follows:

 

		Revenue				Accounts Receivable
		For the Period January 1, 2006 thru April 24, 2006		For the Year Ended December 31, 2005		April 24, 2006		December 31, 2005
Company A		21%		27%		13%		35%
Company B		7		*		19		*
Company C		5		*		11		*
Company D		5		*		10		*
Company E		*		12		*		8

 

* Less than 10%

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. The most significant estimates included in these financial statements are related to revenue recognition.

 

The complexity of the estimation process and factors relating to the assumptions, risks and uncertainties inherent with the use of the proportional performance model affect the amounts of revenue and related expenses reported in our consolidated financial statements. A number of internal and external factors can affect these estimates, including efficiency variances and specification and testing requirement changes.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments with original maturity from the date of purchase of three months or less to be cash equivalents. Cash equivalents consist primarily of money market mutual funds.

 

Fair Value of Financial Instruments

 

The carrying amounts of financial instruments, which include cash and cash equivalents, accounts receivable and accounts payable, approximate their fair value because of the short-term maturity of these instruments. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of debt approximate its fair value.

 

F - 63

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

 

2.     Summary of Significant Accounting Policies -- (Continued):

 

Equipment and Improvements

 

The components of equipment and improvements are stated at cost. The Company provides for depreciation by use of the straight-line method over the estimated useful lives of the related assets (three to five years). Leasehold improvements are amortized by use of the straight-line method over the lesser of the estimated useful life of the asset or the lease term. Repairs and maintenance costs are expensed as incurred.

 

Advertising Costs

 

The Company expenses advertising costs when incurred. Advertising expense totaled $2 and $28 for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005, respectively.

Income Taxes

The Company, with the consent of its shareholders, has elected under Subchapter “S” of the Internal Revenue Code, to be treated substantially as a partnership for income tax purposes. As a result, the shareholders will report the entire corporate taxable income or loss on their individual tax returns.

 

Stock-Based Compensation

 

The Company has adopted a long-term incentive plan which is used to attract and retain employees, advisors, and consultants, as applicable, subject to certain limitations. The exercise price of any award shall not be less than the fair market value of the common stock on the date of the grant. The Company’s board of directors administers the incentive plan, with sole authority to select participants, determine the types of awards to be granted, and all of the terms and conditions of the awards, including whether the grant, vesting or settlement of awards may be subject to the attainment of one or more performance goals. No awards will be granted under the plan if the grant, vesting and/or exercise of the awards would jeopardize the Company’s status as an S-Corp under the Internal Revenue Code or otherwise violates the ownership and transfer restrictions imposed under the Company’s charter. Unless determined by the Company’s board of directors, no award granted under the long-term incentive plan will be transferable except through the laws of descent and distribution.

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), the Company estimated the fair value of each stock option granted in 2005 and 2006 as of the date of the grant using the Black-Scholes-Merton model with the following assumptions:

 

F - 64

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

 

2.     Summary of Significant Accounting Policies -- (Continued):

 

		Options granted during the period January 1, 2006 thru April 24, 2006		Options granted Year 2005
Risk-free rate		4.58% - 4.92%		3.99% - 4.38%
Projected future dividend yield		0.00%		0.00%
Expected life of the options		6.5 years		6.5 years
Volatility		70%		70%

 

As none of the options described above have been exercised, the Company does not have relevant historical data on which to base an estimate of the expected life of the options. The expected life of such options has been estimated to equal the average of the contractual term and the vesting term. As the Company’s common stock is not publicly traded, the Company does not have relevant historical data on which to base an estimate of volatility in the value of such options. The volatility of such options has been estimated to equal the average fluctuations in historical stock prices of publicly traded companies that are otherwise similar to the Company. The Company has also historically experienced a forfeiture rate of approximately 5%. Based on the above assumptions, the fair value of the options granted during the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005 equals approximately $45 and $41, respectively and will be amortized to compensation expense over the vesting period. The Company has expensed $22 and $72 for the period January 1, 2006 thru April 24, 2006 and the year ended September 30, 2005, respectively. As of April 24, 2006 the Company has $43 remaining to be amortized.

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment (“SFAS 123R”). SFAS 123(R) requires the recognition of the fair value of stock-based compensation in net income. SFAS 123(R) supersedes SFAS 123, and Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). The Company adopted SFAS 123(R), but since the Company had previously adopted SFAS 123, the adoption had no significant effect on the Company’s financial position, results of operations or cash flows.

 

3.     Related-Party Transactions:

On April 24, 2006, the Company sold an automobile to a shareholder of the Company for $3 which approximated its net book value. The difference between the net book value and the fair market value of $12 has been recorded as an additional distribution to shareholders.

 

4.     Accounts Receivable:

Included in the Company’s accounts receivable balance at April 24, 2006 and December 31, 2005 is $22 and $8 of unbilled receivables, respectively.

F - 65

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

 

 

5.     Equipment and Improvements:

Equipment and improvements, net consisted of the following as of April 24, 2006 and December 31, 2005:

 

		April 24, 2006			December 31, 2005
Computers, software and equipment		$	95		$	102
Furniture and fixtures			36			36
Leasehold improvements			9			9
Vehicle			—			24
			140			171
Less accumulated depreciation			79			98
Equipment and improvements, net		$	61		$	73

 

During the period January 1, 2006 thru April 24, 2006, the Company retired fully depreciated assets whose original cost was $10 and sold a vehicle to a shareholder (See Note 3).

 

6.     Other Assets:

Other assets consisted of the following as of April 24, 2006 and December 31, 2005:

		April 24, 2006			December 31, 2005
Deferred charges		$	—		$	1
Security deposits			11			14
Total		$	11		$	15

 

 

7.     Accrued Liabilities:

Accrued liabilities consisted of the following as of April 24, 2006 and December 31, 2005:

 

		April 24, 2006			December 31, 2005
Compensation and benefits		$	—		$	58
Miscellaneous			31			19
Total		$	31		$	77

8.     Debt:

On November 27, 2001, the Company entered into a revolving line of credit with a commercial lender (the “Facility”). The Facility provides borrowings of up to $150 and bears interest at the Wall Street Journal’s prime rate plus 1 percent (8.75% at April 24, 2006). On February 6, 2006, the Company changed its agreement to provide borrowings of up to $250 with interest at a variable rate equal to the highest prime rate published in the Wall Street Journal. The weighted average debt during the period January 1, 2006 thru April 24,

 

F - 66

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

 

8.     Debt (Continued):

2006 and for the year ended December 31, 2005 was $50 and $28, respectively, resulting in weighted average interest rates of 9.9% and 7.3%, respectively. Upon the sale of the Company on April 24, 2006 (See Note 12), the line of credit was closed.

On October 15, 2003, the Company entered into an automobile loan of $14 repayable over a period of 36 months with an interest rate of 3.4%. This loan was repaid upon the sale of the automobile (See Note 3).

 

9.     Commitments:

Operating Leases

The Company leases office space under a non-cancelable operating lease expiring on March 5, 2009. Future minimum lease payments under this lease are as follows:

April 25, 2006 to December 31, 2006		$	63
Year Ended December 31, 2007			98
Year Ended December 31, 2008			107
Year Ended December 31, 2009			18

 

Rent expense under all operating leases was approximately $23 and $50 for the period January 1, 2006 through April 24, 2006 and the year ended December 31, 2005, respectively.

 

10.   Stock Options:

As of October 1, 2000, the Company had established an option plan approved by the Board of Directors, the 2000 Equity Incentive Plan of NewTilt, Inc. (the “Plan”). The exercise price for these options is equal to the estimated fair market value of the Company’s common stock at the date of grant, based on management’s assessment. Options expire no later than ten years from the grant date and generally vest as follows: 50% upon the first anniversary of date of grant, an additional 25% on the eighteen-month anniversary and the remaining 25% on the second anniversary of the date of grant. A summary of option activity is as follows:

 

F - 67

---

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)

 

 

10.   Stock Options (continued):

		Options			Weighted Average Exercise Price
Options outstanding at January 1, 2005			212,000		$	1.15
Granted			145,000			2.00
Canceled			(130,000	)		0.80
Exercised			—
Options outstanding at December 31, 2005			227,000			1.89
Granted			70,000			1.50
Canceled			(56,000	)		1.58
Exercised			—
Options outstanding at April 24, 2006			241,000			1.85

 

Summarized information about stock options outstanding at April 24, 2006 is as follows:

 

											Exercisable
Range of Exercise Prices		Number of Options Outstanding			Weighted Average Remaining Contractual Life			Weighted Average Exercise Price			Number of Options Outstanding			Weighted Average Remaining Contractual Life
$0.50			1,000			4.67		$	0.50			1,000			4.67
1.50			70,000			9.92			1.50			30,000			10.00
2.00			170,000			9.33			2.00			149,000			9.42
			241,000			9.50			1.91			180,000			9.50

 

At April 24, 2006, options to purchase 180,000 shares at a weighted average exercise price of $1.91 of common stock were exercisable with the remaining options becoming exercisable at various dates through March 13, 2008 and having expiration dates through April 21, 2016. Upon the sale of the Company on April 25, 2006 (See Note 13), the outstanding 241,000 NewTilt options were converted to Bridgeline options at a conversion rate of 1:4.28 with no change to the original vesting schedule.

11.  Retirement Plan:

The Company has established a 401(k) plan for the benefit of employees effective January 1, 2004. This plan allows for employees to contribute up to 100% of their pay up to the IRS maximum allowable contribution per year. The Company has not made any contributions to the plan since its inception.

F - 68

---

 

New Tilt, Inc.

Notes to Financial Statements

For the period January 1, 2006 thru April 24, 2006 and for the year ended December 31, 2005

(Amounts in thousands, except share and per share amounts)
 

12.   Subsequent Event:

On April 25, 2006, all of the net assets of the Company were acquired by Bridgeline Software, Inc. (“Bridgeline”), a developer of Web applications and software tools headquartered in Woburn, Massachusetts. Purchase consideration was paid in the form of $550 cash, contingent cash consideration of up to $750 to be paid quarterly over the next three years, and 320,000 shares of Bridgeline common stock.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F - 69

---

 

Until                     , 2007 (25 days after the date of this prospectus), all dealers effecting transactions in the shares offered by this prospectus whether or not participating in the offering may be required to deliver a copy of this prospectus. Dealers may also be required to deliver a copy of this prospectus when acting as underwriters and for their unsold allotments or subscriptions.
TABLE OF CONTENTS   Prospectus Summary The Offering Summary Financial Data Risk Factors Cautionary Note Regarding Forward Looking Statements Determination of Offering Price Use of Proceeds Dividend Policy Capitalization Unaudited Condensed Pro Forma Financial Data Dilution Selected Financial Data Management’s Discussion and Analysis Business Management Executive Compensation Certain Relationships and Related Transactions Security Ownership of Certain Beneficial Owners and Management Description of Capital Stock Shares Eligible for Future Sale Underwriting Legal Matters Experts Additional Information Index to Financial Statements	2 5 6 9   17 17 18 18 19 20 22 24 26 38 56 62   65   67 69 73 75 77 77 77 F-1		Bridgeline Software, Inc. 3,000,000 Shares   _____________ Prospectus _____________
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. If anyone provides you with different information, you should not rely on it. We are not making an offer to sell these shares in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate only as of the date on the front cover of the prospectus. Our business, financial condition, results of operations and prospects may have changes since that date.			Joseph Gunnar & Co., LLC                     , 2006

 

 

---

[Alternate Front Cover Page for Selling Shareholder Prospectus]

 

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. The prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED DECEMBER 13, 2006

PROSPECTUS

Bridgeline Software, Inc.

Common Stock

 

This prospectus covers the selling stockholders’ resale of (1) up to 392,000 shares of common stock they now own or have the right to acquire upon exercise of outstanding warrants and (2) up to 300,000 shares of common stock underlying warrants granted to the lead underwriter in our initial public offering. We will not receive any proceeds from the resale of the common stock by the selling stockholders, but we will receive the proceeds of their warrant exercises. The proceeds to the selling stockholders of their resale of the common stock will depend on the market price at the time of sale.

Prior to our initial public offering, there has been no public market for our common stock. We have applied for quotation of our common stock on the Nasdaq Capital Market and the Boston Stock Exchange under the symbols “BLSW” and “BLS”, respectively.

Investing in our common stock involves risks. See “Risk Factors” beginning on page ___ for a discussion of certain factors that should be considered by prospective purchasers of our shares.

These securities have not been approved or disapproved by the Securities and Exchange Commission or any state securities commission, nor has the Securities and Exchange Commission or any state securities commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

Public offering Price	The shares will sell at prevailing market prices or privately negotiated prices if and when the shares are listed on the Nasdaq Capital Market or the Boston Stock Exchange.
Commission	Customary for the type of transaction involved.
Proceeds to Selling Stockholders	Market price, from time to time, a price related to the market price or negotiated price, net of customary commission for execution of the type of transaction.

Public offering Price The shares will sell at prevailing market prices or privately negotiated prices if and when the shares are listed on the Nasdaq Capital Market or the Boston Stock Exchange.

Commission Customary for the type of transaction involved.

Proceeds to Selling Stockholders Market price, from time to time, a price related to the market price or negotiated price, net of customary commission for execution of the type of transaction.

The date of this prospectus is                     , 2007.

 

---

 

Alt - 1

---

[Alternate Page for Selling Shareholder Prospectus (to replace the “Offering” section)]

THE OFFERING

 

 

Common Stock Presently Outstanding:	7,273,833 shares
Common Stock Issuable upon Exercise of Selling Stockholder Warrants:	692,000 shares
Common Stock to be Outstanding Immediately after Selling Stockholder Offering:	7,965,833 shares

________________

 

The number of shares of common stock presently outstanding is based on 7,273,833 shares outstanding immediately following the initial public offering and does not include:

·	345,000 shares issuable if the over-allotment option is exercised in full by the underwriters;

·	490,909 shares issuable upon the release of the closing escrow related to the acquisition of Objectware;

·	932,911 shares issuable upon the exercise of outstanding options at a weighted average exercise price of $2.96 per share;

·	578,269 shares issuable upon the exercise of outstanding warrants; and

·	300,000 shares issuable upon the exercise of the underwriter’s warrants issued in connection with the initial public offering.

 

Common Stock
Offered:	All of the 692,000 shares offered by this prospectus are being sold by the selling stockholders who hold or have the right to acquire shares of common stock upon exercise of outstanding warrants.
Use of Proceeds:	We will not receive any proceeds from the resale of the common stock by the selling stockholders, but we will receive the proceeds of their warrant exercises. The proceeds to the selling stockholders of their resale of the common stock will depend on the market price at the time of sale.
Risk Factors:	You should consider carefully all of the information set forth in this prospectus, and, in particular, the specific factors set forth under “Risk Factors” beginning at page 9, before deciding whether or not to invest in our shares.
Trading Symbols:	We have applied for listing of our common stock on the Nasdaq Capital Market and the Boston Stock Exchange under the symbols “BLSW” and “BLS,” respectively.

Unless otherwise indicated, all information in this prospectus assumes no exercise of the over-allotment option granted to the underwriters.

_______________________

“Bridgeline,” “Bridgeline Software,” “iapps,” “netEDITOR,” “netEDITOR-pro” and “Orgitecture” are our trademarks and service marks. We have registered the trademarks “Bridgeline,” “iapps” and “netEDITOR” with the United States Patent and Trademark Office, and have filed applications to register “netEDITOR-pro” and “Orgitecture,” and claim common law rights in such marks. This prospectus refers to the trade names, service marks and trademarks of other companies. These references are made with due recognition of the rights of these companies and without any intent to misappropriate these names or marks.

Alt - 2

---

[Alternate Page for Selling Shareholder Prospectus (to replace the “Underwriting” section)]

SELLING STOCKHOLDERS

The following is a list of the selling stockholders who own or who have the right to acquire the 692,000 shares of common stock covered by this prospectus. As set forth below and elsewhere in this prospectus, some of these selling stockholders hold or within the past three years have held, a position, office or other material relationship with us.

The following table sets forth information concerning the selling stockholders, including:

·	the number of shares currently held;

·	the number of shares issuable upon exercise of warrants; and

·	the number of shares offered by each selling shareholder.

We have no knowledge of the intentions of any selling shareholder to actually sell any of the securities listed under the columns “Shares Being Offered.”

 

 

 

 

 

 

Alt - 3

---

		Shares Owned at Closing of Initial Public Offering (1)						Shares Being Offered			Shares Owned after Resale of Warrant Shares (2)
Name		Number			Percentage			Number			Number			Percentage
Neil T. Anderson			30,000			*			30,000			0			*
Paul Auersperg			5,000			*			5,000			0			*
Christopher P. Baker			36,667			*			10,000			26,667			*
Balfour Associates, L.P.			20,000			*			20,000			0			*
Burg Family Trust			5,000			*			5,000			0			*
Brian Callahan			10,000			*			10,000			0			*
William B. Coldrick (3)			57,223			0.8%			10,000			47,223			0.6%
Edward C. Davenport			5,000			*			5,000			0			*
James R. Davis			25,000			*			25,000			0			*
Thomas B. Dupree, Jr.			10,000			*			10,000			0			*
Fortune Footwear, Inc.			5,000			*			5,000			0			*
Albert Freed			5,000			*			5,000			0			*
Ronald Heffernan			65,231			*			10,000			55,231			*
Herbert Wrabel Living Trust			5,000			*			5,000			0			*
High Capital Funding, LLC			10,000			*			10,000			0			*
Charles Jia			5,000			*			5,000			0			*
Mitchell and Allison Kersch			5,000			*			5,000			0			*
Elia Kotler			5,000			*			5,000			0			*
John Landy			30,000			*			30,000			0			*
Scott J. and Suzanne Lefebvre			5,000			*			5,000			0			*
Larry Lowrance			10,000			*			10,000			0			*
Thomas L. and Theresa M. Massie (4)			916,667			12.5%			10,000			906,667			11.3%
Robert S. McCoy			5,000			*			5,000			0			*
Robert McLemore			41,667			*			5,000			36,667			*
Ian D. Mead			10,000			*			10,000			0			*
John and Betty Panagolpolous			10,000			*			10,000			0			*
George Rizos			5,000			*			5,000			0			*
Robert and Kara Seeger (5)			220,188			3.0%			5,000			215,188			2.7%
John L. Troutman			5,000			*			5,000			0			*
Joseph A. Alagna			37,216			*			37,216			0			*
Joseph Duarte			16,363			*			16,363			0			*
Michael Mondiello			1,300			*			1,300			0			*
Bradford Pine			1,750			*			1,750			0			*
Anthony Sica			4,406			*			4,406			0			*
Stephan A. Stein			34,015			*			34,015			0			*
Abner Zalaznick			2,000			*			2,000			0			*
Nicholas Lobasso			3,000			*			3,000			0			*
Gary Saccaro			3,000			*			3,000			0			*
Joseph Gunnar & Co., LLC			308,950			4.1%			308,950			0			*

 

* Less than 1%.

(1)	Based on 7,273,833 shares outstanding immediately following the initial public offering, plus, for each person, such number of shares of common stock that the selling stockholder has the right to acquire beneficial ownership of within 60 days after October 31, 2006.

(2)	This table assumes that each selling stockholder will sell all shares offered for sale by it under this registration statement. Stockholders are not required to sell their shares.

(3)	Mr. Coldrick is a Director of the company. Includes 5,556 shares subject to options that are exercisable within

Alt - 4

---

60 days of October 31, 2006.

(4)	Mr. Massie is President, Chief Executive Officer and a Director of the company. Includes 40,000 shares subject to options that are exercisable within 60 days of October 31, 2006.

(5)	Mr. Seeger is Senior Vice President of Business Development of the company. Includes 68,164 shares subject to options that are exercisable within 60 days of October 31, 2006.

 

PLAN OF DISTRIBUTION

We are registering the shares of common stock on behalf of the selling stockholders. As used in this prospectus, “selling stockholders” includes the pledges, donees, transferees or others who may later hold the selling stockholders’ interests. We have agreed to pay the costs and fees of registering the shares, but the selling stockholders will pay any brokerage commissions, discounts or other expenses relating to the sale of the shares, including attorneys’ fees.

The stockholders and any of their pledgees, assignees and successors-in-interest may, from time to time, sell any or all of their shares of common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The stockholders may use any one or more of the following methods when selling shares:

·	ordinary brokerage transactions and transactions in which the broker dealer solicits purchasers;

·	block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction;

·	purchases by a broker-dealer as principal and resale by the broker dealer for its account;

·	an exchange distribution in accordance with the rules of the applicable exchange;

·	privately negotiated transactions;

·	settlement of short sales;

·	broker-dealers may agree with the stockholders to sell a specified number of such shares at a stipulated price per share;

·	a combination of any such methods of sale; and

·	any other method permitted pursuant to applicable law.

The stockholders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus.

Broker-dealers engaged by the stockholders may arrange for other brokers dealers to participate in sales. Broker-dealers may receive commissions or discounts from the stockholders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The stockholders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved.

The stockholders may from time to time pledge or grant a security interest in some or all of the shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock from time to time under this prospectus, or under an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act of 1933, as amended, amending the list of stockholders to include the pledgee, transferee or other successors in interest as stockholders under this prospectus.

The stockholders and any broker-dealers or agents that are involved in selling the shares may be deemed to be “underwriters” within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act.

The selling stockholders have advised us that they have not entered into any agreements, understandings or arrangements with any underwriters or broker-dealers regarding the sale of their securities. Under the rules and regulations of the NASD, any such broker-dealer may not receive discounts, concessions or commissions in excess

Alt - 5

---

 

of 8% in connection with the sale of any securities being registered hereunder.

We are required to pay all fees and expenses incident to the registration of the shares. We have agreed to indemnify the stockholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act. The selling stockholders will be subject to the prospectus delivery requirements of the Securities Act. We have informed the selling stockholders that the anti-manipulative provisions of Regulation M promulgated under the Securities Exchange Act of 1934 may apply to their sales in the market.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Alt - 6

---

[Alternate Back Cover Page for Selling Shareholder Prospectus]

 

---

---

 

Until                     , 2007 (25 days after the date of this prospectus), all dealers effecting transactions in the shares offered by this prospectus whether or not participating in the offering may be required to deliver a copy of this prospectus. Dealers may also be required to deliver a copy of this prospectus when acting as underwriters and for their unsold allotments or subscriptions.

 

TABLE OF CONTENTS

Prospectus Summary
The Offering
Summary Financial Data
Risk Factors
Cautionary Note Regarding Forward Looking Statements
Determination of Offering Price
Use of Proceeds
Dividend Policy
Capitalization
Unaudited Condensed Pro Forma Financial Data
Dilution
Selected Financial Data
Management’s Discussion and Analysis Business
Business
Management
Executive Compensation
Certain Relationships and Related Transactions
Security Ownership of Certain Beneficial Owners and Management
Description of Capital Stock
Shares Eligible for Future Sale
Selling Stockholders
Plan of Distribution
Legal Matters
Experts
Index to Financial Statements

 

 

 

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. If anyone provides you with different information, you should not rely on it. We are not making an offer to sell these shares in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate only as of the date on the front cover of the prospectus. Our business, financial condition, results of operations and prospects may have changes since that date.

 

 

 

692,000 Shares

 

 

Bridgeline Software, Inc.

 

 

 

 

---

---

Alt - 7

---

PART II

Information Not Required In Prospectus

Item 24.  Indemnification of Directors and Officers

 

Section 102 of the General Corporation Law of the State of Delaware permits a corporation to eliminate the personal liability of directors of a corporation to the corporation or its shareholders for monetary damages for a breach of fiduciary duty as a director, except for breaches of the director’s duty of loyalty to the corporation or its shareholders, acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of a law, authorizations of the payments of a dividend or approval of a stock repurchase or redemption in violation of Delaware corporate law or for any transactions from which the director derived an improper personal benefit. Our Amended and Restated Certificate of Incorporation provides that no director will be liable to us or our shareholders for monetary damages for breach of fiduciary duties as a director, subject to the same exceptions as described above.

Section 145 of the General Corporation Law of the State of Delaware provides that a corporation has the power to indemnify a director, officer, employee, or agent of the corporation and certain other persons serving at the request of the corporation in related capacities against expenses (including attorneys’ fees), judgments, fines, and amounts paid in settlements actually and reasonably incurred by the person in connection with a threatened, pending, or completed action, suit or proceeding to which he or she is or is threatened to be made a party by reason of such position, if such person acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation, and, in any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful, except that, in the case of actions brought by or in the right of the corporation, indemnification is limited to expenses (including attorneys’ fees) actually and reasonably incurred by the person in connection with defense or settlement of such action or suit and no indemnification shall be made with respect to any claim, issue, or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or other adjudicating court determines that, despite the adjudication of liability but in view of all of the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. In addition, to the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit, or proceeding described above (or claim, issue, or matter therein), such person shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection therewith. Expenses (including attorneys’ fees) incurred by an officer or director in defending any civil, criminal, administrative, or investigative action, suit, or proceeding may be advanced by the corporation upon receipt of an undertaking by such person to repay such amount if it is ultimately determined that such indemnification is not required under Section 145 of the General Corporation Law of the State of Delaware.