Edgar Filing: Bridgeline Digital, Inc.

blin20140331_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

☒ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014

☐ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission File Number 333-139298

Bridgeline Digital, Inc.

(Exact name of registrant as specified in its charter)

Delaware	52-2263942
State or other jurisdiction of incorporation or organization	IRS Employer Identification No.

80 Blanchard Road
Burlington, Massachusetts	01803
(Address of Principal Executive Offices)	(Zip Code)

(781) 376-5555

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) ☒ Yes ☐ No

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

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

(Do not check if a smaller reporting company)

Smaller reporting company ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No ☒

The number of shares of Common Stock par value $0.001 per share, outstanding as of May 12, 2014 was 21,829,176.

Bridgeline Digital, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period ended March, 2014

Index

		Page
Part I	Financial Information

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2014 (unaudited) and September 30, 2013	4

	Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended March 31, 2014 and 2013	5

	Condensed Consolidated Statements of Comprehensive Loss (unaudited) for the three and six months endedMarch 31, 2014 and 2013	6

	Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended March 31, 2014 and 2013	7

	Notes to Interim Condensed Consolidated Financial Statements (unaudited)	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Qualitative and Quantitative Disclosures About Market Risk	31

Item 4.	Controls and Procedures	32

Part II	Other Information

Item 1.	Legal Proceedings	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 6.	Exhibits	34


Signatures		35

Bridgeline Digital, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period ended March 31, 2014

Statements contained in this Report on Form 10-Q that are not based on historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of forward-looking terminology such as “should,” “could,” “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intends,” “continue,” or similar terms or variations of those terms or the negative of those terms. These statements appear in a number of places in this Form 10-Q and include statements regarding the intent, belief or current expectations of Bridgeline Digital, Inc. Forward-looking statements are merely our current predictions of future events. Investors are cautioned that any such forward-looking statements are inherently uncertain, are not guaranties of future performance and involve risks and uncertainties. Actual results may differ materially from our predictions. Important factors that could cause actual results to differ from our predictions include the impact of the weakness in the U.S. and international economies on our business, our inability to manage our future growth effectively or profitably, fluctuations in our revenue and quarterly results, our license renewal rate, the impact of competition and our ability to maintain margins or market share, the limited market for our common stock, the volatility of the market price of our common stock, the performance of our products, our ability to respond to rapidly evolving technology and customer requirements, our ability to protect our proprietary technology, the security of our software, our dependence on our management team and key personnel, our ability to hire and retain future key personnel, or our ability to maintain an effective system of internal controls. Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized, nor is there any assurance that we have identified all possible issues which we might face. We assume no obligation to update our forward-looking statements to reflect new information or developments. We urge readers to review carefully the risk factors described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 as well as in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov.

Where we say “we,” “us,” “our,” “Company” or “Bridgeline Digital” we mean Bridgeline Digital, Inc.

PART I—FINANCIAL INFORMATION

Item 1.

Financial Statements.

BRIDGELINE DIGITAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

(unaudited)

ASSETS	March 31,			September 30,
	2014			2013
Current assets:
Cash and cash equivalents	$	3,455		$	2,830
Accounts receivable and unbilled receivables, net		3,438			3,194
Prepaid expenses and other current assets		846			963
Total current assets		7,739			6,987
Equipment and improvements, net		2,752			3,065
Intangible assets, net		1,887			1,517
Goodwill		23,141			23,777
Other assets		1,526			1,631
Total assets	$	37,045		$	36,977

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	1,500		$	1,746
Accrued liabilities		1,086			1,093
Accrued earnouts, current		668			561
Debt, current		12			1,165
Capital lease obligations, current		376			397
Deferred revenue		2,386			1,960
Total current liabilities		6,028			6,922

Accrued earnouts, net of current portion		554			950
Debt, net of current portion		6,194			4,725
Capital lease obligations, net of current portion		436			544
Other long term liabilities		1,092			1,088
Total liabilities	$	14,304		$	14,229

Commitments and contingencies

Stockholders’ equity:
Preferred stock - $0.001 par value; 1,000,000 shares authorized; none issued and outstanding		-			-
Common stock -$0.001 par value; 30,000,000 shares authorized;21,825,510 at March 31, 2014 and 18,313,765 at September 30, 2013 shares issued and outstanding		22			18
Additional paid-in capital		47,411			44,206
Accumulated deficit		(24,405	)		(21,314	)
Accumulated other comprehensive loss		(287	)		(162	)
Total stockholders’ equity		22,741			22,748
Total liabilities and stockholders’ equity	$	37,045		$	36,977

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

BRIDGELINE DIGITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

(Unaudited)

	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Revenue:
Digital engagement services	$	3,610		$	4,489		$	8,159		$	9,339
Subscription and perpetual licenses		1,307			1,024			2,884			1,811
Managed service hosting		385			491			772			1,047
Total revenue		5,302			6,004			11,815			12,197
Cost of revenue:
Digital engagement services		2,669			2,494			5,172			5,248
Subscription and perpetual licenses		452			247			849			415
Managed service hosting		68			76			152			148
Total cost of revenue		3,189			2,817			6,173			5,811
Gross profit		2,113			3,187			5,642			6,386
Operating expenses:
Sales and marketing		1,928			2,164			4,038			3,998
General and administrative		1,167			946			2,198			2,300
Research and development		579			247			1,102			379
Depreciation and amortization		551			390			1,005			814
Total operating expenses		4,225			3,747			8,343			7,491
Loss from operations		(2,112	)		(560	)		(2,701	)		(1,105	)
Interest expense, net		(167	)		(59	)		(334	)		(135	)
Loss before income taxes		(2,279	)		(619	)		(3,035	)		(1,240	)
Provision for income taxes		35			68			56			89
Net loss	$	(2,314	)	$	(687	)	$	(3,091	)	$	(1,329	)

Net loss per share:
Basic and diluted	$	(0.13	)	$	(0.05	)	$	(0.17	)	$	(0.09	)
Number of weighted average shares outstanding:
Basic and diluted		17,794,609			14,878,361			17,894,425			14,830,488

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

BRIDGELINE DIGITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Dollars in thousands)

(Unaudited)

	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Net Loss	$	(2,314	)	$	(687	)	$	(3,091	)	$	(1,329	)

Other comprehensive gain (loss): Net change in foreign currency translation adjustment		(93	)		12			(125	)		51
Comprehensive loss	$	(2,407	)	$	(675	)	$	(3,216	)	$	(1,278	)

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

BRIDGELINE DIGITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

	Six Months Ended
	March 31,
	2014			2013
Cash flows from operating activities:
Net loss	$	(3,091	)	$	(1,329	)
Adjustments to reconcile net loss to net cash (used in)/provided by operating activities:
Amortization of intangible assets		341			274
Depreciation		647			540
Other amortization		272			79
Stock-based compensation		167			279
Contingent earnout liability adjustment		-			(312	)
Changes in operating assets and liabilities:
Accounts receivable and unbilled receivables		(251	)		199
Prepaid expenses and other assets		446			(116	)
Accounts payable and accrued liabilities		(621	)		(410	)
Deferred revenue		426			1,828
Other liabilities		5			(52	)
Total adjustments		1,432			2,309
Net cash (used in)/provided by operating activities		(1,659	)		980
Cash flows from investing activities:
Equipment and improvements		(224	)		(239	)
Software development capitalization costs/other intangibles		(106	)		(670	)
Contingent acquisition payments		(284	)		(237	)
Net cash used in investing activities		(614	)		(1,146	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs		2,753			-
Proceeds from issuance of convertible debt, net of issuance costs		913			-
Proceeds from exercise of employee stock options		185			67
Proceeds from employee stock purchase plan		13			46
Borrowings from bank line of credit		746			725
Payments on bank line of credit		(1,026	)		(610	)
Payments on bank term loan		(273	)		(183	)
Payments on subordinated promissory notes		(71	)		(112	)
Principal payments on capital leases		(217	)		(145	)
Net cash provided by/(used in) financing activities		3,023			(212	)
Effect of exchange rate changes on cash and cash equivalents		(125	)		51
Net increase/(decrease) in cash and cash equivalents		625			(327	)
Cash and cash equivalents at beginning of period		2,830			2,126
Cash and cash equivalents at end of period	$	3,455		$	1,799
Supplemental disclosures of cash flow information:
Cash paid for:
Interest	$	104		$	135
Income taxes	$	44		$	13
Non cash activities:
Equipment purchased under capital leases	$	89		$	123
Equipment and other assets included in accounts payable	$	22		$	-
Accrued contingent consideration (earnouts)	$	-		$	83

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

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

1. Description of Business

Overview

Bridgeline Digital, The Digital Engagement Company™, enables its customers to maximize the performance of their mission critical websites, intranets, and online stores. Bridgeline’s iAPPS® platform deeply integrates Web Content Management, eCommerce, eMarketing, Social Media management, and Web Analytics to help marketers deliver online experiences that attract, engage and convert their customers across all digital channels. Bridgeline’s iAPPS platform combined with its digital services assists customers in maximizing on-line revenue, improving customer service and loyalty, enhancing employee knowledge, and reducing operational costs.

In fiscal 2012, Bridgeline Digital announced the release of a new product, iAPPSds (“distributed subscription”), a platform that empowers franchise and large dealer networks with state-of-the-art web engagement management while providing superior oversight of corporate branding. iAPPSds deeply integrates content management, eCommerce, eMarketing and web analytics and is a self-service web platform that is offered to each authorized franchise or dealer for a monthly subscription fee. On August 1, 2013, we acquired franchise web developer ElementsLocal, expanding Bridgeline Digital’s presence in the franchise market place.

The iAPPS platform is delivered through a cloud-based SaaS (“Software as a Service”) multi-tenant business model, whose flexible architecture provides customers with state of the art deployment providing maintenance, daily technical operation and support; or via a traditional perpetual licensing business model, in which the iAPPS software resides on a dedicated server in either the customer’s facility or Bridgeline’s co-managed hosting facility.

iAPPS Content Manager and iAPPS Commerce were selected as finalists for the 2014, 2013, and 2012 CODiE Awards for Best Content Management Solution and Best Electronic Commerce Solution, globally. In 2014, Bridgeline Digital won ten Horizon Interactive Awards for outstanding development of web applications and websites and won fifteen Horizon Interactive Awards in 2013. Also in 2013, the Web Marketing Association sponsored Internet Advertising Competition honored Bridgeline Digital with three awards for iAPPS customer websites and B2B Magazine selected Bridgeline Digital as one of the Top Interactive Technology companies in the United States. In 2013, KMWorld Magazine Editors selected Bridgeline Digital as one of the 100 Companies That Matter in Knowledge Management and also selected iAPPS as a Trend Setting Product in 2013.

Bridgeline Digital was incorporated under the laws of the State of Delaware on August 28, 2000.

Locations

The Company’s corporate office is located in Burlington, Massachusetts. The Company maintains regional field offices serving the following geographical locations: Atlanta, GA; Baltimore, MD; Boston, MA; Chicago, IL; Dallas, TX; Denver, CO; New York, NY; San Diego, CA; San Luis Obispo, CA; and Tampa, FL. The Company has one wholly-owned subsidiary, Bridgeline Digital Pvt. Ltd. located in Bangalore, India.

2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

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

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Unaudited Interim Financial Information

The accompanying interim Condensed Consolidated Balance Sheet as of March 31, 2014 and September 30, 2013, and the interim Condensed Consolidated Statements of Operations, Comprehensive Loss, and Cash Flows for the three and six months ended March 31, 2014 and 2013 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and with the instructions to Form 10-Q and Regulation S-X, 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 year ended September 30, 2013. These interim condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments and accruals, necessary for the fair presentation of the Company’s financial position at March 31, 2014 and September 30, 2013 and the results of its operations and cash flows for the three and six months ended March 31, 2014 and 2013, respectively. The results for the six months ended March 31, 2014 are not necessarily indicative of the results to be expected for the year ending September 30, 2014. The accompanying September 30, 2013 Condensed Consolidated Balance Sheet has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by US GAAP for complete financial statements.

Subsequent Events

The Company evaluated subsequent events through the date of this filing and concluded there were no material subsequent events requiring adjustment to or disclosure in these interim condensed consolidated financial statements.

Recent Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update No. 2013-11: “Income Taxes (Topic 740): Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”. This guidance requires an unrecognized tax benefit related to a net operating loss carryforward, a similar tax loss or a tax credit carryforward to be presented as a reduction to a deferred tax asset, unless the tax benefit is not available at the reporting date to settle any additional income taxes under the tax law of the applicable tax jurisdiction. The guidance is effective for the fiscal years and interim periods beginning after December 15, 2013 with early adoption permitted. Management is in the process of evaluating the effects of this guidance but does not believe it will have a significant impact on our condensed consolidated financial statements.

All other Accounting Standards Updates issued but not yet effective are not expected to have a material effect on the Company’s future financial statements.

3. Accounts Receivable and Unbilled Receivables

Accounts receivable and unbilled receivables consists of the following:

	As of			As of
	March 31, 2014			September 30, 2013
Accounts receivable	$	3,290		$	3,188
Unbilled receivables		244			111
Subtotal		3,534			3,299
Allowance for doubtful accounts		(96	)		(105	)
Accounts receivable and unbilled receivables, net	$	3,438		$	3,194

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

4. Intangible Assets

Changes in the carrying amount of intangible assets are as follows:

	As of		As of
	March 31, 2014		September 30, 2013
Domain and trade names	$	17	$	34
Customer related		1,547		1,182
Non-compete agreements		323		301
Balance at end of period	$	1,887	$	1,517

Total amortization expense related to intangible assets was $216 and $118 for the three months ended March 31, 2014 and 2013 and $341 and $274 for the six months ended March 31, 2014 and 2013, respectively. Amortization expenses are reflected in operating expenses on the Condensed Consolidated Statements of Operations.

5. Goodwill

Changes in the carrying amount of goodwill are as follows:

	As of			As of
	March 31, 2014			September 30, 2013
Balance at beginning of period	$	23,777		$	21,545
Acquisitions		-			1,897
Contingent acquisition payments		-			83
Purchase price allocation adjustments		(636	)		252
Balance at end of period	$	23,141		$	23,777

6. Debt

Debt consists of the following:

	As of			As of
	March 31, 2014			September 30, 2013
Line of credit borrowings	$	3,223		$	3,504
Bank term loan		-			272
Subordinated convertible debt		3,000			2,000
Subordinated promissory notes		44			114
Other (debt warrants)		(61	)		-
Total debt	$	6,206		$	5,890
Less current portion	$	12		$	1,165
Long term debt, net of current portion	$	6,194		$	4,725

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Line of Credit

In December 2013, the Company entered into a Loan and Security Agreement with BridgeBank (the “BridgeBank Loan Agreement”). The Loan Agreement has a 27 month term which expires on March 31, 2016. The Loan Agreement provides for up to $5 million of revolving credit advances which may be used for acquisitions and working capital purposes. Borrowings are limited to the lesser of (i) $5 million and (ii) 80% of eligible receivables as defined. The Company can borrow up to $1.0 million in out of formula borrowings for specified periods of time. Borrowings bear interest at BridgeBank’s prime plus 1.00%. The Company pays an annual commitment fee of 0.25%. Borrowings are secured by all of the Company’s assets and all of the Company’s intellectual property. The Company is also required to comply with certain financial covenants. The BridgeBank Loan Agreement replaced the Company’s prior credit facility with Silicon Valley Bank (“SVB”), which expired on December 31, 2013. As of March 31, 2014, the Company had an outstanding balance under the BridgeBank Loan Agreement of $3.2 million. There were no funds available for borrowing at March 31, 2014.

The Company had an Amended and Restated Loan and Security Agreement with SVB (the “Loan Agreement”). The Loan Agreement had a two year term which expired on March 31, 2012. The Loan Agreement provided for up to $5.0 million of revolving credit advances, of which $3.0 million may be used for acquisitions and up to $5.0 million may be used for working capital purposes. Borrowings were limited to the lesser of (i) $5.0 million and (ii) 80% of eligible receivables as defined. In the event that the borrowing base formula resulted in less than $5.0 million in available borrowing, the Company could have borrowed up to $2.0 million in out of formula borrowings (provided such amount does not exceed $5.0 million) for specified periods of time. Borrowings bore interest at SVB’s prime plus 1.00% or 1.25%, depending on the level of the adjusted EBITDA, as defined. The Company paid an annual commitment fee of 0.50% and an unused fee of 0.25%. Borrowings were secured by all of the Company’s assets and all of the Company’s intellectual property. The Company was also required to comply with certain financial and performance covenants.

In May 2011, the Company amended its loan arrangement (the “Amendment”) with SVB Under the terms of the existing agreement with SVB, the Company’s line of credit was limited to the lesser of (i) $5 million and (ii) 80% of eligible receivables as defined, and up to $2.0 million could be borrowed in out of formula borrowings for specified periods of time (provided the total amount outstanding does not exceed $5.0 million).

The Amendment: (i) extended the maturity date of the line of credit for one year to March 31, 2012; (ii) revised certain financial covenants; and (iii) amended the out of formula borrowings to be structured as a $2 million term loan and interest on the term loan will be at SVB’s prime rate plus 1.75%. Interest on the term loan was paid until April 1, 2012 and on and after April 2, 2012, principal and interest on the term loan was being paid over 36 months ending on April 1, 2015. In May 2012, we amended our loan agreement (the “2012 Amendment”) with SVB, extending the maturity date of the line of credit for one year to March 31, 2014. The 2012 Amendment also revised a financial covenant, increasing our minimum liquidity requirement. Minimum liquidity is defined as funds held with SVB plus borrowing availability on our line of credit.

In February 2013, the Company amended its loan agreement (the “February 2013 Amendment”) with SVB, extending the maturity date of the line of credit for one year to March 31, 2015. The 2013 Amendment also revised certain financial covenants. The Company would not have been in compliance with one of its covenants for the three months ended December 31, 2012 if the amendment was not completed. In July 2013, the Company amended its loan arrangement (the “July 2013 Amendment”) with SVB. The July 2013 Amendment increased the borrowing availability on accounts receivable, revised certain financial covenants, and increased the interest rate on the line of credit from prime plus 1.25% to prime plus 2.25% and increased the interest rate on the term loan from prime plus 1.75% to prime plus 2.75%In addition, the repayment schedule for the term loan was accelerated to end in April 2014. There was $611 remaining on the term loan as of June 30, 2013. The July 2013 Amendment also included a waiver by SVB of certain financial covenant defaults. The Company would not have been in compliance with certain of its financial covenants as of June 30, 2013 if the July 2013 Amendment had not been completed and the waiver had not been granted. In November 2013, the Company amended its loan agreement (“the November 2013 Amendment”) with SVB. The November 2013 Amendment accelerated the maturity date of the line of credit to December 31, 2013 at which time this line was replaced with the BridgeBank Loan Agreement and the term loan was paid in full.

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Subordinated Convertible Debt

On September 30, 2013, Bridgeline Digital entered into a Note Purchase Agreement (the "Purchase Agreement") with accredited investors pursuant to which Bridgeline Digital sold an aggregate of $2.0 million of 10% secured subordinated convertible notes (the "Notes"). The gross proceeds to Bridgeline Digital at the closing of this private placement were $2.0 million. The Notes accrue interest at a rate of ten percent (10%) per annum and mature on September 30, 2016. Interest on the Notes is payable quarterly in cash. The Notes are convertible at the election of the holder into shares of common stock of Bridgeline Digital at a conversion price equal to $1.30 per share at any time prior to the maturity date, provided that no holder may convert the Notes if such conversion would result in the holder beneficially owning more than 4.99% of the number of shares of Bridgeline Digital common stock outstanding at the time of conversion.

On November 6, 2013, Bridgeline Digital entered into an amendment (the "Amendment") to the Purchase Agreement by and among Bridgeline Digital and the accredited investors’ party thereto. The Amendment increased the aggregate amount of 10% secured subordinated convertible notes (the "New Notes") able to be sold by Bridgeline Digital to $3.0 million. On November 6, 2013, Bridgeline Digital sold an additional $1.0 million of New Notes (the "Second Closing"). The gross proceeds to Bridgeline Digital at the Second Closing of this private placement were $1.0 million. The Notes accrue interest at a rate of ten percent (10%) per annum and mature on November 6, 2016. Interest on the Notes is payable quarterly in cash. The Notes are convertible at the election of the holder into shares of common stock of Bridgeline Digital at a conversion price equal to $1.30 per share at any time prior to the maturity date, provided that no holder may convert the Notes if such conversion would result in the holder beneficially owning more than 4.99% of the number of shares of Bridgeline Digital common stock outstanding at the time of conversion.

The Notes are secured by all of Bridgeline Digital's assets. The security interest granted to the holders of the Notes is subordinate to the security interest held by Bridgeline Digital's senior lender, BridgeBank. Bridgeline Digital may prepay any portion of the principal amount of the outstanding Notes at any time, provided that if Bridgeline Digital prepays any principal on or before September 30, 2014, Bridgeline Digital will pay a penalty equal to 10% of the principal amount being prepaid. Under certain circumstances Bridgeline Digital has the right to force conversion of the Notes into shares of Bridgeline Digital common stock in the event the Bridgeline Digital common stock trades in excess of $2.60 per share for 20 trading days out of any 30 trading day period.

The Notes contain customary events of default. Upon the occurrence of any event of default the interest rate under the Notes will increase. In addition, upon the occurrence of a payment default under the Notes, Bridgeline Digital must pay a premium equal to 20% of the outstanding principal amount of the Notes. In the event of a change in control of Bridgeline Digital while the Notes are outstanding, Bridgeline Digital will provide the holders of the Notes with the opportunity to convert the Notes immediately prior to the change in control. In the event the holders of the Notes do not elect to convert the Notes, Bridgeline Digital may prepay all outstanding principal and accrued interest under the Notes.

The placement agent for both transactions was Taglich Brothers, Inc. As compensation for the initial transaction on September 30 2013, Bridgeline Digital paid a fee of $160 and issued to Taglich Brothers, Inc., or its designees, five-year warrants to purchase an aggregate of 153,846 shares of common stock at an exercise price equal to $1.30 per share. The warrants are first exercisable on March 30, 2014, and provide the holders piggyback registration rights with respect to the shares of common stock underlying the warrants and contain a cashless exercise provision. As compensation for the Second Closing, Bridgeline Digital paid Taglich Brothers, Inc. a fee of $80 and issued to Taglich Brothers, Inc., or its designees, five-year warrants to purchase an aggregate of 76,923 shares of common stock at an exercise price equal to $1.30 per share. The warrants are first exercisable on May 6, 2014, provide the holders piggyback registration rights with respect to the shares of common stock underlying the warrants and contain a cashless exercise provision. Fair market value of the warrants are $61 and is included in current and non-current debt with the offsetting amount recorded to additional paid in capital in the Condensed Consolidated Balance Sheet. The fair market value of the warrants will be amortized on a straight-line basis over the estimated life of two years.

The shares of common stock issuable upon conversion of the Notes and upon exercise of the warrants are restricted securities and may be sold only pursuant to Rule 144 or in another transaction exempt from the registration requirements under the Securities Act of 1933. Pursuant to the terms of the Purchase Agreement, Bridgeline Digital has agreed to provide piggyback registration rights with respect to the shares of common stock issuable upon conversion of the Notes in the event Bridgeline Digital files a registration statement, with certain limited exceptions.

Subordinated Promissory Note

In May 2010, in connection with the acquisition of TMX, the Company issued a $500 subordinated promissory note (“the Note”) payable to TMX. The Note is subordinated to the Company’s primary lender and is payable in twelve quarterly installments of $42, plus interest at 1%, with the first payment due on January 15, 2011. The Note may be paid in whole or in part at any time without discount, premium, or penalty.

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

In May 2012, the Company assumed two Promissory Notes in connection with the acquisition of MarketNet, Inc. The first Promissory Note in the amount of $63 is payable in eight equal installments of $8, including interest accrued at 5%, and matures in May 2014. The first installment was paid in July 2012. The second Promissory Note in the amount of $80 is payable in twelve equal installments of $7, including interest accrued at 5%, and matures in May 2015. The first installment was paid in July 2012.

7. Fair Value Measurement and Fair Value of Financial Instruments

The Company follows ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”) for fair value measurements. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The standard provides a consistent definition of fair value, which focuses on an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard also prioritizes, within the measurement of fair value, the use of market-based information over entity specific information and establishes a three-level hierarchy for fair value measurements based on the nature of inputs used in the valuation of an asset or liability as of the measurement date.

The hierarchy established under ASC 820 gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

Level 1 –Quoted prices in active markets for identical assets or liabilities;

Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company’s other financial instruments consist principally of accounts receivable, accounts payable, and debt. The company believes the recorded values for accounts receivable and accounts payable approximate current fair values as of March 31, 2014 and September 30, 2013 because of their nature and durations. The carrying value of debt instruments also approximate fair value as of March 31, 2014 and September 30, 2013 based on acceptable valuation methodologies which use market data of similarly sized and situated debt issues.

Assets and liabilities of the Company measured at fair values on a recurring basis as of March 31, 2014 and September 30, 2013 are as follows:

	March 31, 2014

	Level 1		Level 2		Level 3		Total
Financial Liabilities:
Contingent consideration related to acquisitions					$	1,222	$	1,222
Total Liabilities	$	-	$	-	$	1,222	$	1,222

	September 30, 2013

	Level 1		Level 2		Level 3		Total
Financial Liabilities:
Contingent consideration related to acquisitions					$	1,511	$	1,511
Total Liabilities	$	-	$	-	$	1,511	$	1,511

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

The Company determines the fair value of acquisition-related contingent consideration based on assessment of the probability that the Company would be required to make such future payments. Changes to the fair value of contingent consideration are recorded in general and administrative expenses. The following table provides a rollforward of the fair value, as determined by Level 3 inputs, of the contingent consideration.

	Contingent Consideration As of 3/31/2014

Balance at September 30, 2013	$	1,511
Payments		(284	)
Adjustments included in net earnings		(5	)
Balance at March 31, 2014	$	1,222

8. Other Long Term Liabilities

Deferred Rent

In connection with leases for the Company’s headquarters in Burlington, Massachusetts and New York, the Company made investments in leasehold improvements at these locations of approximately $1.4 million, of which the respective landlords funded approximately $857. The capitalized leasehold improvements are being amortized over the life of each lease. The improvements funded by the landlords are treated as lease incentives. Accordingly, the funding received from the landlords was recorded as fixed asset additions and a deferred rent liability on the Condensed Consolidated Balance Sheet. As of March 31, 2014, $130 was reflected in Accrued Liabilities and $812 is reflected in Other Long Term Liabilities. The deferred rent liability is being amortized as a reduction of rent expense over the lives of the leases.

9. Shareholders’ Equity

Common Stock

In March 2014, the Company sold 3,200,000 shares of common stock at $0.95 per share for gross proceeds of $3 million in a private placement. Net proceeds to the Company after offering expenses were approximately $2.7 million. In addition, the Company issued the placement agent five year warrants to purchase an aggregate of 320,000 shares of Bridgeline’s common stock at a price equal to $1.05 per share. There are no plans to register the common stock issued in this offering, however in the event the Company does register other Common stock, the Company agreed to provide piggyback registration rights with respect to the shares of common stock sold in the offering and underlying the warrants.

In January 2014, the Company issued 56,897 shares of common stock at $1.16 per share to four members of its Board of Directors in lieu of cash payments for their services as board members. The shares vest in equal installments on a monthly basis through the end of the service period of September 30, 2014. The aggregate fair value of the shares is $66 and will be expensed over the service period. A total of $19 was recorded as expense in the three months ended March 31, 2014.

In connection with the acquisition of ElementsLocal on August 1, 2013, the Company issued 526,438 shares to the sellers of ElementsLocal. In addition, contingent consideration not to exceed 338,461 shares of Bridgeline Digital common stock is contingently issuable to the sellers of ElementsLocal. The contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving certain revenue targets. As of March 31, 2014, the stockholders of ElementsLocal earned 56,410 shares of common stock.

On June 19, 2013, the Company sold 2,300,000 shares of common stock at $1.00 per share for gross proceeds of $2.3 million in a private placement. Net proceeds to the Company after offering expenses were approximately $2.1 million. In addition, the Company issued the investors and placement agent and its affiliates five year warrants to purchase an aggregate of 460,000 and 230,000 shares, respectively, of Bridgeline’s common stock at a price equal to $1.25 per share. There are no plans to register the common stock issued in this offering, however in the event the Company does register other Common stock, the Company agreed to provide piggyback registration rights with respect to the shares of common stock sold in the offering and underlying the warrants.

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

In connection with the acquisition of MarketNet on May 31, 2012, contingent consideration of 204,331 shares of Bridgeline Digital common stock is contingently issuable to the sole stockholder of MarketNet. The contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving certain operating and revenue targets. The common stock has been issued and is being held in escrow pending satisfaction of the applicable earnout targets. As of March 31, 2014, the sole stockholder of MarketNet earned 102,168 shares of common stock, with 17,028 shares issued during the three months ended March 31, 2014. In addition, MarketNet is also eligible to earn additional equity consideration of 200,000 shares of Bridgeline Digital common stock if a certain annual revenue threshold is met in any fiscal year during the next three years.

In connection with the acquisition of Magnetic Corporation on October 3, 2011, contingent consideration of 166,666 shares of Bridgeline Digital common stock is contingently issuable to the sole stockholder of Magnetic. The contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving certain operating and revenue targets. The common stock has been issued and is being held in escrow pending satisfaction of the applicable earnout targets. As of March 31, 2014, the sole stockholder of Magnetic earned 138,882 shares of common stock, with 13,888 shares issued during the three months ended March 31, 2014.

In order to increase employee retention and employee morale, in October 2011, the Company offered its employees the opportunity to have certain outstanding options modified by (i) reducing the grant exercise price to $0.67, the fair market value of the common stock as of the modification date and (ii) starting a new three year vesting schedule. The aggregate fair value of the modified options of approximately $90 was calculated using the difference in value between the original terms and the new terms as of the modification date. The incremental cost of the modified option over the original option will be recognized as additional compensation expense over the new three year vesting period beginning on the date of modification. This opportunity was generally limited to options issued subsequent to the October 2008 repricing described in Note 11 to the Company’s Annual Report on Form 10-K for fiscal 2011. Options to purchase a total of 697,667 shares of common stock were exchanged for new grants in the October 28, 2011 repricing.

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 have become employees of the Company. At March 31, 2014, the Company maintained one stock option plan and one employee stock purchase plan.

Amended and Restated Stock Incentive Plan

Effective April 2013, the Company’s Amended and Restated Stock Incentive Plan (the “Plan”) provides for the issuance of up 3,900,000 million shares of common stock. The Plan authorizes 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. Options granted under the Plan may be granted with contractual lives of up to ten years. There were 3,568,923 options outstanding reserved under the Plan as of March 31, 2014 and 331,077 shares available for future issuance.

Employee Stock Purchase Plan

On April 12, 2012, the Company’s stockholders approved and adopted the Bridgeline Digital, Inc. 2012 Employee Stock Purchase Plan (the “ESPP”). Under the terms of the ESPP, the Company will grant eligible employees the right to purchase shares of Bridgeline common stock through payroll deductions at a price equal to 85% of the fair market value of Bridgeline common stock on the purchase termination date of defined offering or purchase periods. Each offering period is six months in duration. The ESPP permits the Company to offer up to 300,000 shares of common stock. The maximum number of shares of common stock that may be purchased by all participants in any purchase period may not exceed 150,000 shares.

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Common Stock Warrants

On October 21, 2010, the Company issued 50,000 common stock warrants to purchase shares of the Company’s common stock to a non-employee consultant as compensation for services rendered. The warrants vested over a one year period and expire on October 15, 2015. Of the warrants issued, 25,000 are exercisable at an exercise price of $1.00 per share and 25,000 are exercisable at an exercise price of $2.00 per share.

On May 31, 2012, the Company issued five year warrants to the placement agent in the Company’s private placement. The warrants are exercisable to purchase 217,931 shares of the Company’s common stock at a price equal to $1.40 per share.

On June 19, 2013, the Company issued five year warrants to the investors and placement agent in the Company’s private placement. The warrants are exercisable to purchase 460,000 and 230,000 shares, respectively, of the Company’s common stock at a price equal to $1.25 per share.

On September 30, 2013, the Company issued five year warrants to the placement agent in the Company’s placement of subordinated convertible debt. The warrants are exercisable to purchase 153,846 of the Company’s common stock at a price equal to $1.30 per share. The warrants are first exercisable on March 30, 2014, provide the holders piggyback registration rights with respect to the shares of common stock underlying the warrants and contain a cashless exercise provision.

On November 1, 2013, the Company issued five year warrants to the placement agent in the Company’s placement of subordinated convertible debt. The warrants are exercisable to purchase 76,923 shares of the Company’s common stock at a price equal to $1.30 per share. The warrants are first exercisable on May 6, 2014, provide the holders piggyback registration rights with respect to the shares of common stock underlying the warrants and contain a cashless exercise provision.

On March 28, 2014, the Company issued five year warrants to the investors and placement agent in the Company’s private placement. The warrants are exercisable to purchase 320,000 shares of the Company’s common stock at a price equal to $1.05 per share.

As of March 31, 2014: (i) placement agent warrants to purchase 217,931, 230,000, 230,769, and 320,000 shares at an exercise price of $1.40, $1.25, $1.30 and $1.05, respectively are outstanding; (ii) investor warrants to purchase 460,000 shares at an exercise price of $1.25, and (iii) warrants issued to a non-employee consultant to purchase 25,000 shares at an exercise price of $1.00 and 25,000 shares at an exercise price of $2.00 are outstanding.

Summary of Option and Warrant Activity and Outstanding Shares

	Stock Options					Stock Warrants
				Weighted				Weighted
				Average				Average
				Exercise				Exercise
	Options			Price		Warrants		Price

Outstanding, September 30, 2013		2,872,844		$	0.94		1,111,777	$	1.30
Granted		1,087,500		$	1.12		396,923	$	1.10
Exercised		(215,087	)	$	0.83		-		-
Forfeited or expired		(176,334	)	$	1.21		-		-
Outstanding, March 31, 2014		3,568,923		$	0.98		1,508,700	$	1.25

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

10. Accumulated Other Comprehensive Loss

The following table presents changes in accumulated other comprehensive loss for six months ended March 31, 2014:

	Cumulative
	Foreign Currency
	Translation
	Adjustment

Balance at September 30, 2013	$	(162	)
Foreign currency translation adjustment		(125	)
Balance at March 31, 2014	$	(287	)

11. Net Loss Per Share

Basic and diluted net loss per share is computed as follows:

	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Net loss	$	(2,314	)	$	(687	)	$	(3,091	)	$	(1,329	)

Weighted average common shares outstanding - basic and diluted		17,795			14,878			17,894			14,830


Net loss per share - basic and diluted	$	(0.13	)	$	(0.05	)	$	(0.17	)	$	(0.09	)

Basic net loss per share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding. Diluted net income per share is computed using the weighted average number of common shares outstanding during the period plus the dilutive effect of outstanding stock options and warrants using the “treasury stock” method. The computation of diluted earnings per share does not include the effect of outstanding stock options and warrants that are anti-dilutive.

For the three and six months ended March 31, 2014, options to purchase shares of the Company’s common stock of 706,206 and 590,188 were excluded from the computation of diluted net loss per share as the effect was anti-dilutive to the Company’s net loss. Warrants to purchase 1,508,700 shares of common stock and contingent shares to be issued in connection with prior acquisitions of e.Magination, Marketnet, Magnetic, and ElementsLocal have also been excluded as they are anti-dilutive to the Company’s net loss.

12. Income Taxes

Income tax expense was $35 and $68 for the three months ended March 31, 2014 and 2013 and $56 and $89 for the six months ended March 31, 2014 and 2013, respectively. Income tax expense consists of the estimated liability for federal and state income taxes owed by the Company, including the alternative minimum tax. Net operating loss carry forwards are estimated to be sufficient to offset additional taxable income for all periods presented.

The Company does not provide for U.S. income taxes on the undistributed earnings of its Indian subsidiary, which the Company considers to be a permanent investment.

BRIDGELINE DIGITAL, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

13. Related Party Transactions

As part of the Magnetic acquisition, the Company entered into an operating lease for the Bridgeline Tampa location with the previous owner of Magnetic who now serves as the Senior Vice President of Enterprise Development. The lease term is three years and rent is $85 thousand per year. In December 2013 our employee sold this property to an unrelated third party.

In October 2013, Michael Taglich joined the Board of Directors. Mr. Taglich is the Chairman and President of Taglich Brothers, Inc. a New York based securities firm. Taglich Brothers, Inc. was the agent for the past three private placements of Bridgeline Digital common stock which took place in 2012, 2013 and in March 2014. Taglich Brothers, Inc. was also the agent for Bridgeline’s convertible debt offerings of $2 million and $1 million in September and November 2013, respectively. Mr. Taglich personally owns 467,000 shares of Bridgeline. Other employees, affiliates and clients of Taglich Brothers, Inc. own approximately 6,200,000 shares of Bridgeline stock. The fees paid to Taglich Brothers, Inc. in connection with the 2012, 2013 and 2014 private placements of common stock were $651. Fees paid to Taglich Brothers, Inc. in connection with the 2013 convertible debt offerings were $240. The Company also has an annual service contract for $18 with Taglich Brothers, Inc. to perform market research.

14. Legal Proceedings

The Company is subject to ordinary routine litigation and claims incidental to its business. As of March, 2014, the Company was not engaged with any material legal proceedings.

Item 2.

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

This section contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors and risks including risks described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 as well as in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov.

This section should be read in combination with the accompanying unaudited consolidated financial statements and related notes prepared in accordance with United States generally accepted accounting principles.

Overview

In fiscal 2012, Bridgeline Digital announced the release of a new product, iAPPSds (“distributed subscription”), a platform that empowers franchise and large dealer networks with state-of-the-art web engagement management while providing superior oversight of corporate branding. iAPPSds deeply integrates content management, eCommerce, eMarketing and web analytics and is a self-service web platform that is offered to each authorized franchise or dealer for a monthly or annual subscription fee. On August 1, 2013, we acquired franchise web developer ElementsLocal, expanding Bridgeline Digital’s presence in the franchise market place.

Bridgeline Digital was incorporated under the laws of the State of Delaware on August 28, 2000.

Customer Information

We currently have over 2,500 customers, the majority of which are iAPPSds customers who pay a monthly subscription fee. For the three and six months ended March 31, 2014 and 2013 no customer represented 10% or more of total revenue.

Acquisitions

ElementsLocal

In the fourth quarter of fiscal 2013, we had one acquisition. On August 1, 2013, the Company completed the acquisition of Transformational Technologies, Inc. (“ElementsLocal”), a California based developer of an online SaaS platform for the franchise marketplace. The Company acquired all of the outstanding capital stock of ElementsLocal for consideration consisting of (i) $463 thousand in cash; (ii) $604 thousand in shares of Bridgeline Digital common stock (valued at $1.15 per share); (iii) assumption of $188 thousand of indebtedness; and (iv) contingent consideration of up to $904 thousand in cash and $396 thousand in shares of Bridgeline Digital common stock. The contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving a certain quarterly revenue target during the period. The contingent common stock payable each earnout period is determined by dividing $33 thousand by the greater of: (i) the average closing price for Bridgeline Digital common stock for the 30 day trading period preceding the end of the earnout period; or (ii) $1.17. To the extent that a quarterly revenue target is not met in a particular quarter, the earn-out period will be extended for up to four additional quarters. The Company is required to assess the probability of the acquired business achieving the contingent cash and stock payments which requires management to make estimates and judgments based on forecasts of future performance. ElementsLocal’s operating results are reflected in the Company’s condensed consolidated financial statements as of the acquisition date.

There were no acquisitions during our first two fiscal quarters of 2014.

Results of Operations

Three and Six Months Ended March 31, 2014 compared to the Three and Six Months Ended March 31, 2013

Consolidated Revenue, Cost of Revenue, Gross Profit, and Gross Margin

	Three Months			Three Months									Six Months			Six Months
	Ended			Ended									Ended			Ended
	March 31,			March 31,						%			March 31,			March 31,						%
Revenue:	2014			2013			Change			Change			2014			2013			Change			Change
Digital engagement services
iAPPS digital engagement services	$	3,089		$	3,562			(473	)		(13%	)	$	7,001		$	6,975			26			0	%
% of total revenue		58	%		59	%								59	%		57	%
Other digital engagement services		521			927			(406	)		(44%	)		1,158			2,364			(1,206	)		(51%	)
% of total revenue		10	%		15	%								10	%		19	%
Subtotal digital engagement services		3,610			4,489			(879	)		(20%	)		8,159			9,339			(1,180	)		(13%	)
% of total revenue		68	%		75	%								69	%		77	%
Subscription and perpetual licenses		1,307			1,024			283			28	%		2,884			1,811			1,073			59	%
% of total revenue		25	%		17	%								24	%		15	%
Managed service hosting		385			491			(106	)		(22%	)		772			1,047			(275	)		(26%	)
% of total revenue		7	%		8	%								7	%		9	%
Total revenue	$	5,302		$	6,004		$	(702	)		(12%	)	$	11,815		$	12,197		$	(382	)		(3%	)
Cost of revenue:
Digital engagement services
iAPPS digital engagement services		2,365			1,911			454			24	%		4,480			3,690			790			21	%
% of iAPPS digital engagement services revenue		77	%		54	%								64	%		53	%
Other digital engagement costs		304			583			(279	)		(48%	)		692			1,558			(866	)		(56%	)
% of other digital engagement services revenue		58	%		63	%								60	%		66	%
Subtotal digital engagement services costs		2,669			2,494			175			7	%		5,172			5,248			(76	)		(1%	)
% of digital engagement services revenue		74	%		56	%								63	%		56	%
Subscription and perpetual licenses		452			247			205			83	%		849			415			434			105	%
% of subscription and perpetual revenue		35	%		24	%								29	%		23	%
Managed service hosting		68			76			(8	)		(11%	)		152			148			4			3	%
% of managed service hosting revenue		18	%		15	%								20	%		14	%
Total cost of revenue		3,189			2,817			372			13	%		6,173			5,811			362			6	%
Gross profit	$	2,113		$	3,187		$	(1,074	)		(34%	)	$	5,642		$	6,386		$	(744	)		(12%	)
Gross profit margin		40	%		53	%								48	%		52	%

Revenue

Our revenue is derived from three sources: (i) digital engagement services; (ii) subscription and perpetual licenses; and (iii) managed service hosting.

Digital Engagement Services

Digital engagement services revenue is comprised of iAPPS digital engagement related services and other digital engagement related services generated from non-iAPPS related engagements. In total, revenue from digital engagement services decreased $879 thousand, or 20%, to $3.6 million for the three months ended March 31, 2014 compared to the prior period. Revenue from iAPPS digital engagement services decreased $473 thousand, or 13% to $3.1 million compared to the three months ended March 31, 2013. The decrease in iAPPS digital engagements services is related to unfavorable timing of closing new contracts earlier in the quarter, therefore, delaying our commencement of the projects. Revenue from non-iAPPS digital engagement services decreased $406 thousand, or 44%, compared to the three months ended March 31, 2013. The decrease in non-iAPPS digital engagements services compared to the prior period is related to our focus on selling higher-margin iAPPS digital engagements to both new and existing customers.

Digital engagement services revenue as a percentage of total revenue decreased to 68% from 75% for the three months ended March 31, 2014 compared to the prior period. The decrease is attributable to the decrease in non-iAPPS digital engagement services revenue and the timing of recognizing revenue from new engagements.

Revenue from iAPPS digital engagement services increased $26 thousand to $7.0 million compared to the six months ended March 31, 2013. The increase in iAPPS digital engagements services is related to an increase in demand for our iAPPS product suite and an increase in iAPPS subscription and perpetual licenses sold. Revenue from non-iAPPS digital engagement services decreased $1.2 million, or 51%, compared to the six months ended March 31, 2013. In total, revenue from digital engagement services decreased $1.2 million, or 13%, to $8.2 million for the six months ended March 31, 2014. The decrease compared to the prior period is due to a decrease in non-iAPPS engagement services as we continue to concentrate on selling higher-margin iAPPS digital engagements to both new and existing customers.

Digital engagement services revenue as a percentage of total revenue decreased to 69% from 77% for the six months ended March 31, 2014 compared to the prior period. The decrease is attributable to the decrease in non-iAPPS digital engagement services revenue.

Subscription and Perpetual Licenses

Revenue from subscription and perpetual licenses increased $283 thousand, or 28%, to $1.3 million compared to the three months ended March 31, 2013. The increase is due to the increase in license revenues from our product for the franchise industry, iAPPSds, incremental SaaS licenses from our acquisition of ElementsLocal (acquired in the fourth quarter of fiscal 2013), and incremental iAPPS annual maintenance revenue.

Subscription and perpetual license revenue as a percentage of total revenue for the three months ended March 31, 2014 increased to 25% from 17% compared to the three months ended March 31, 2013.

Revenue from subscription and perpetual licenses increased $1 million, or 59%, to $2.9 million compared to the six months ended March 31, 2013. The increase is due to the increase in license revenues from our product for the franchise industry, iAPPSds, incremental SaaS licenses from our acquisition of ElementsLocal (acquired in the fourth quarter of fiscal 2013), and incremental iAPPS annual maintenance revenue.

Subscription and perpetual license revenue as a percentage of total revenue for the six months ended March 31, 2014 increased to 24% from 15% compared to the six months ended March 31, 2013.

Managed Service Hosting

Revenue from managed service hosting decreased $106 thousand, or 22%, to $385 thousand compared to the three months ended March 31, 2013. The decrease is due to our efforts to engage with customers that are aligned with our core competencies and proactively end our engagements with a number of smaller hosting customers obtained through acquisitions.

Managed services revenue as a percentage of total revenue decreased for the three months ended March 31, 2014 to 7% from 8% compared to the three months ended March 31, 2013.

Revenue from managed service hosting decreased $275 thousand, or 26%, to $772 thousand compared to the six months ended March 31, 2013. The decrease is due to our efforts to engage with customers that are aligned with our core competencies and proactively end our engagements with a number of smaller hosting customers obtained through acquisitions.

Managed services revenue as a percentage of total revenue decreased for the six months ended March 31, 2014 to 7% from 9% for six months ended March 31, 2013.

Costs of Revenue

Total cost of revenue increased $372 thousand, or 13%, to $3.2 million for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increases are due to fixed costs to support revenue and increases in third party labor costs to deliver iAPPS digital engagement services combined with the decrease in revenues.

Total cost of revenue increased $362 thousand, or 6%, to $6.2 million for the six months ended March 31, 2014 compared to the six months ended March 31, 2013. The increases are due to fixed costs to support revenue and increases in third party labor costs to deliver iAPPS digital engagement services combined with the decrease in revenues.

Cost of Digital Engagement Services

Cost of digital engagement services increased $175 thousand, or 7%, to $2.7 million for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Costs associated with non-iAPPS related engagements decreased in line with non-iAPPS digital engagement services, however, our costs associated with iAPPS related engagements increased due to costs for third parties to assist with implementations.

Cost of digital engagement services decreased $76 thousand, or 1%, to $5.2 million for the six months ended March 31, 2014 compared to the six months ended March 31, 2013. Costs associated with non-iAPPS related engagements decreased in line with non-iAPPS digital engagement services, however, our costs associated with iAPPS related engagements increased in due to costs for third parties to assist with implementations.

Cost of Subscription and Perpetual License

Cost of subscription and perpetual licenses increased $205 thousand, or 83%, to $452 thousand compared to the three months ended March 31, 2013. This increase is attributable to amortization of software costs associated with the development of iAPPS compared to the prior quarter, as we released new versions of iAPPS that have commenced amortization over a three year period. In addition, the increases are due to incremental license costs related to ElementsLocal acquired in the fourth quarter of fiscal 2013 and costs to support our network operations center.

The cost of subscription and perpetual licenses as a percentage of subscription and perpetual license revenue increased to 35% from 24% compared to the three months ended March 31, 2013. This is due to amortization of software costs associated with the development of iAPPS and acquired non-iAPPS SaaS license costs which have a lower margin than iAPPS SaaS licenses.

Cost of subscription and perpetual licenses increased $434 thousand, or 105%, to $849 thousand compared to the six months ended March 31, 2013. This increase is due to amortization of software costs associated with the development of iAPPS, incremental license costs related to the acquisition of ElementsLocal, and costs to support our network operations center.

The cost of subscription and perpetual licenses as a percentage of subscription and perpetual license revenue increased to 29% from 23% compared to the six months ended March 31, 2013. This is due to amortization of software costs associated with the development of iAPPS and incremental license costs related to the acquisition of ElementsLocal.

Cost of Managed Service Hosting

Cost of managed service hosting decreased $8 thousand, or 11%, to $68 thousand for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The cost of managed services as a percentage of managed services revenue increased to 18% from 15% compared to the three months ended March 31, 2013. The percentage increase is attributable to fixed costs to support the network operations center.

Cost of managed service hosting increased $4 thousand, or 3%, to $152 thousand for the six months ended March 31, 2014 compared to the six months ended March 31, 2013. The cost of managed services as a percentage of managed services revenue increased to 20% from 14% compared to the six months ended March 31, 2013. The percentage increases are attributable to fixed costs to support the network operations center.

Operating Expenses

	Three Months			Three Months									Six Months			Six Months
	Ended			Ended									Ended			Ended
	March 31,			March 31,						%			March 31,			March 31,						%
Operating Expenses:	2014			2013			Change			Change			2014			2013			Change			Change
Sales and marketing	$	1,928		$	2,164		$	(236	)		(11%	)	$	4,038		$	3,998		$	40			1	%
% of total revenue		36	%		36	%								34	%		33	%
General and administrative		1,167			946			221			23	%		2,198			2,300			(102	)		(4%	)
% of total revenue		22	%		16	%								19	%		19	%

Research and development		579			247			332			134	%		1,102			379			723			191	%
% of total revenue		11	%		4	%								9	%		3	%

Depreciation and amortization		551			390			161			41	%		1,005			814			191			23	%
% of total revenue		10	%		6	%								9	%		7	%
Total operating expenses	$	4,225		$	3,747		$	478			13	%	$	8,343		$	7,491		$	852			11	%

Sales and Marketing Expenses

Sales and marketing expenses decreased $236 thousand, or 11%, to $1.9 million compared to the three months ended March 31, 2013 and increased $40 thousand, or 1%, to $4.0 million compared to the six months ended March 31, 2013. Sales and marketing expenses represented 36% for both the three months ended March 31, 2014 and 2013 and represented 34% and 33% of total revenue for the six months ended March 31, 2014 and 2013.

The decreases for the three months ended March 31, 2014 compared to the prior period is primarily attributable to a decrease in marketing and sales related compensation expense. The slight increase for the six months ended March 31, 2014 compared to the prior period is primarily attributable to incremental sales and marketing expenses from the acquisition of ElementsLocal in August 2013, offset by decreases in marketing expenses and sales related compensation expense.

General and Administrative Expenses

General and administrative expenses increased $221 thousand, or 23%, to $1.2 million compared to the three months ended March 31, 2013 and decreased $102 thousand, or 4%, to $2.2 million compared to the six months ended March 31, 2013. General and administrative expenses represented 22% and 16% of total revenue for the three months ended March 31, 2014 and 2013 and represented 19% for both the six months ended March 31 2014 and 2013. In the three months ended March 31, 2013, we recognized a favorable acquisition earnout adjustment of $312 thousand. Negating the effect of this adjustment would result in an overall decrease in general and administrative expenses quarter over quarter due to a decrease in general legal expenses and consolidation of administrative functions. The decrease in expense for the six months ended March 31, 2014 compared to the prior period was due to decreases in headcount and a decrease in general legal expenses, as well as the effect of the earnout adjustment mentioned above.

Research and Development

Research and development expense increased by $332 thousand, or 134%, to $579 thousand compared to the three months ended March 31, 2013 and increased $723 thousand, or 191%, to $1.0 million compared to the six months ended March 31, 2013. The increases in research and development expense for the three and six months ended March 31, 2014 compared to the prior quarter is due to the capitalization of software development costs related to enhancements to our iAPPS product platform, which decreases our overall research and development expenses. We capitalized $398 thousand in the three months ended March 31 2013 and only capitalized $15 thousand of software development costs in the current period. In the six months ended March 31, 2013, we capitalized $670 thousand in the three months ended March 31, 2013 and only capitalized $95 thousand of software development costs in the current six month period.

Depreciation and Amortization

Depreciation and amortization expense increased $161 thousand, or 41%, compared to the three months ended March 31, 2013 and increased $191 thousand, or 23%, compared to the six months ended March 31, 2013. The increases in depreciation and amortization for the three and six months ended March 31, 2014 are attributable to depreciation related to our network operation center and amortization of intangible assets acquired from acquisitions.

Depreciation and amortization expenses represented 10% and 6% of total revenue for the three months ended March 31, 2014 and 2013 and represented 9% and 7% of total revenue for the six months ended March 31, 2014 and 2013.

Non-Operating Expenses and Adjusted EBITDA

	Three Months			Three Months									Six Months			Six Months
	Ended			Ended									Ended			Ended
	March 31,			March 31,						%			March 31,			March 31,						%
Non-Operating and Other:	2014			2013			Change			Change			2014			2013			Change			Change
Loss from operations	$	(2,112	)	$	(560	)	$	(1,552	)		277	%	$	(2,701	)	$	(1,105	)	$	(1,596	)		144	%
Interest expense net		(167	)		(59	)		(108	)		183	%		(334	)		(135	)		(199	)		147	%
Loss before income taxes		(2,279	)		(619	)		(1,660	)		268	%		(3,035	)		(1,240	)		(1,795	)		145	%
Provision for income taxes		35			68			(33	)		(49%	)		56			89			(33	)		(37%	)
Net loss	$	(2,314	)	$	(687	)	$	(1,627	)		237	%	$	(3,091	)	$	(1,329	)	$	(1,762	)		133	%

Non-GAAP measure
Adjusted EBITDA	$	(1,294	)	$	17		$	(1,311	)		(7,712%	)	$	(1,274	)	$	67		$	(1,341	)		(2,001%	)

Loss from Operations

The loss from operations was ($2.1) million for three months ended March 31, 2014, compared to a loss of ($560) thousand in the prior period. The decline in income in the current quarter and year to date can be attributed to less revenue combined with fixed costs to support the overall revenue base. In addition, in comparison to the previous period which recognized an earnout adjustment of $312 thousand and capitalized software of $398 thousand, we had no earnout adjustments and only capitalized $95 thousand of software. In the current period we also recognized additional intangible amortization of $75 thousand from our acquisition of Elements during the last fiscal quarter of 2013. Depreciation and amortization expenses also increased as we continue to support the growth and expansion of the Company.

Income Taxes

The provision for income tax expense decreased $33 thousand, or 49%, compared to the three months ended March 31, 2013 and decreased $33 thousand or 37%, compared to the months ended March 31, 2013. The decreases are attributable to a reduction in taxes paid by our foreign subsidiary in India. Income tax expense represents the estimated liability for federal and state income taxes owed, including the alternative minimum tax. We have net operating loss carryforwards and other deferred tax benefits that are available to offset future taxable income.

Adjusted EBITDA

We also measure our performance based on a non-GAAP (“Generally Accepted Accounting Principles”) measurement of earnings before interest, taxes, depreciation, and amortization and before stock-based compensation expense and impairment of goodwill and intangible assets (“Adjusted EBITDA”).

We believe this non-GAAP financial measure of Adjusted EBITDA is useful to management and investors in evaluating our operating performance for the periods presented and provide a tool for evaluating our ongoing operations.

Adjusted EBITDA, however, is not a measure of operating performance under GAAP and should not be considered as an alternative or substitute for GAAP profitability measures such as (i) income from operations and net income, or (ii) cash flows from operating, investing and financing activities, both as determined in accordance with GAAP. Adjusted EBITDA as an operating performance measure has material limitations since it excludes the financial statement impact of income taxes, net interest expense, amortization of intangibles, depreciation, other amortization and stock-based compensation, and therefore does not represent an accurate measure of profitability. As a result, Adjusted EBITDA should be evaluated in conjunction with net income for a complete analysis of our profitability, as net income includes the financial statement impact of these items and is the most directly comparable GAAP operating performance measure to Adjusted EBITDA. Our definition of Adjusted EBITDA may also differ from and therefore may not be comparable with similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. Because of the limitations that Adjusted EBITDA has as an analytical tool, investors should not consider it in isolation, or as a substitute for analysis of our operating results as reported under GAAP.

The following table reconciles net (loss) income (which is the most directly comparable GAAP operating performance measure) to EBITDA, and EBITDA to Adjusted EBITDA (in thousands):

	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Net loss	$	(2,314	)	$	(687	)	$	(3,091	)	$	(1,329	)
Provision for income tax		35			68			56			89
Interest expense, net		167			59			334			135
Amortization of intangible assets		216			118			341			274
Depreciation		325			272			647			540
EBITDA		(1,571	)		(170	)		(1,713	)		(291	)
Other amortization		152			35			272			79
Stock based compensation		125