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. 

 

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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.

 

Our auditors identified material weaknesses in our internal control over financial reporting as of September 30, 2006. Failure to achieve and maintain effective internal control over financial reporting could result in our failure to accurately report our financial results.

 

In connection with its audit of our financial statements, our external auditors, UHY LLP, advised us that they were concerned that as of and for the year ended September 30, 2006, our accounting resources did not include enough people with the detailed knowledge, experience and training in the selection and application of certain accounting principles generally accepted in the United States of America (GAAP) to meet our financial reporting needs. This control deficiency contributed to material weaknesses in internal control with respect to accounting for revenue recognition, equity and acquisitions. A “material weakness” is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement in the financial statements or related disclosures will not be prevented or detected. In preparation for this offering, we engaged a consultant experienced in accounting and financial reporting who assisted us in preparing our financial statements. We have begun the process of identifying candidates to assume newly created positions in our company, one of which will be at the vice-president level, with specific responsibilities for external financial reporting, internal control, revenue recognition and purchase accounting. We intend to have these resources in place sometime during the third quarter of fiscal year 2007. We estimate that the annual cost of the new positions referred to above will be between $250,000 and $350,000. In addition, we expect to incur significant additional costs in the future. While we expect to complete the process of bringing our internal control documentation into compliance with SOX Section 404 as quickly as possible, we cannot at this time estimate how long it will take to complete the process or its ultimate cost. We expect such costs to be significant.

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.

 

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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 74 of this prospectus.

Increasing government regulation could affect our business and may adversely affect our financial condition. 

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  

 

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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 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.

 

 

SHARES ELIGIBLE FOR FUTURE SALE

 

Upon completion of this offering, we will have outstanding 7,277,250 shares of common stock (including the 3,000,000 shares of common stock issued in this offering, and assuming no exercise of the underwriters’ over-allotment) without taking into account any options or warrants that may be granted or exercised. Upon completion of this offering, we will have options outstanding to purchase 869,432 shares of common stock and warrants outstanding to purchase 727,852 shares of common stock (including warrants to purchase 150,000 shares of our common stock issued to the underwriters in this offering).

 

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

 

 

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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 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.

 

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UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting agreement dated as of June 28, 2007 (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 Gunnar & Co., LLC		1,300,000
Security Research Associates, Inc.		1,000,000
Maxim Group LLC		300,000
vFinance Investments, Inc.		300,000
Newbridge Securities Corporation		100,000
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 $0.25 per share. Securities dealers may re-allow a concession not in excess of $0.10 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 $17,250,000, the total underwriters’ discounts and commissions would be $1,380,000, and total proceeds to us would be $15,870,000.

 

Underwriting Compensation

The underwriters will purchase the shares offered hereby at a discount of 8% of the initial public offering price (or $0.40 per share). We have agreed to pay the representative of the underwriters a non-accountable expense allowance equal to 2% of the gross proceeds from the sale of the shares offered hereby. Our agreement with the underwriters also provides that we will pay all expenses in connection with qualifying the shares for sale under the laws of those states as the underwriter may designate and the costs of review by the NASD of the underwriting arrangements between the underwriters and us. We have paid

 

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$25,000 as an advance against the expense allowance, which will reduce the expense allowance payable at the closing of the offering. If this offering is not completed, the representative will refund any portion of the $25,000 that exceeds their non-accountable expenses.

 

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 5% 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 at a price per share equal to 150% 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. Pursuant to NASD Conduct Rules, this warrant may not be sold, transferred, assigned or otherwise disposed of, or be the subject of any short, put or call transaction, for a period of 180 days immediately following the effectiveness of the registration statement of which this prospectus is a part the or commencement of sales in this offering.

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. We have agreed to reimburse the underwriters’ legal counsel’s fees in an amount not to exceed $100,000, which is deemed an item of value under NASD Conduct Rules.

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.

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Indemnification

We have agreed to indemnify the underwriters against certain civil liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect of any such liabilities.

LEGAL MATTERS

Morse, Barnes-Brown & Pendleton, P.C., Waltham, Massachusetts, has acted as our counsel in connection with this offering, including with respect to the validity of the issuance of the common stock offered in this prospectus. Certain legal matters will be passed upon for the underwriters by Cozen O’Connor, Washington, D.C.

 

EXPERTS

The consolidated financial statements of Bridgeline Software, Inc. at September 30, 2006 and 2005 and for the years then ended, the financial statements of Objectware, Inc. at September 30, 2006 and 2005 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 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.

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BRIDGELINE SOFTWARE, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

		Page
UNAUDITED COMBINED PRO FORMA CONDENSED FINANCIAL STATEMENTS OF BRIDGELINE SOFTWARE, INC., OBJECTWARE, INC. AND NEW TILT, INC.:
Introduction to Unaudited Combined Pro Forma Condensed Financial Statements		F – 3
Unaudited Combined Pro Forma Condensed Balance Sheet at March 31, 2007		F – 4
Unaudited Combined Pro Forma Condensed Statement of Operations for the six months ended March 31, 2007		F – 8
Unaudited Combined Pro Forma Condensed Statement of Operations for the year ended September 30, 2006		F – 11
BRIDGELINE SOFTWARE, INC.:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		F – 17
Consolidated Balance Sheets of Bridgeline Software, Inc. at March 31, 2007 and September 30, 2006 and 2005		F – 18
Consolidated Statements of Operations for Bridgeline Software Inc. for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005		F – 19
Consolidated Statements of Shareholders’ Equity for Bridgeline Software, Inc. for the six months ended March 31, 2007 and the years ended September 30, 2006 and 2005		F – 20
Consolidated Statements of Cash Flows for Bridgeline Software, Inc. for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005		F – 21
Notes to Consolidated Financial Statements		F – 22

F-1

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BRIDGELINE SOFTWARE, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS  

 

 

OBJECTWARE, INC.:		Page
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS		F – 58
Balance Sheets for Objectware, Inc. at March 31, 2007 and September 30, 2006 and 2005		F – 59
Statements of Operations for Objectware, Inc. for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005		F – 60
Statements of Shareholder’s Equity for Objectware, Inc. for the six months ended March 31, 2007 and the years ended September 30, 2006 and 2005		F – 61
Statements of Cash Flows for Objectware, Inc. for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005		F – 62
Notes to Financial Statements		F – 63
NEW TILT, INC.:
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS		F – 75
Balance Sheets for New Tilt, Inc. at April 24, 2006 and at December 31, 2005		F – 76
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 – 77
Statements of Shareholders’ 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 – 78
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 – 79
Notes to Financial Statements		F – 80

F-2

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BRIDGELINE SOFTWARE, INC.

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

The Unaudited Combined Pro Forma Financial Statements give effect to the receipt and application of the proceeds from the sale of securities to be offered in this Registration Statement pursuant to a firm underwriting commitment as defined in Rule 170.

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 Company expects that the allocation of purchase price will be finalized within 90 days of the closing of the transaction. Such purchase price adjustments will reflect the fair value of the assets and liabilities acquired at the date of closing. Subsequent to the closing, the purchase price for Objectware will be adjusted as necessary for contingent earn-out consideration when earned. The Company is not aware of any other contingencies that would affect the allocation of purchase price.

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 and New Tilt 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.

 

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BRIDGELINE SOFTWARE, INC.

UNAUDITED COMBINED PRO FORMA CONDENSED BALANCE SHEET

MARCH 31, 2007

(Dollars 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 March 31, 2007. The pro forma adjustments reflect the Use of Proceeds from the Offering as though it were completed on March 31, 2007 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 March 31, 2007.

 

						Probable				Pro Forma					Pro Forma
						Acquisition				Acquisition					Offering
						Historical				Adjustments					Adjustments				Pro Forma
		Historical				(Note 1)				(Note 2)					(Note 3)				Combined
ASSETS
Cash and cash equivalents		$	96			$	422			$	(3,527	)(a)			$	10,155	(k)		$	7,146
Accounts receivable and other current assets			1,398				607				(82	)(b)				—				1,923
Total current assets			1,494				1,029				(3,609	)				10,155				9,069
Other assets			1,153				407				(66	)(c)				(474	)(l)			1,020
Intangible assets, net			241				—				409	(d)				—				650
Goodwill			6,496				—				4,849	(e)				—				11,345
Total assets		$	9,384			$	1,436			$	1,583				$	9,681			$	22,084
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Short-term debt, net of discount		$	2,769			$	—			$	—				$	(2,769	)(m)		$	—
Current liabilities and accrued expenses			2,049				281				(154	)(f)				—				2,176
Total current liabilities			4,818				281				(154	)				(2,769	)			2,176
Other liabilities			73				252				(243	)(g)				—				82
Total liabilities			4,891				533				(397	)				(2,769	)			2,258
Shareholders’ equity:
Common stock			4				2				(2	)(h)				3	(n)			7
Additional paid-in capital			9,980				—				2,883	(i)				12,510	(o)			25,373
Accumulated earnings (deficit)			(5,491	)			901				(901	)(j)				(63	)(p)			(5,554	)
Total shareholders’ equity			4,493				903				1,980					12,450				19,826
Total liabilities and shareholders’ equity		$	9,384			$	1,436			$	1,583				$	9,681			$	22,084

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

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED BALANCE SHEET

MARCH 31, 2007

(Dollars 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 March 31, 2007.

The following table summarizes the estimated the purchase price allocation and estimated fair values of the assets and liabilities to be acquired at the closing date of the proposed Objectware acquisition:

		Historical at March  31, 2007				Estimated Fair Value on Acquisition Date
Net assets acquired:
Cash		$	422			$	200
Other current assets			529				450
Equipment			166				100
Other assets			319				316
Intangible assets			—				409
Goodwill			—				4,849

Total assets		$	1,436				6,324
Accrued income taxes payable		$	94				—
Current liabilities			67				67
Deferred revenues, current			120				60
Deferred revenues, long-term			240				—
Deferred tax liabilities			12				9
Total liabilities			533				136
Total equity			903
Total liabilities and equity		$	1,436
Net assets acquired						$	6,188
Purchase price:
Cash paid						$	2,580
Equity exchanged							2,700
Options exchanged							183
Closing costs and fees							725
Total purchase price consideration						$	6,188

 

F-5

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED BALANCE SHEET

MARCH 31, 2007

(Dollars in thousands)

If the acquisition of Objectware is completed, the Company may be required to pay additional consideration and contingent consideration in accordance with the terms of the acquisition agreement. In addition, we may be required to pay additional consideration and issue additional shares (to be determined at the offering price) at the closing resulting from a purchase price adjustment computation should Objectware’s working capital as defined in the acquisition agreement, exceed $750. Any additional potential consideration to be paid will be in the form of cash (60%) and common stock (40%, valued at the offering price), however the Company is unable to determine whether such adjustment will be required until the closing.

The Company may also be required to pay additional contingent consideration up to $1,800 in the form of additional purchase price of which up to $800 will be payable in cash, quarterly over the three years subsequent to the closing of this acquisition. These payments are contingent upon Objectware generating positive earnings before interest, taxes and depreciation and amortization (“EBITDA”) of at least $250 per calendar quarter during the 12 consecutive calendar quarters following the acquisition.

The fair market value of the following assets are estimated in the pro forma presentation.

Intangible assets - The Company estimates a fair value of $409 to be assigned to intangible assets in its purchase price allocation. These assets are identified as the estimated fair value of customer relationships ($345) and the estimated fair value of the non-competition provision of employment agreements ($64) as determined using a discounted cash flow model prepared by management. Management estimates the useful life of these intangible assets to be five years.

Equipment - Based on an internal analysis of the fixed asset register provided by Objectware, the Company has estimated the fair value of equipment expected to have continuing value to the Company subsequent to the acquisition to be $100.

 

2.	Pro Forma Acquisition Adjustments

(a) $3,527 represents cash consideration paid, including expenses, in the Objectware acquisition.

(b) $82 represents a net adjustment of deferred tax assets against deferred tax liabilities of $3 (see (g) below) and an adjustment to accounts receivable of $79 to reflect a reduction in required working capital at the effective date of the acquisition.

(c) based on an internal analysis of the fixed asset register provided by Objectware, the Company has estimated that the fair value of such assets that will have a continuing value to the Company will be $100, resulting in an adjustment of $66.

(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 as described in Note (1) above.

(e) $4,849 represents the excess of the cost of the probable acquisition over the net amounts assigned to acquired assets and liabilities as detailed in Note (1) above.

(f) $154 represents the total of $94 of Objectware’s income taxes payable that will be not be assumed by the Company and $60 of current deferred revenue related to a service arrangement of Objectware, the performance of which has been completed. Objectware has extended the payment terms offered to a certain customer. There are no services remaining to be delivered in connection with this arrangement and revenue associated with the receivable has been deferred by Objectware. Since this deferred revenue does not represent a legal performance obligation of the Company at the time of the acquisition, it will not be recognized as a liability at the time of acquisition consistent with paragraph 5 of EITF 01-3, Accounting in a Business Combination for Deferred Revenue of an Acquiree.

(g) $243 represents $240 of non-current deferred revenue related to service arrangements of Objectware, the performance of which has been completed (see (f) above) and $3 net adjustment of deferred tax assets against deferred tax liabilities.

 

F-6

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED BALANCE SHEET

MARCH 31, 2007

(Dollars in thousands)

(h) $2 represents the effect of the elimination of Objectware’s common stock outstanding as detailed in Note (1) above.

(i) $2,883 represents the effect of the issuance of the Company’s common stock in connection with the probable acquisition of Objectware as detailed in Note (1) above.

(j) $901 represents the effect of the elimination of Objectware’s accumulated earnings (see (a) above).

 

3.	Pro Forma offering Adjustments

The Unaudited Combined Pro Forma Financial Statements give effect to the receipt and application of the proceeds from the sale of securities to be offered in this Registration Statement pursuant to a firm underwriting commitment as defined in Rule 170.

(k) $10,155 represents net cash received in the offering ad detailed below and as described in the Use of Proceeds.

 

·  Gross proceeds		$	15,000
·  Underwriter discount and fees			(1,500	)
·  Legal, accounting and other fees			(545	)
·   Net proceeds of the offering			12,955
Repayment of senior notes			(2,800	)
Net cash received		$	10,155

(l) $474 represents the total of $32 of unamortized debt fees incurred in connection with issuance of the Senior Notes Payable that will be amortized in accordance with APB 26, Early Extinguishment of Debt, when the notes are paid from the Proceeds of the offering as described above and  in the Use of Proceeds, and $442 of deferred costs associated with the offering that will be charged to additional paid in capital when the offering is completed. Deferred offering costs consist of accounting, underwriter and legal fees directly related to the offering.

(m) $2,769 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 $31 unamortized discount on debt that will be amortized in full when the notes are paid in accordance with APB 26, Early Extinguishment of Debt.

(n) $3 represents the effect of the expected issuance of the Company’s common stock in connection with the offering.

(o) $12,510 represents the effect of the issuance of the Company’s common stock in connection with the offering.

(p) $63 represents the effect of $32 and $31 of costs to be fully amortized as discussed above in (l) and (m), respectively.

 

F-7

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BRIDGELINE SOFTWARE, INC.

UNAUDITED COMBINED PRO FORMA CONDENSED STATEMENT OF OPERATIONS

FOR THE SIX MONTHS ENDED MARCH 31, 2007

(Dollars in thousands, except per share amounts)

The following unaudited combined pro forma condensed statement of operations for the six months ended March 31, 2007 reflects adjustments related to the effects of the Offering, the probable acquisition of Objectware as if these events occurred as of the beginning of the period on October 1, 2006.

						Probable				Pro Forma				Pro Forma
						Acquisition				Acquisition				Offering
						Historical				Adjustments				Adjustments				Pro Forma
		Historical				(Note 1)				(Note 2)				(Note 3)				Combined
Revenue:
Web services		$	3,684			$	2,111			$	—			$	—			$	5,795
Managed services			597				513				—				—				1,110
Subscriptions			251				—				—				—				251
Total revenue			4,532				2,624				—				—				7,156
Cost of revenue			2,156				1,179				133	(a)			—				3,468
Gross profit			2,376				1,445				(133	)			—				3,688
Operating expenses:
Sales and marketing			1,577				—				—				—				1,577
Technology development			346				—				—				—				346
General and administrative expenses			1,095				1,508				(872	)(b)			—				1,731
Total operating expenses			3,018				1,508				(872	)			—				3,654
Income (loss) from operations			(642	)			(63	)			739				—				34
Other income (expenses):
Other income (expense)			—				40				—				—				40
Interest expense			(686	)			—				—				674	(c)			(12	)
Income (loss) before income taxes			(1,328	)			(23	)			739				674				62
Provision (benefit) for income taxes (Note 4)			—				—				(43	)			—				(43	)
Net income (loss)		$	(1,328	)		$	(23	)		$	696			$	674			$	19
Net income (loss) per share:
Basic		$	(0.31	)														$	0.00
Diluted		$	(0.31	)														$	0.00
Number of weighted average shares (Note 5):
Basic			4,275,107												1,978,909	(d)			6,254,016
Diluted			4,275,107												3,417,596	(e)			7,692,703

 

 

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

 

F-8

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE SIX MONTHS ENDED MARCH 31, 2007

(Dollars in thousands)

1.   Probable Acquisition of Objectware 

 

The amounts represent the historical operating results of Objectware for the six months ended March 31, 2007.

2.   Pro Forma Acquisition Adjustments 

 

The following adjustments assume the transactions described above occurred on October 1, 2006.

(a)  The $133 net increase in cost of revenues represents the effect of the following items:

 

(i)

$41 increase in amortization and depreciation expense resulting from the values assigned to intangible assets and property of Objectware upon acquisition. In accordance with Note 1 to the Unaudited Combined Pro Forma Condensed Balance Sheet as of March 31, 2007, the Company estimates that $409 in purchase price will be allocated to intangible assets, which will be amortized over a five year period resulting in a Pro Forma effect of $41.

(ii)

$92 increase resulting from a reclassification of overhead expenses to cost of sales to conform to the Company’s accounting policy. In accordance with Objectware’s accounting policy, cost of sales consists solely of direct labor and contract labor. The Company’s cost of sales includes direct labor, contract labor and associated overhead costs. The Company intends to conform Objectware’s accounting policy to the Company’s upon closing of the acquisition and, accordingly, an adjustment for the applicable overhead based on the Company’s policy has been reclassified from general and administrative expenses to cost of sales (see (b)(iii) below).

(b) The $872 decrease in general and administrative expenses represents the effect of the following items:

 

(i)

$761 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. Upon the closing of the Objectware acquisition, the former owner of Objectware will execute an employment agreement with a stated compensation of $250, including bonus. The pro forma adjustment takes into account the difference between actual compensation paid for the six months ending March 31, 2007 ($886) and the pro forma contractual rate ($125) for the period.

(ii)

$19 decrease in depreciation expense resulting from the values assigned to property and equipment for Objectware. The pro forma adjustment reflects the difference in actual depreciation expense for the six months ending March 31, 2007 ($34) and the pro forma depreciation expense computed based upon the estimated fair value assigned to property and equipment at the date of acquisition in accordance with Note 1 to the Unaudited Combined Pro Forma Condensed Balance Sheet as of March 31, 2007.

(iii)

$92 decrease resulting from a reclassification of overhead expenses to cost of sales to conform to the Company’s accounting policy (see Note (a)(ii) above).

 

F-9

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE SIX MONTHS ENDED MARCH 31, 2007

(Dollars in thousands)

3.   Pro Forma Offering Adjustments 

 

The Unaudited Combined Pro Forma Financial Statements give effect to the receipt and application of the proceeds from the sale of securities to be offered in this Registration Statement pursuant to a firm underwriting commitment as defined in Rule 170.

The following adjustments assume the transactions described above occurred on October 1, 2006.

(c) The $674 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 $43 increase in income tax expense is the result of state income expense resulting from the pro forma net income derived from combining Objectware as of the beginning of the period on October 1, 2006. The Company’s net operating loss carryforwards are sufficient offsets all federal taxable income such that no federal income tax expense would be incurred for the six months ended March 31, 2007.

 

 

5.  Weighted Average Shares Outstanding

(d)  The shares expected to be issued in connection with the probable acquisition of Objectware and shares issued in the offering related to pro forma adjustments above 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, 2006.  The Pro Forma share adjustments are as follows:

●	Issuance of 509,091 shares from the offering to repay senior notes payable of $2,800,000.

●	Issuance of 421,636 shares from the offering to pay underwriter, accounting, legal and other fees totaling $2,319,000.

●	Issuance of 557,273 shares from the offering as partial consideration representing the cash portion and fees pursuant to the Objectware acquisition totaling $3,065,000.

●	Issuance of 540,000 shares as partial consideration pursuant to the Objectware acquisition totaling $2,700,000.

(e)  Diluted weighted average shares are calculated utilizing the treasury stock method whereby the basic weighted average shares of 4,275,107 are increased by the Pro Forma adjustments of 1,978,909 plus the dilutive effect of the weighted average “in-the-money” options of 860,580 and warrants of 578,107.

F-10

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BRIDGELINE SOFTWARE, INC.

UNAUDITED COMBINED PRO FORMA CONDENSED STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2006

(Dollars in thousands, except per share amounts)

 

 

The following unaudited combined pro forma condensed statement of operations for the year ended September 30, 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								Pro Forma
						Acquisition				Probable				Acquisition				Pro Forma
						Historical				Acquisition				Adjustments				Adjustments				Pro Forma
		Historical				(Note 1)				(Note 2)				(Note 3)				(Note 4)				Combined
Revenue:
Web services		$	6,525			$	919			$	3,120			$	—			$	—			$	10,564
Managed services			1,243				—				782				—				—				2,025
Subscriptions			467				—				—				—				—				467
Total revenue			8,235				919				3,902				—				—				13,056
Cost of revenue			3,809				851				1,764				229	(a)			—				6,653
Gross profit			4,426				68				2,138				(229	)			—				6,403
Operating expenses:
Sales and marketing			3,227				77				—				—				—				3,304
Technology development			176				—				—				—				—				176
General and administrative expenses			1,833				301				1,400				(425	)(b)							3,109
Total operating expenses			5,236				378				1,400				(425	)			—				6,589
Income (loss) from operations			(810	)			(310	)			738				196				—				(186	)
Other income (expenses):
Other income (expense)			—				10				58				—				—				68
Interest expense			(638	)			(2	)			(1	)			—				624	(c)			(17	)
Income (loss) before income taxes			(1,448	)			(302	)			795				196				624				(135	)
Provision (benefit) for income taxes (Note 5)			—				—				309				—				(252	)			57
Net income (loss)		$	(1,448	)		$	(302	)		$	486			$	196			$	876			$	(192	)
Net income (loss) per share:
Basic		$	(0.36	)																		$	(0.03	)
Diluted		$	(0.36	)																		$	(0.03	)
Number of weighted average shares (Note 6):
Basic and Diluted			4,046,278																2,290,586				6,336,864

 

 

 

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

 

F-11

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2006

(Dollars 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 for the period October 1, 2005 to December 31, 2005, which were derived from the accounting records of New Tilt for such period combined with New Tilt’s results of operations from January 1, 2006 through the date of acquisition which are included in the audited financial statements of New Tilt appearing elsewhere in this Registration Statement and are summarized below:

		October 1, 2005 to December 31, 2005				January 1, 2006 to April 24, 2006				October 1, 2005 to April 24, 2006
Revenue		$	515			$	404			$	919
Cost of revenue			459				392				851
Gross Margin			56				12				68
Sales and marketing			36				41				77
General and administrative expenses			131				170				301
Total operating expenses			167				211				378
Loss from operations			(111	)			(199	)			(310	)
Other income			—				10				10
Interest expense			—				(2	)			(2	)
Loss before taxes			(111	)			(191	)			(302	)
Provision (benefit) for income taxes			—				—				—
Net loss		$	(111	)		$	(191	)		$	(302	)

 

 

 

 

F-12

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2006

(Dollars in thousands)

 

 

The following table summarizes the purchase price allocation and fair values assigned to the assets and liabilities acquired in the New Tilt acquisition:

		Historical at April 24, 2006				Fair Value on Acquisition Date
Net assets acquired:
Cash		$	159			$	159
Other current assets			181				181
Equipment			61				56
Other assets			11				59
Intangible assets			—				91
Goodwill			—				1,123

Total assets		$	412				1,669
Current liabilities		$	98				70
Deferred tax liabilities			—				49
Total liabilities			98				119
Total equity			314
Total liabilities and equity		$	412
Net assets acquired						$	1,550
Purchase price:
Cash paid						$	550
Equity exchanged							717
Warrants issued and options exchanged							121
Closing costs and fees							162
Total purchase price consideration						$	1,550

In addition to the consideration paid at closing, the Company may be required to pay contingent consideration in the form of additional purchase price of up to $750 payable in cash, quarterly over the three years subsequent to the closing of this acquisition. These payments are contingent upon New Tilt generating positive earnings before interest, taxes and depreciation and amortization (“Post-Merger EBITDA”) each calendar quarter during the 12 consecutive calendar quarters following the acquisition. As of March 31, 2007, $144 has been paid as additional consideration to the former owners of New Tilt in the form of earn-out.

The fair market value of the following assets are estimated in the pro forma presentation.

F-13

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2006

(Dollars in thousands)

Intangible assets - The Company allocated a fair value of $91 to intangible assets in its purchase price allocation. These assets are identified as the estimated fair value of customer relationships ($29) and the estimated fair value of the non-competition provision of employment agreements ($62) as determined using a discounted cash flow model prepared by management. Management estimates the useful life of these intangible assets to be five years.

Equipment - The Company has estimated the fair value of equipment to be $56 based on an internal analysis of the fixed asset register provided by New Tilt. For pro forma presentation, the Company has utilized its fixed asset depreciation policy as detailed in Note 1 to the financial statements, whereby depreciation is computed by use of the straight-line method over the estimated useful lives of the related assets (three years for computer hardware and software and five years for office furniture and equipment).

 

2.   Probable Acquisition of Objectware

 

The amounts represent the historical operating results of Objectware for the twelve months September 30, 2006. Please refer to Note 1 of the Unaudited Combined Pro Forma Condensed Balance Sheet as of March 31, 2007 for the estimated purchase price allocation of the Objectware acquisition.

 

3.   Pro Forma Acquisition Adjustments

 

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

(a)           The $229 net increase in cost of revenues represents the effect of the following items:

 

	(i)	$93 increase in amortization expense resulting from the values assigned to intangible assets of New Tilt ($11) and Objectware ($82) upon acquisition. In accordance with Note 1 to the Unaudited Combined Pro Forma Condensed Statement of Operations for the year ended September 30, 2006, the Company has allocated $91 of the New Tilt purchase price to intangible assets, which is amortized over a five year period resulting in a pro forma effect of $11. In accordance with Note 1 to the Unaudited Combined Pro Forma Condensed Balance Sheet as of March 31, 2007, the Company estimates that $409 in purchase price for Objectware will be allocated to intangible assets, which will be amortized over a five year period resulting in a Pro Forma effect of $82.
	(ii)	$19 decrease in New Tilt’s stock-based compensation in order to conform to the Company’s accounting policy; this pro forma adjustment is the result of stock compensation expenses computed pursuant to New Tilt’s accounting policy in accordance with SFAS 123R ($19) as compared to the stock compensation expense that would have been recorded in accordance with the Company’s accounting policy under the intrinsic value method in accordance with APB 25 ($0).
	(iii)	$155 increase resulting from a reclassification of period expenses to cost of sales to conform to the Company’s accounting policy. In accordance with Objectware’s accounting policy, cost of sales consists solely of direct labor and contract labor. The Company’s cost of sales includes direct labor, contract labor and associated overhead costs. The Company intends to conform Objectware’s accounting policy to the Company’s upon closing of the acquisition and, accordingly, an adjustment for the applicable overhead based on the Company’s policy has been reclassified from general and administrative expenses to cost of sales (see Note (b)(iv) below).

 

(b)           The $425 decrease in general and administrative expenses represents the effect of the following items:

 

F-14

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2006

(Dollars in thousands)

 

	(i)	$208 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. Upon the closing of the Objectware acquisition, the former owner of Objectware will execute an employment agreement with a stated compensation of $250, including bonus. The pro forma adjustment takes into account the difference between actual compensation paid for the year ended September 30, 2006 ($458) and the pro forma contractual rate ($250) for the period.
	(ii)	$41 decrease in depreciation expense resulting from the values assigned to property and equipment for New Tilt $(12) and Objectware ($29). The pro forma adjustment reflects the difference in actual depreciation expense for the year ended September 30, 2006 for New Tilt ($24) and Objectware ($59) and the pro forma depreciation expense computed based upon the estimated fair value assigned to property and equipment at the date of acquisition in accordance with Note 1 to the Unaudited Combined Pro Forma Condensed Balance Sheet as of March 31, 2007.

	(iii)	$21 decrease in New Tilt’s stock-based compensation in order to conform to the Company’s accounting policy; this pro forma adjustment is the result of stock compensation expenses computed pursuant to New Tilt’s accounting policy in accordance with SFAS 123R ($21) as compared to the stock compensation expense that would have been recorded in accordance with the Company’s accounting policy under the intrinsic value method in accordance with APB 25 ($0).
	(iv)	$155 decrease resulting from a reclassification of period expenses to cost of sales to conform to the Company’s accounting policy (see Note (a)(iii) above).

 

4.   Pro Forma Offering Adjustments

The Unaudited Combined Pro Forma Financial Statements give effect to the receipt and application of the proceeds from the sale of securities to be offered in this Registration Statement pursuant to a firm underwriting commitment as defined in Rule 170.

 

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

(c)  The $624 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

 

5.   Income Taxes

 

The $252 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 year ended September 30, 2006.

 

6.   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 and shares issued in the offering related to pro forma adjustments above are included in the computation of weighted average shares outstanding as if these shares were

F-15

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BRIDGELINE SOFTWARE, INC.

NOTES TO UNAUDITED COMBINED PRO FORMA CONDENSED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED SEPTEMBER 30, 2006

(Dollars in thousands)

 

 

issued as of the beginning of the period on October 1, 2005. The Pro Forma share adjustments are as follows:

 

●	Issuance of 509,091 shares from the offering to repay senior notes payable of $2,800,000.

●	Issuance of 421,636 shares from the offering to pay underwriter, accounting, legal and other fees totaling $2,319,000.

●	Issuance of 557,273 shares from the offering as partial consideration representing the cash portion and fees pursuant to the Objectware acquisition totaling $3,065,000.

●	Issuance of 540,000 shares as partial consideration pursuant to the Objectware acquisition totaling $2,700,000.

●	Pro Forma effect of issuing an additional 182,222 shares as partial consideration pursuant to the New Tilt acquisition as if the acquisition had occurred as of the beginning of the period on October 1, 2005.

●	Pro Forma effect of issuing 129,455 shares from the offering as partial consideration representing the cash portion and fees pursuant to the New Tilt acquisition totaling $712,000, as if the acquisition had occurred as of the period on October 1, 2005.

 

 

F-16

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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, 2006 and 2005 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, 2006 and 2005 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 $2,020,000 and accumulated deficit of approximately $4,163,000 at September 30, 2006 and will need to repay its senior debt obligations of $2,800,000 and related interest during fiscal year 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

February 5, 2007, except for the

fifth paragraph of Note 11 to which

the date is June 20, 2007
 

F-17

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BRIDGELINE SOFTWARE, INC.

CONSOLIDATED BALANCE SHEETS

(Information as of March 31, 2007 is Unaudited)

(Dollars in thousands, except per share data)

 

 

ASSETS		March 31,				September 30,
		2007				2006				2005
Current assets:
Cash and cash equivalents		$	96			$	591			$	138
Accounts receivable (less allowance for doubtful accounts of $52, $52 and $58, respectively)			985				810				605
Unbilled receivables			332				633				167
Prepaid expenses and other current assets			81				39				25
Total current assets			1,494				2,073				935
Equipment and improvements, net			364				429				267
Definite-lived intangible assets, net			241				303				331
Goodwill			6,496				6,346				5,097
Deferred financing fees, net			32				273				—
Other assets			757				400				109
Total assets		$	9,384			$	9,824			$	6,739
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Senior notes payable		$	2,769			$	2,497			$	—
Financing agreement			—				—				292
Capital lease obligations - current			49				45				11
Notes payable to shareholders - current			—				—				85
Accounts payable			856				581				272
Deferred revenue			401				264				183
Accrued liabilities			743				706				271
Total current liabilities			4,818				4,093				1,114
Capital lease obligations, less current portion			73				99				33
Total liabilities			4,891				4,192				1,147
Commitments and contingencies
Shareholders’ equity:
Preferred stock — $0.001 par value; 1,000,000 shares authorized;      none issued and outstanding			—				—				—
Common stock — $0.001 par value; 20,000,000 shares authorized:     4,277,250; 4,273,833 and 3,903,833 shares issued and outstanding,     respectively			4				4				4
Additional paid-in capital			9,980				9,791				8,303
Accumulated deficit			(5,491	)			(4,163	)			(2,715	)
Total shareholders’ equity			4,493				5,632				5,592
Total liabilities and shareholders’ equity		$	9,384			$	9,824			$	6,739

 

 

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

 

F-18

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BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Information for the Six Months Ended March 31, 2007 and 2006 is Unaudited)

(Dollars in thousands, except per share data)

 

 

 

		Six Months Ended March 31,								Year Ended September 30,
		2007				2006				2006				2005
Revenue:
Web services		$	3,684			$	2,760			$	6,525			$	4,182
Managed services			597				578				1,243				1,244
Subscription			251				231				467				343
Total revenue			4,532				3,569				8,235				5,769
Cost of revenue:
Web services			1,995				1,486				3,389				2,629
Managed services			146				153				363				457
Subscription			15				30				57				27
Total cost of revenue			2,156				1,669				3,809				3,113
Gross profit			2,376				1,900				4,426				2,656
Operating expenses:
Sales and marketing			1,577				1,163				3,227				2,060
General and administrative			1,095				753				1,833				1,014
Technology development			346				52				176				43
Total operating expenses			3,018				1,968				5,236				3,117
Loss from operations			(642	)			(68	)			(810	)			(461	)
Interest expense			(686	)			(52	)			(638	)			(56	)
Loss before income taxes			(1,328	)			(120	)			(1,448	)			(517	)
Income taxes			—				—				—				—
Net loss		$	(1,328	)		$	(120	)		$	(1,448	)		$	(517	)
Net loss per share:
Basic and diluted		$	(0.31	)		$	(0.03	)		$	(0.36	)		$	(0.14	)
Number of weighted average shares:
Basic and diluted			4,275,107				3,903,833				4,046,278				3,804,527

 

 

 

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

 

F-19

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BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 is Unaudited)

(Dollars in thousands)

 

 

 

										Additional								Total
		Common Stock								Paid-in				Accumulated				Shareholders’
		Shares				Par Value				Capital				Deficit				Equity
Balance, September 30, 2004			3,427,166			$	3			$	6,069			$	(2,198	)		$	3,874
Issuance of stock and warrants 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				—				838				—				838
Exercise of warrants			50,000				—				—				—				—
Issuance of common stock warrants in private placement of debt			—				—				646				—				646
Stock based compensation			—				—				4				—				4
Net loss			—				—				—				(1,448	)			(1,448	)
Balance, September 30, 2006			4,273,833				4				9,791				(4,163	)			5,632
Stock based compensation			—				—				176				—				176
Exercise of stock options			3,000				—				12				—				12
Exercise of stock warrants			417				—				1				—				1
Net loss			—				—				—				(1,328	)			(1,328	)
Balance, March 31, 2007			4,277,250			$	4			$	9,980			$	(5,491	)		$	4,493

 

 

 

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

F-20

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BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Information as of March 31, 2007 and 2006 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

(Dollars in thousands)

 

 

		Six Months Ended March 31,								Year Ended September 30,
Cash flows from operating activities:		2007				2006				2006				2005
Net loss		$	(1,328	)		$	(120	)		$	(1,448	)		$	(517	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation			105				62				186				106
Amortization of intangible assets			62				55				119				94
Amortization of debt discount and deferred financing fees			513				—				436				7
Stock based compensation			176				2				4				8
Gain on sale of assets			(1	)			—				—				—
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable and unbilled receivables			126				(69	)			(498	)			245
Other assets			(399	)			(149	)			(287	)			3
Accounts payable and accrued liabilities			412				115				721				(136	)
Deferred revenue			37				234				34				(240	)
Total adjustments			1,031				250				715				87
Net cash provided by (used in) operating activities			(297	)			130				(733	)			(430	)
Cash flows from investing activities:
Acquisitions, net of cash acquired			—				—				(553	)			(310	)
Proceeds from sale of assets			16				—				—				—
Contingent acquisition payments			(150	)			(42	)			(126	)			(113	)
Equipment and improvements expenditures			(55	)			(27	)			(163	)			(122	)
Net cash used in investing activities			(189	)			(69	)			(842	)			(545	)
Cash flows from financing activities:
Proceeds from issuance of senior notes payable, net of deferred costs			—				—				2,434				—
Proceeds from / payments on financing agreement, net			—				(24	)			(292	)			292
Proceeds from exercise stock options and warrants			13				—				—				—
Principal payments on capital leases			(22	)			(1	)			(29	)			(49	)
Principal payments on notes payable to shareholders			—				(40	)			(85	)			(86	)
Net cash provided by (used in) financing activities			(9	)			(65	)			2,028				157
Net increase (decrease) in cash			(495	)			(4	)			453				(818	)
Cash and cash equivalents at beginning of period			591				138				138				956
Cash and cash equivalents at end of period		$	96			$	134			$	591			$	138
Supplemental disclosures of cash flow information:
Cash paid for:
Interest		$	177			$	52			$	133			$	50
Non cash activities:
Issuance of common stock for acquisitions		$	—			$	—			$	838			$	2,219
Warrants issued in connection with equity and debt transactions		$	—			$	—			$	646			$	436
Purchase of capital equipment through capital leases		$	—			$	121			$	129			$	39

 

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

F-21

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

(Dollars 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, operating as a single segment, 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 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 $3,324 and $2,020 and an accumulated deficit of $5,491 and $4,163 at March 31, 2007 and September 30, 2006, respectively.  The Company’s revenues have not grown sufficiently to satisfy its increases in debt service, principally relating to the $2,800 senior notes payable described in Note 7 to the financial statements, capital expenditures and operating activities and to generate sufficient cash flows to maintain operations.  The Company has issued various equity and debt securities to satisfy its capital requirements and has taken significant steps to streamline its operations over the last several years and will continue to do so as circumstances warrant. Overall, the Company has experienced an increase in both headcount and operating expenses as a result of its acquisitions.  During the same period, the Company has taken significant steps to control its administrative costs.  To date, these steps have included reducing or maintaining existing administrative headcount and limiting infrastructure, operating and capital expenditures where appropriate. The Company must increase revenue from current levels to achieve profitability and generate future positive cash flow.  In order to increase revenue, the Company has expanded its sales force through its acquisition of New Tilt in April 2006, while reducing headcount in other areas, and has expanded into the healthcare and education sectors of the industry.  Long-term cash requirements, other than for normal operating expenses and for commitments described in Note 8 to the financial statements, 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 its business.

The Company continues to monitor cash flow and has developed a contingency plan to effect further reductions to headcount, infrastructure and capital expenditures, as necessary, to fund on-going operations.  Except for the scheduled repayment of the senior notes payable described below, the Company believes that based on current revenue projections that cash flow from operations should be sufficient to

 

F-22

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

meet its cash requirements and allow it to continue as a going concern through September 30, 2007. The Company expects that the proceeds from the planned public offering, will be sufficient to repay the senior notes payable and will also provide additional working capital to fund current operations and to fund the long term cash requirements described above.

 

Since the planned initial public offering (the “Offering” or “IPO”) is not expected to be completed by the April 2007 original maturity date of the senior notes payable, the Company has obtained extensions from the note holders extending the maturity of the senior notes payable, as described in Note 11, to July 5, 2007. If the Offering is not completed by the extended maturity date, the Company would need to seek either a further extension to the maturity date or secure additional financing to repay the senior notes payable and related interest. There can be no assurances that the Company will complete the planned initial public offering or will be able, if necessary, to obtain either a further extension of the senior notes payable or additional 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 initial public offering or obtain other sources of cash to repay the 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.

 

Unaudited Interim Financial Information

 

The accompanying interim consolidated balance sheet as of March 31, 2007, the consolidated statements of operations and cash flows for the six months ended March 31, 2007 and 2006, and the consolidated statement of shareholders’ equity for the six months ended March 31, 2007 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, 2006 and 2005 and include all adjustments, consisting of normal recurring adjustments and accruals, necessary for the fair presentation of the Company’s financial position at March 31, 2007 and its results of operations and its cash flows for the six months ended March 31, 2007 and 2006. The results for the six months ended March 31, 2007 are not necessarily indicative of the results to be expected for the year ending September 30, 2007.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its Indian subsidiary. All significant inter-company accounts and transactions have been eliminated.  The functional currency for the Company’s Indian subsidiary is the U.S. dollar.  Translation adjustments are not material.

2.    Summary of Significant Accounting Policies

 

Revenue Recognition

 

Substantially all of the Company’s revenue is generated from three activities: Web Services, Managed Services, and Subscriptions.

 

 

F-23

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

The Company recognizes revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”), Emerging Issues Task Force Issue No. 00-21, Accounting For Revenue Arrangements with Multiple Deliverables (“EITF 00-21”), and American Institute of Certified Public Accountants Statement of Position No. 97-2, Software Revenue Recognition (“SOP 97-2”) and related interpretations. Revenue is recognized when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) delivery has occurred or 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 reasonably assured. Billings made or payments received in advance of providing services are deferred until the period these services are provided.

Web Services

 

Web Services include professional services primarily related to the Company’s Web development solutions that address specific customer needs such as information architecture and usability engineering, interface configuration, Web application development, rich media, e-Commerce, e-Learning and e-Training, search engine optimization, and content management. Web Services engagements often include a hosting arrangement that provides for the use of certain hardware and infrastructure, generally at the Company’s network operating center. As described further below, revenue for these hosting arrangements is included in Managed Services. Web services engagements that include hosting arrangements are accounted for as multiple element arrangements as described below under “Multiple-Element Arrangements.”

For Web Services engagements sold on a stand alone basis, revenue is recognized in accordance with SAB 104.  Web Services are contracted for on either a fixed price or time and materials basis.  For its fixed price engagements, the Company applies the proportional performance model to recognize revenue based on cost incurred in relation to total estimated cost at completion. The Company has determined that labor costs are the most appropriate measure to allocate revenue among reporting periods, as they are the primary input when providing Web Services. Customers are invoiced monthly or upon the completion of milestones. For milestone based projects, since milestone pricing is based on expected hourly costs and the duration of such engagements is relatively short, this input approach principally mirrors an output approach under the proportional performance model for revenue recognition on such fixed priced engagements.  For time and materials contracts, revenues are recognized as the services are provided.

Web Services are often sold as part of multiple element arrangements wherein perpetual licenses for the Company’s NetEDITOR Software, retained professional services, hosting and/or Subscriptions are provided in connection with Web Services engagements.  The Company’s revenue recognition policy with respect to these multiple element arrangements is described further below under the caption “Multiple Element Arrangements.”

Sales of perpetual licenses for the Company’s NetEDITOR software and related post-contract customer support (“PCS”) are included in Web Services.  Revenues derived from perpetual license sales have been insignificant in all periods presented (representing less than 3% of Web Services revenues).

 

Managed Services

 

Managed Services include retained professional services and hosting services.

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 professional services hours each month on a “use it or lose it” basis.   For retained professional services sold on a stand-alone basis, revenue is recognized in accordance with SAB 104.  The Company recognizes

F-24

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

revenue as the services are delivered or over the term of the contractual retainer period.  These arrangements do not require formal customer acceptance and do not grant any future right to labor hours contracted for but not used.

 

Hosting arrangements provide for the use of certain hardware and infrastructure, generally at the Company’s network operating center.  For all periods presented, the only customers under contractual hosting arrangements have been previous Web Services customers. Hosting revenue has historically been insignificant to both the Company’s business strategy and to total revenues. Set-up costs associated with hosting arrangements are not significant and the Company does not charge its customers any set-up fees.  Hosting agreements are month-to-month arrangements that provide for termination for convenience by either party upon 30-days notice.  Revenue is recognized monthly as the hosting services are delivered.   As described below, hosting revenues associated with the Company’s Subscriptions are included in Subscriptions revenue.

Retained professional services are sold on a stand-alone basis or in multiple element arrangements with Web Services and, occasionally, Subscriptions.  Hosting services are only sold in connection with Web Services and are not sold on a stand-alone basis.   The Company’s revenue recognition policy with respect to multiple element arrangements is described further below under the caption “Multiple Element Arrangements.”

 

Subscriptions

 

Subscriptions consist of agreements that provide access to the Company’s Orgitecture software (“Licensed Subscription Agreements”) through a hosting arrangement.

Licensed Subscription Agreements are sold exclusively as a component of multiple element arrangements that include Web Services and, occasionally, retained professional services and hosting services.  The Company’s revenue recognition policy for such multiple element arrangements is described below under the caption “Multiple Element Arrangements.”  The Company has concluded that, consistent with EITF 00-3, Application of AICPA SOP 97-2, “Software Revenue Recognition”, to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware, that its Licensed Subscription Agreements are outside the scope of SOP 97-2 since the software is only accessible through a hosting arrangement with the Company and the customer cannot take possession of the software.   Licensed Subscription Agreements are month-to-month arrangements that provide for termination for convenience by either party upon 30 to 45-days notice.  Revenue is recognized monthly as the related hosting services are delivered. When an up-front fee is charged, the revenue related to such up-front fee is amortized over 24 months. 

Multiple Element Arrangements

 

As described above, Web Services are often sold as part of multiple element arrangements.  Such arrangements may include delivery of a perpetual license for the Company’s NetEDITOR software at the commencement of a Web Services engagement or delivery of retained professional services, hosting services and/or Subscriptions subsequent to completion of such engagement, or combinations thereof.  In accounting for these multiple element arrangements, the Company follows EITF 00-21 and, as described further below, has concluded that each element can be treated as a separate unit of accounting.

When Web Services engagements include a perpetual license for the Company’s NetEDITOR software, the Company has concluded that the Web Services and the perpetual NetEDITOR license are separate units of accounting as each has stand-alone value to the customer and the Company has established vendor specific objective evidence (VSOE) of fair value for the software and objective and reliable third party evidence of fair value for the Web Services.  In such arrangements, the perpetual NetEDITOR license is the delivered 

 

F-25

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

element and the Web Services, and any PCS are the undelivered elements.  The Company recognizes revenue from perpetual NetEDITOR licenses and related PCS in accordance with SOP 97-2 and recognizes revenue from Web Services following the proportional performance model as described above.  The amount of revenue to be recognized upon delivery of the software is determined using the residual method whereby the value ascribed to the delivered element (i.e., the NetEDITOR license) is equal to the total consideration of the multiple element arrangement less the third party evidence of fair value of the undelivered elements (i.e., Web Services and, if applicable, PCS).

Following SOP 97-2, revenue is recognized upon delivery of the perpetual NetEDITOR license because the Web Services are not essential to the functionality of the software and the Company has established VSOE of fair value for the software.  Any related PCS revenue is also recognized upon delivery of the software since PCS is included with the price of the software license, extends only for a period of one year or less and the cost of providing the PCS is deemed to be insignificant.  PCS does not contain rights to unspecified upgrades to the software, nor has the Company issued any upgrades.

When Web Services engagements include retained professional services and hosting services and/or Subscriptions, the Company has concluded that each element can be accounted for separately as the delivered elements (i.e., the Web Services) have stand alone value and there is objective and reliable third party evidence of fair value for each of the undelivered elements (i.e., the retained professional services and hosting services and/or Subscriptions).   Web Services are available from other vendors and are regularly sold by the Company on a stand-alone basis pursuant to a standard price list which is not discounted. Web Services do not involve significant production, modification, or customization of the Company’s licensed software products. Objective and reliable third party evidence of fair value for the undelivered elements has been established as the Company’s retained professional services, hosting services and Licensed Subscription Agreements are sold pursuant to standard price lists which are not discounted.

The amount of revenue to be recognized in the multiple element arrangements described above is determined using the residual method whereby the value ascribed to the delivered element (i.e., the Web Services) is equal to the total consideration of the multiple element arrangement less the third party evidence of fair value of the undelivered elements (i.e., retained professional services, hosting services and/or Licensed Subscription Agreements).

Direct costs associated with web development services and retained professional services are recorded as the services are delivered and the corresponding revenue is recognized.  Direct costs associated with Licensed Subscription Agreements or hosting services are expensed as incurred.

Customer Payment Terms

The Company’s payment terms with customers typically are “due upon receipt” or “net 30 days from invoice”. Payments terms may vary by customer but in all instances do not exceed 45 days from invoice date. For Web Services, the Company typically invoices project deposits of between 20% and 33% of the total contract value which are record as deferred revenue until such time the related services are completed. Subsequent invoicing for Web Services is either monthly or upon achievement of milestones and payment terms for such billings are within the standard terms described above. Invoicing for subscriptions and hosting are typically issued monthly and are generally due upon invoice receipt. The Company’s agreements with customers do not provide for any refunds for services or products and therefore no specific reserve for such is maintained. In the infrequent instances where customers raise concerns over delivered products or services, the Company has endeavored to remedy the concern and all costs related to such matters have been insignificant in all periods presented.

 

F-26

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

Warranty

 

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. 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 related cost to satisfy the warranty obligation is estimated and accrued. Warranty claims to date have been immaterial.

Reimbursable Expenses

 

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.

 

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

Segment Information

 

The Company is structured and operates internally as one reportable operating segment as defined in Statement of Financial Accounting Standard (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”). SFAS 131 establishes standards for the way public business enterprises report information about operating segments in annual consolidated financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. Although the Company had three U.S. operating locations and an Indian subsidiary at September 30, 2006 and 2005, under the aggregation criteria set forth in SFAS 131, the Company operates in only one reportable operating segment since each location has similar economic characteristics.

 

Concentration of Credit Risk, Significant Customers and Off-Balance Sheet Risk

 

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

F-27

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

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.

 

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

 

		Six Months Ended March 31,								Year Ended September 30,
		2007				2006				2006				2005
Customer #1			20%				21%				22%				12%
Customer #2			*				12%				*				19%
* Represents less than 10%

 

 

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

						September 30,
		March 31, 2007				2006				2005
Customer #1			15%				17%				11%
Customer #2			*				*				22%
Customer #3			*				*				12%
* Represents less than 10%

The Company has no significant off-balance sheet risks such as foreign exchange contracts, interest rate swaps, option contracts or other foreign hedging agreements.

 

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, receivables, accounts payable and senior notes payable approximate their fair value because of the short-term maturity of these instruments. Based on rates available to the Company at September 30, 2006 and 2005 for loans with similar terms, the carrying values of capital lease obligations approximate their fair value.

 

F-28

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

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 these 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 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.  Pursuant to SFAS No. 86 “Accounting for Cost of Computer Systems to be Sold, Leased or Otherwise Marketed,” 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.

During our fiscal year 2005, a research and development center in Bangalore, India was established by the Company to manage the Company’s technology development requirements. Since inception, the Company has derived technology benefits from engagements with customers; however it is not possible to track and quantify such costs separately for any periods.

 

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, generally three to ten years, and are subject to impairment tests as previously described under Impairment of Long-Lived and Intangible Assets.

 

F-29

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

 

Deferred Financing Fees

The Company incurred $481 of direct costs in connection with the issuance of $2,800 in Senior Notes Payable and include the fair value of underwriter debt warrants of $115 (See Note 7). These costs are being amortized using the straight-line method, which approximates the interest method, over the one year term of the notes.

 

Deferred Offering Costs

 

As of March 31, 2007 and September 30, 2006, the Company incurred $442 and $116, respectively, of direct costs in connection with the anticipated initial public offering of its common stock as described in Note 11. These costs are included in other assets and will be charged to additional paid in capital upon a successful closing 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 and meets all other relevant criteria. Such consideration is paid when the contingency is resolved subsequent to acquisition and is recorded as additional goodwill resulting from the business combination.

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 for impairment annually and 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 acquisition transactions of comparable third party sales 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.

 

F-30

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

Advertising Costs

 

All advertising costs are expensed when incurred. Advertising costs were $60 and $80 for the six months ended March 31, 2007 and 2006 and $124 and $118 for the years ended September 30, 2006 and 2005, respectively.

 

Stock-Based Compensation

 

At March 31, 2007, the Company maintained two stock-based compensation plans which are more fully described in Note 9.

Effective October 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payments (“SFAS 123R”). Because the Company used the fair-value-based method for disclosure under SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), it adopted SFAS 123R using the modified prospective method. Under the modified prospective method, compensation expense recognized beginning on that date will include: (a) compensation expense for all share-based payments granted prior to, but not yet vested as of October 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS  123, and (b) compensation expense for all share-based payments granted on or after October 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The pro forma effect of stock-based compensation expenses pursuant to SFAS 123R is disclosed in the financial statements. Under the modified prospective transition method the results for prior periods are not restated.

Through September 30, 2006, the Company accounted for stock compensation awards under the provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (“SFAS 148”). As permitted by SFAS 123, for all periods through September 30, 2006, the Company measured 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 and following the disclosure-only provisions of SFAS 123.

Under the intrinsic value method, compensation expense is determined at the measurement date, generally the date of grant, as the excess, if any, of the estimated fair value of the Company’s common stock (the “Stock Price”) and the exercise price, multiplied by the number of options granted. Generally, the Company grants stock options with exercise prices equal to or greater than 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. The Company recognized stock-based compensation expense of $2 for the six months ended March 31, 2006 and $4 and $8 in stock-based compensation expense for the years ended September 30, 2006 and 2005, 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 the trading prices of a peer group of comparable public companies.

 

 

F-31

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

The fair value of the common stock for options granted from inception to July 31, 2005 was originally estimated by the board of directors with input from management.  The Company did not obtain contemporaneous valuations by an unrelated valuation specialist because, at the time of the issuances of stock options during this period, the Company had completed several contemporaneous sales of its common stock to unrelated accredited investors in private placement transactions for cash. The Company believes these contemporaneous sales represent the most reasonable estimate of fair value during this period. 

Determining the fair value of the Company’s common stock requires making complex and subjective judgments.  The Company’s approach to valuation is based on several factors.  Since August 1, 2005 the Company has not completed any private placement sales of its common stock, and accordingly, used an approach to valuation based on a weighted average of enterprise value as determined using three customary valuation techniques: the discounted cash flow method, the market approach, and the guideline public company method.  The Company believes that due to its size (under $10 million), continued operating losses, a business plan highly dependent on future acquisitions, and its limited ability to raise the capital for such acquisitions, that a weighted average of these three techniques is the most reasonable approach to the valuation of our stock.

Under the discounted cash flow method, since Bridgeline is an emerging growth company with a business plan highly dependent on acquisitions, estimates of revenue, market growth rates and costs are used when applying the appropriate discount rates.  Discount rates utilized in the Company’s analyses ranged from 35% to 21% based on a capital asset pricing model which considered factors such as risk-free rate of return, an equity risk adjustment and a size discount due to its limited revenues. The estimates used are consistent with the plans and estimates that it uses to manage the business.  However, there is inherent uncertainty in making these estimates and based on historical significant differences between prior forecasts and prior actual results, the Company applies a lower weighting to the enterprise value determined using the discounted cash flow method.

Under the market approach, since there have been no equity transactions involving the Company since July 2005, the Company evaluated merger and acquisition transactions involving comparable public and private companies to determine its enterprise value. The Company used estimated revenues and applied the comparable multiple derived from such transactions. Since the Company’s revenues are considerably lower and it has incurred losses since inception in relation to the comparable group, the Company applies the lowest weighting to the enterprise value derived using the market approach.

 

The final technique utilized in its analysis is the guideline public company method.  The Company used data provided by a third party for ten comparable publicly traded companies.  Due to its relatively small size, continued operating losses and the high risks associated with its forecasted revenue growth through acquisitions, the Company determined its enterprise value by multiplying its rolling twelve months sales by the market value of invested capital-to-revenues ratio applicable to those companies in the statistical 10^th percentile (on a scale of 100%) .  The Company believes that a value market multiple of comparable public companies based on market value of invested capital to revenues provides an objective basis for measuring its fair market value.  Accordingly, the Company places the highest weighting on this factor in its analysis.  

The weighted average enterprise value, as described above, is reduced by a lack of marketability discount of 20% which reflects the Company’s small size, its continued losses since inception, and its inability to provide a distribution of earnings to shareholders. The Company also considers the post-public offering holding periods applicable to existing stock, warrant and option holders as potential risks to marketability.  These holding periods range from six months to one year.

F-32

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

The per share enterprise value determined above is used as an input to the Black-Scholes-Merton option valuation model in determining stock-based compensation or if applicable, pro forma stock-based compensation.

During the 12-month period ended March 31, 2007, the Company granted stock options with exercise prices as follows:

Grants made during Quarter Ended		Number of Options Granted		Weighted-Average Exercise Price		Weighted-Average Fair Value per Share		Weighted-Average Intrinsic Value per Share
June 30, 2006		102,420		$3.75		$2.24		—
September 30, 2006		50,000		$3.75		$2.46		—
December 31, 2006		31,880		$3.75		$2.50		—
March 31, 2007		—		—		—		—

Significant Factors Contributing to the Difference between Fair Value as of the Date of Grant and the Estimated Initial Public Offering Price

 

The Company has granted stock options with exercise prices of $3.75 during the period January 1, 2006 to April 30, 2007.  The Company has determined that the deemed fair value of its common stock increased from $2.11 to $3.56 per share over the same period.  The principal factors contributing to the increase in the fair value of the Company’s stock during this period are as follows:

 

	●	In April 2006, the Company issued notes in the aggregate of $2.8 million through a private placement with attached warrants in order to finance its initial public offering, acquire New Tilt, Inc and fund on-going operations (see Note 7).
	●	In April 2006, the Company acquired the business and assets of New Tilt, Inc. adding 12 employees and extending its product offering in the Boston market into the health and life sciences sector of the industry (see Note 3).
	●	In May 2006, the Company launched its research and development initiative in Bangalore, India to redesign its on-demand software platform.  The Company hired an additional 25 software engineers over a six month period to achieve an anticipated launch date by July 2007.
	●	On December 7, 2006, the Company signed a definitive merger agreement with Objectware, Inc. The acquisition of Objectware, Inc. will add 25 employees and allow the Company to expand into the Atlanta market and significantly increase revenues (see Note 11).
	●	On December 13, 2006, the Company filed its initial registration statement with the Securities and Exchange Commission (see Note 11).

●

In April 2007, the Company extended the maturity date of the senior notes payable described above to June 21, 2007 and on June 20, 2007, the Company further extended the maturity date to July 5, 2007 (see Note 11).

 

 

F-33

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

The difference between the fair value of the Company’s common stock at April 30, 2007 and the per share price for its IPO of $5.00 is principally due to the accretive pro forma effect on reveunes and earnings attributable to the pending acquisition of Objectware, Inc. (See Note 11).

Based on the IPO price of $5.00, the intrinsic value of the options outstanding at March 31, 2007 is approximately $1,606,000 of which $1,089,000 related to vested options and $517,000 related to unvested options.

 

Although it is reasonable to expect that the completion of the IPO will add value to the shares because they will have increased liquidity and marketability, the amount of additional value can be measured with neither precision nor certainty.

The Company granted the following stock options during the six months ended March 31, 2007 and the years ended September 30, 2006 and 2005:

						Weighted Average Per Share
						Weighted				Estimated				Intrinsic
						Average				Fair Value of				Value
		Options				Exercise				Common Stock				at Grant
		Granted				Prices				at Grant Date				Date
Six Months Ended March 31, 2007			31,880			$	3.75			$	2.50			$	—
Year Ended September 30, 2006			204,920			$	3.75			$	2.26			$	—
Year Ended September 30, 2005			429,616			$	3.44			$	3.75			$	0.31

The fair value of options granted is determined using the Black-Scholes-Merton option valuation model (the “Model”). Certain assumptions were used by the Company in the application of the Model 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 U.S. Treasury zero-coupon issues with equivalent remaining terms. 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 September 30, 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 consistent with SFAS 123R and Securities and Exchange Commission Staff Accounting Bulletin No. 107, Share Based Payment. For purposes of calculating the pro forma compensation expense illustrated above, the Company used its cumulative actual forfeiture rates of between 11% and 13% for all awards which management believes is a reasonable approximation of anticipated future forfeitures. The fair value is amortized ratably over the vesting period of the awards, which is typically three years. The Company may elect to use different assumptions under the Model in the future or select a different option valuation model altogether, which could materially affect its net income or loss and net income or loss per share in the future. At September 30, 2006, based on the Model, there was approximately $363 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all equity compensation plans. The Company recognized $91 of expense for the three months ended December 31, 2006 subsequent to the October 1, 2006 adoption of SFAS 123.

 

F-34

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

The following disclosure 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. The Company believes that the Model 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:

		Six Months Ended				Year Ended September 30,
		March 31, 2006				2006				2005
Net loss		$	(120	)		$	(1,448	)		$	(517	)
Deduct: Stock based employee
compensation determined under
the fair value based method
for all awards, net of tax effect			(254	)			(507	)			(321	)
Pro forma net loss		$	(374	)		$	(1,955	)		$	(838	)
Pro forma net loss per share:
Basic and diluted		$	(0.08	)		$	(0.48	)		$	(0.22	)
As reported net loss per share:
Basic and diluted		$	(0.03	)		$	(0.36	)		$	(0.14	)
Weighted average shares outstanding:
Basic and diluted			4,273,833				4,046,278				3,804,527

 

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
Year Ended September 30,
2006		$ 2.07 - $2.46		70%		4.31% - 4.70%		0%		6.5 - 10		$ 3.75
2005		$ 3.75		70% - 90%		3.26% - 4.13%		0%		6.5		$ 3.00 - $ 3.75

 

F-35

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

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 representative of pro forma effects on operations for future periods.

 

Valuation of Options and Warrants Issued to Non-Employees

 

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:

		Year Ended September 30,
		2006				2005
Options granted to non-employees			9,227				—
Warrants granted to non-employees			392,000				75,727
Contractual lives in years			5 - 10				5
Estimated fair value of common stock		$	2.07 - 2.46			$	3.75
Exercise prices		$	0.001 - 4.68			$	4.68
Estimated stock volatility			70%				70% - 90%
Risk free rate of return		3.70% to 4.93%				3.36% to 3.48%
Dividend Rate			0%				0%

 

Based on the IPO price of $5.00, the intrinsic value of the options outstanding at March 31, 2007 was approximately $1,606,000 of which $1,089,000 related to vested options and $517,000 related to unvested options.

Although it is reasonable to expect that the completion of the IPO will add value to the shares because they will have increased liquidity and marketability, the amount of additional value can be measured with neither precision nor certainty.

 

F-36

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

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 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 its Indian subsidiary, 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. The balance of these excluded equity instruments were 1,447,2775, 1,050,843, 1,507,856 and 1,034,176 at March 31, 2007 and 2006 and September 30, 2006 and 2005, respectively.

Reclassifications

Certain amounts in the September 30, 2005 financial statements have been reclassified to conform with the September 30, 2006 presentation.

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

 

 

F-37

---

BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

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 States 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 not yet adopted SFAS 157. As a result, the consolidated financial statements do not include any adjustments relating to any potential adjustments to the carrying value of assets and liabilities. Management of the Company is currently evaluating the impact of SFAS 157 on the consolidated financial statements.

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.

 

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of this statement on the Company’s results of operations and financial condition.

 

3.    Acquisitions

 

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 expects to expand its services in the health care and insurance industries. The aggregate current consideration of approximately $1,550 consisted of $550 in cash, 320,000 shares of common stock valued at $717, 37,830 options for common stock valued at $121 and closing costs of $162. Additional consideration of up to approximately $750 may be paid over a three-year period in cash as additional consideration.

F-38

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

The additional consideration described above is based upon the attainment by the acquired entity of defined operating objectives.  At March 31, 2007, the maximum remaining future consideration pursuant to this arrangement is approximately $606.  To date $144 was recorded as an increase to goodwill under this arrangement.

 

Acquired intangible assets of $91 were assigned as follows: $29 was assigned to customer relationships and $62 was assigned to non-compete agreements.

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 expects to expand its services to not-for-profit organizations.

The initial consideration of approximately $2,606 consisted of $355 in cash, 476,667 shares of common stock valued at $1,788, 72,527 warrants for common stock valued at $269, 43,764 options for common stock valued at $162 and closing costs of $32. 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 March 31, 2007, the maximum remaining future consideration pursuant to this arrangement is approximately $135.  To date $165 was recorded as an increase to goodwill under this arrangement.

Acquired intangible assets of $353 were assigned as follows: $180 was assigned to 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 acquisition has been treated as a non-taxable transaction; therefore the intangible assets, including goodwill, are not tax deductible for the Company.

The Company completed the acquisition of New Tilt, Inc. (“New Tilt”) on April 24, 2006 and 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:

 

F-39

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

		New Tilt				Iapps
Net assets acquired:
Cash		$	159			$	77
Other current assets			181				104
Equipment			56				54
Other assets			59				202
Intangible assets			91				353
Goodwill			1,123				2,244

Total assets			1,669				3,034
Current liabilities			70				246
Deferred tax liabilities			49				182
Total liabilities			119				428
Net assets acquired		$	1,550			$	2,606
Purchase price:
Cash paid		$	550			$	355
Equity exchanged			717				1,788
Warrants issued and options exchanged			121				431
Closing costs and fees			162				32
Total purchase price		$	1,550			$	2,606

Unaudited Pro Forma Information

The following unaudited pro forma information reflects the results of operations of the Company as though the acquisitions of New Tilt and iapps were completed as of October 1, 2004:

F-40

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

		Pro Forma (Unaudited)
		Years Ended September 30,
		2006				2005
Revenue		$	9,154			$	8,349
Net loss		$	(1,850	)		$	(638	)
Net loss per share:
Basic and diluted		$	(0.44	)		$	(0.15	)
Number of weighted average shares:
Basic and diluted			4,228,499				4,223,833

 

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

·	Reduction in depreciation of $12 and $23 resulting from the fair values assigned to property and equipment for New Tilt and iapps at the time of acquisition. The pro forma adjustment reflects the difference in historical depreciation expense for the years ended September 30, 2006 and 2005, respectively, for New Tilt ($24) and iapps ($42) and the pro forma depreciation expense computed based upon the estimated fair value assigned to property and equipment as described above.
·	Increases of $11 and $18 in amortization expense resulting from the values assigned to intangible assets of New Tilt and iapps upon acquisition. As described above, the Company has allocated $91 of the New Tilt purchase price and $353 of the iapps purchase price, to intangible assets, which are amortized over a five year period resulting in a pro forma effect of $11 and $18 for the years ended September 30, 2006 and 2005, respectively.
·	Reduction in stock-compensation expense of $40 and $72 for New Tilt for the years ended September 30, 2006 and 2005, respectively; this pro forma adjustment is the result of stock compensation expenses computed pursuant New Tilt’s accounting policy in accordance with SFAS 123 of $40 and $72, as compared to the stock compensation expense that would have been recorded in accordance with the Company’s accounting policy under the intrinsic method in accordance with APB 25 of $0 and $0 for the years ended September 30, 2006 and 2005, respectively.
·	The effect of additional interest expense $142 and $282 that would have been incurred to finance a portion of the purchase price for New Tilt for the years ended September 30, 2006 and 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 year ended September 30, 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 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.

 

F-41

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

4.    Equipment and Improvements

Equipment and improvements, net consisted of the following:

 

		As of				As of September 30
		March 31, 2007				2006				2005
Furniture and fixtures		$	134			$	136			$	111
Acquired software			146				124				75
Computers and peripherals			645				629				365
Leasehold improvements			38				38				28
			963				927				579
Less accumulated depreciation			599				498				312
		$	364			$	429			$	267

  

 

Included above are assets acquired under capitalized leases of $207 as of March 31, 2007 and $207 and $97 as of September 30, 2006 and 2005, respectively, with accumulated depreciation thereon of $125, $92 and $41, respectively.

The Company has $180, $233 and $96 of net property and equipment at March 31, 2007 and September 30, 2006 and 2005, respectively, for use in its hosting arrangements.

 

 

5.    Definite Lived Intangible Assets and Goodwill

Definite lived intangible assets and goodwill consisted of the following:

 

		Useful				As of March 31, 2007
		Lives in				Gross				Accumulated				Net
		Years				Asset				Amortization				Amount
Intangible assets;
Domain and trade names		10				$	29			$	(14	)		$	15
Customer related		5					478				(274	)			204
Acquired software		3					95				(73	)			22
Total intangible assets						$	602			$	(361	)		$	241
Goodwill						$	6,496			$	—			$	6,496

 

 

F-42

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

						As of September 30, 2006												As of September 30, 2005
						Gross				Accumulated				Net				Gross				Accumulated				Net
						Asset				Amortization				Amount				Asset				Amortization				Amount
Intangible assets;
Domain and trade names						$	29			$	(13	)		$	16			$	29			$	(10	)		$	19
Customer related							478				(229	)			249				387				(145	)			242
Acquired software							95				(57	)			38				95				(25	)			70
Total intangible assets						$	602			$	(299	)		$	303			$	511			$	(180	)		$	331
Goodwill						$	6,346			$	—			$	6,346			$	5,097			$	—			$	5,097

 

 

The aggregate amortization expense for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005 is as follows:

		Total				Expense Charge To
		Amortization				Cost of
		Expense				Revenue				Operations
Six Months Ended March 31, 2007		$	62			$	61			$	1
Six Months Ended March 31, 2006		$	55			$	54			$	1
Year Ended September 30, 2006		$	119			$	117			$	2
Year Ended September 30, 2005		$	94			$	92			$	2

The estimated amortization expense for fiscal years 2007, 2008, 2009, 2010, 2011 and thereafter is $108, $70, $64, $37, $18 and $6, respectively.

 

As discussed more fully in Note 3, goodwill increased $150 in the six months ended March 31, 2007. Goodwill increased $1,249 and $2,244 in the years ended September 30, 2006 and 2005. The increase in the year ended September 30, 2006 included $1,123 as a result of the acquisition of New Tilt and $126 due to contingent consideration earned under the acquisition agreements with iapps and New Tilt. The increase in the year ended September 30, 2005 included $2,131 as a result of the acquisition of iapps and $113 due to contingent consideration earned under the acquisition agreements with iapps and Lead Dog.  Goodwill at October 1, 2004 included $2,821 resulting from the 2002 acquisition of Lead Dog.

F-43

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

6.    Accrued Liabilities

Accrued liabilities consisted of the following:

		As of				As of September 30,
		March 31, 2007				2006				2005
Compensation and benefits		$	329			$	259			$	144
Subcontractors			108				58				31
Deferred rent			65				59				44
Interest			84				70				—
Professional fees			121				178				4
Other			36				82				48
		$	743			$	706			$	271

 

7.     Indebtedness

 

The Company’s indebtedness consisted of the following:

Senior Notes Payable

		As of				As of September 30,
		March 31, 2007				2006				2005
Senior notes payable		$	2,800			$	2,800			$	—
Discount on senior notes payable attributable to warrants			(31	)			(303	)			—
		$	2,769			$	2,497			$	—

 

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.

The Senior Notes are collateralized 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,

F-44

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

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. As part of the Senior Notes, the Company's investment banker received $280 in fees which are recorded as deferred financing fees and are being amortized over the one-year term of the notes.

 

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. This debt carries an interest rate of 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%. Interest expense related to this debt, including amortization of the deferred financing fees, was $678 for the six months ended March 31, 2007 and $558 for the year ended September 30, 2006. 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 complete an initial public offering by the maturity date 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 an initial public offering.

Financing Agreement

		As of				As of September 30,
		March 31, 2007				2006				2005
Financing agreement		$	—			$	—			$	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 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 $0, $43, $58 and $37 for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005, respectively. The weighted average borrowings incurred by the Company under the Agreement was $0, $403, $272 and $319 for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005, respectively. In connection with the Senior Notes described above, all amounts outstanding under this arrangement were repaid in June 2006.  The terms of the Senior Notes prohibited any additional borrowings under the Agreement.

F-45

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

Capital Lease Obligations 

		As of				As of September 30,
		March 31, 2007				2006				2005
Capital lease obligations		$	122			$	144			$	44

 

 

As of September 30, 2006, the Company had remaining the following minimum lease payments under capitalized lease obligations:

Year Ending September 30,
2007		$	67
2008			66
2009			40
2010			13
2011			1
Totals			187
Less interest at a weighted average of 14.15%			43
Total capital lease obligations		$	144

Notes Payable to Shareholders

		As of				As of September 30,
		March 31, 2007				2006				2005
Notes payable to shareholders		$	—			$	—			$	85

 

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 fair value ($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 $0, $3, $5 and $6 for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005, respectively. The amounts outstanding under these notes were $0, $0 and $45 at March 31, 2007 and September 30, 2006 and 2005, 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.  Imputed interest on this advance was immaterial.

 

F-46

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

 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 India.  Future minimum rental commitments under non-cancelable operating leases with initial or remaining terms in excess of one year at September 30, 2006 were as follows:

Year Ending September 30,
2007		$	306
2008			338
2009			291
2010			239
2011			230
Total		$	1,404

 

Rent expense for six months ended March 31, 2007 and 2006 was $305 and $258 and for the years ended September 30, 2006 and 2005 was approximately $615 and $501, respectively, exclusive of sublease income of $17, $49, $100 and $68 for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005, respectively. The Company’s sub rental agreements expired contemporaneous with the associated leases on November 30, 2006. The Company has amended this lease for only the space it utilizes for a period of two additional years.

 

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 Bridgeline with certain advisory services concerning potential acquisitions and transactions. The term of the agreement is for one year with    

F-47

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

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 September 30, 2006 and 2005.

 

9.     Shareholder’s Equity

 

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 160,542 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.

In connection with the December 2004 acquisition of iapps described in Note 3, the Company issued 72,527 warrants to its investment advisor for services rendered in connection with the acquisition. The warrants are exercisable $4.68 per share at any time within five years from the grant date. The Company

F-48

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

valued the warrants at $269 using the Model and assumptions 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 and assumptions 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. As of September 30, 2006, 50,000 Debt Warrants have been exercised by Senior Note holders. 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 such offering. The Company valued the Debt Warrants at $531 and the Underwriter’s Debt Warrants at $115 using the Model and assumptions as described in Note 2. The value of the Debt Warrants was recorded as a discount on the Senior Notes and is being amortized over the one year term of the Senior Notes. The value of the Underwriter’s Debt Warrants was charged to deferred financing costs and is being amortized over the one year term of the Senior Notes.

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 such 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 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 470,413 options reserved for issuance under the Plan as of September 30, 2006.

2001 Lead Dog Stock Option Plan

In connection with the Company’s merger with Lead Dog in February 2002, the Company assumed 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 for one year subsequent to the merger. 

F-49

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

A summary of combined option and warrant activity is as follows:

		Stock Options								Stock Warrants
						Weighted								Weighted
						Average								Average
						Exercise								Exercise
		Options				Price				Warrants				Price
Outstanding, September 30, 2004			575,055			$	2.553				160,542			$	4.081
Granted (1)			429,616			$	3.439				75,727			$	4.680
Exercised			—				—				—				—
Cancelled or expired			(206,764	)		$	2.851				—				—
Outstanding, September 30, 2005			797,907			$	2.953				236,269			$	4.273
Granted (2)			204,920			$	3.750				392,000			$	1.533
Exercised (3)			—				—				(50,000	)		$	0.001
Cancelled or expired			(73,240	)		$	3.492				—				—
Outstanding, September 30, 2006			929,587				3.086				578,269			$	2.653
Granted (4)			31,880			$	3.750				—				—
Exercised (3)			(3,000	)			3.750				(417	)		$	4.680
Cancelled or expired			(89,035	)		$	3.713				—				—
Outstanding, March 31, 2007			869,432			$	3.152				577,852			$	2.810

 

(1) The weighted average grant-date fair value of options and warrants granted during the fiscal year ended September 30, 2005 was $3.75 and $3.75, respectively.

 

(2) The weighted average grant-date fair value of options and warrants granted during the fiscal year ended September 30, 2006 was $2.28 and $2.24, respectively.

 

(3) The intrinsic value of options and warrants exercised during the period from October 1, 2006 through March 31, 2007 was $0 and $0, respectively. Warrants exercised during the year ended September 30, 2006 had an intrinsic value of $2.23 per share. There were no other options or warranst exercised in any of the periods presented.

 

(4) The weighted average grant-date fair value of options granted during the period October 1, 2006 through March 31, 2007 was $2.50.

 

F-50

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

A summary of options outstanding and options exercisable at September 30, 2006:

				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				6.00			$	41,253				24,167			$	41,253
	$ 0.357				15,397				6.30			$	21,454				15,397			$	21,454
	$ 1.072				63,374				5.42			$	2,432				63,374			$	2,432
	$ 1.200				43,764				8.21			$	14,444				43,764			$	14,444
	$ 3.000				257,138				6.50			$	—				231,552			$	—
	$ 3.750				525,747				8.85			$	—				172,202			$	—
					929,587												550,456

 

A summary of options outstanding and options exercisable at March 31, 2007:

				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				5.50			$	41,253				24,167			$	41,253
	$ 0.357				3,219				5.35			$	2,424				3,219			$	2,424
	$ 1.072				43,672				4.92			$	1,676				43,672			$	1,676
	$ 1.200				43,111				7.71			$	14,227				43,111			$	14,227
	$ 3.000				254,974				5.99			$	—				242,551			$	—
	$ 3.750				500,289				8.10			$	—				203,575			$	—
					869,432												560,295

 

The aggregate intrinsic value in the table above represents the total intrinsic value, based on the Company’s estimate of fair value of $2.46 at March 31, 2007 and September 30, 2006 which would have been received by the option holders had all option holders exercised their options as of those dates.

 

F-51

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

A summary of options issued during the period from October 1, 2005 through March 31, 2007 are detailed below:

 

Date of Grant		Number of Options				Option Exercise Price				Fair Value				Intrinsic Value
December 2005 January 2006 February 2006 March 2006 April 2006 September 2006 October 2006 November 2006 December 2006 January 2007 February 2007 March 2007			16,667 16,667 8,333 10,833 102,420 50,000 31,880 — — — — —			$	3.75   3.75   3.75   3.75   3.75   3.75   3.75 — — — — —			$	2.07   2.16   2.28   2.37   2.24   2.46   2.50 — — — — —			$	—   —   —   —   —   —  — — — — — —
			236,800

A summary of the status of Bridgeline’s nonvested shares as of September 30, 2006, and changes during the six months ended March 31, 207, is presented below.

 

Nonvested Shares		Shares		Weighted-Average Grant-Date Fair Value
Nonvested at September 30, 2006		379,131		$2.11
Granted		31,880		2.50
Vested		(32,647)		1.93
Forfeited		(69,227)		2.10
Nonvested at March 31, 2007		309,137		2.13

 

As of September 30, 2006 there was $363 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted average of 1.3 years. The total fair value of shares vested during the years ended September 30, 2006 and 2005 were $936 and $360, respectively of which options with a value $339 have been subsequently cancelled after vesting in years ended September 30, 2006 and 2005.

 

The Company has 112,000 nonvested shares pertaining to warrants at both September 30, 2006 and March 31, 2007. Such nonvested warrants had a weighted average grant-date fair value of $2.24. There were no warrants granted, vested or forfeited in the period October 1, 2006 through March 31, 2007.

 

The fair value of the underlying common stock using the retrospective method at the option grant date was determined by management as detailed in Note 2 under Stock-Based Compensation.

F-52

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

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: 

 

		Year Ended September 30,
		2006				2005
Income tax benefit at the federal statutory rate of 34%		$	(538	)		$	(175	)
Permanent differences, net			151				45
State income benefit, net of federal benefit			(70	)			(20	)
Change in valuation allowance attributable to operations			464				150
Other			(7	)			—
		$	—			$	—

As of September 30, 2006, the Company has net operating loss carryforwards (“NOLs”) of approximately $3,919 for federal purposes and $3,578 for state purposes, which will be available to offset future taxable income. Approximately $1,164 of the Company’s net operating losses are attributable to acquired entities. These net operating losses were fully reserved for at the respective acquisition dates. In the event the Company realizes these assets in the future, the benefit will be recorded as a reduction of goodwill. If not used, the federal carryforwards will expire between 2020 and 2026 and the state carryforwards will expire between 2007 and 2026.

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-53

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

(Dollars 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,
Deferred tax assets:		2006				2005
Short-term:
Contract loss reserve		$	59			$	—
Long-term
Net operating loss carry forwards			1,551				1,186
Deferred tax liabilities:
Current:
Other			23				(3	)
Long-term:
Intangibles			(122	)			(132	)
Depreciation			(38	)			(57	)
			1,473				994
Valuation allowance			1,473				994
		$	-0-			$	-0-

 

For the year ended September 30, 2006 the valuation allowance for deferred tax assets increased $479 which was mainly due to the operating loss incurred and $15 due to the acquisition of New Tilt. For the year ended September 30, 2005, the valuation allowance for deferred tax assets increased $15 which was mainly due to the operating loss incurred offset by the $135 decrease in the iapps acquisition.,. The Company has NOLs and other deferred tax benefits that are available to offset future taxable income. A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Accordingly, the Company has established a full valuation allowance against its net deferred tax asset at September 30, 2006 and 2005, 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. To date, the foreign taxes not incurred as a result of this tax holiday have not been significant.

Undistributed earnings of the Company’s foreign subsidiary amounted to approximately $186 and $18 at September 30, 2006 and 2005, respectively. 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, 2006, there would be minimal withholding taxes upon remittance of all previously unremitted earnings.

F-54

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

 

11.   Events Subsequent to September 30, 2006

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.   Had this amendment not been executed, the value of the Debt Warrants would have been recorded as a liability and such value would have been subject to adjustment based on changes in the value of the Company’s common stock. As of September 30, 2006, based on the Company's estimate of the fair value of the common stock at $2.46 per share, the adjustment to the value of the Debt Warrants that would have been recognized had they been recorded as a liability was approximately $60.

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 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 estimated initial public offering price of its shares) 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. The acquisition of Objectware is contingent on the Company raising at least $10 million in its initial public offering. On March 29, 2007, the expiration date of the purchase agreement was extended to June 15, 2007.

Initial Public Offering of Common Stock

 

The Company intends to undertake an initial public offering of its Common Stock, the net proceeds of which will be used to repay the Senior Notes described in Note 7, to fund the cash portion of the Objectware acquisition described above and for general corporate purposes.

 

In December 2006, the Company filed a registration statement with the Securities and Exchange Commission for an initial public offering of its common stock.  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.

 

Extension of Senior Notes Payable

On March 29, 2007, the maturity date of the Senior Notes Payable described in Note 7 was extended to the earlier of June 21, 2007 or the date the Company closes a firm underwritten initial public offering. The interest rate from April 1, 2007 to June 21, 2007 shall be a rate of 15% per annum. In the event that the notes are not paid by June 21, 2007, the interest rate shall increase to a rate of 18% per annum subject to the terms and provisions of the notes. In accordance with the extension agreement, interest will accrue, but no payments of principal or interest will be required prior to the extended maturity date. One June 20, 2007, the maturity date was further extended to July 5, 2007 with no other terms of the agreement being modified.

F-55

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BRIDGELINE SOFTWARE, INC.

                    

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      

(Information as of March 31, 2007 and for the Six Months Ended March 31, 2007 and 2006 is unaudited)

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

 

Loan Agreements

In April 2007, the Company issued secured promissory notes to its Chief Executive Office and a member of the Board of Directors aggregating $200,000.  The notes bear interest at a rate of 15 % per annum payable, along with the outstanding principal on the notes on the earlier of October 3, 2007 or the closing of an initial public offering of securities pursuant to the Company’s registration statement described above. The note holder’s security interest with regards to the notes is pari pasu to the security interest of the holders of the Senior Notes described in Note 7.

Financing Agreement

In May 2007, the Company, the holders of the Senior Notes, and the lender (the “Lender”) under the Financing Agreement (the “Agreement”) described in Note 7, entered into a subordination agreement wherein the Senior Note holders subordinated their security interest to the Lender up to a maximum of $375,000.  Also in May 2007, the Company and the Lender amended the Agreement to reduce the maximum borrowings allowed under the Agreement from $750,000 to $375,000.

Sub Lease Agreement

In January 2007, the Company entered into an arrangement to sub lease certain excess office space.  The terms of the sublease are substantially consistent with the terms of the original lease.

F-56

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Objectware, Inc.

  

Report of Independent Certified Public Accountants	F-58
Balance Sheets as of March 31, 2007 and September 30, 2006 and 2005	F-59
Statements of Operations for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005	F-60
Statements of Shareholder’s Equity for the six months ended March 31, 2007 and the years ended September 30, 2006 and 2006	F-61
Statements of Cash Flows for the six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005	F-62
Notes to Financial Statements	F-63

 

 

 

 

 

 

 

 

 

F-57

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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, 2006 and 2005, and the related statements of operations, shareholder’s equity, and cash flows for the years then ended. 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, 2006 and 2005, 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

February 5, 2007

 

F-58

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OBJECTWARE, INC.

BALANCE SHEETS

(Information as of March 31, 2007 is Unaudited)

(Dollars in thousands, except share amounts)

 

		March 31,				September 30,
ASSETS		2007				2006				2005
Current assets:
Cash and cash equivalents		$	422			$	976			$	530
Accounts receivable, net			529				345				180
Current portion of long-term receivable			60				60				37
Due from shareholder			—				32				27
Deferred tax asset			3				3				48
Other current assets			15				14				19
Total current assets			1,029				1,430				841
Equipment and improvements, net			166				165				134
Long-term receivable, net of current portion			229				288				226
Other assets			12				12				11
Total assets		$	1,436			$	1,895			$	1,212
LIABILITIES AND SHAREHOLDER’S EQUITY
Current liabilities:
Accounts payable		$	42			$	32			$	24
Income taxes payable			94				236				184
Accrued liabilities			25				87				81
Deferred revenue			120				293				238
Total current liabilities			281				648				527
Deferred tax liability			12				12				19
Long-term deferred revenue			240				309				226
Total liabilities			533				969				772
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
Retained earnings			901				924				438
Total shareholder’s equity			903				926				440
Total liabilities and shareholder’s equity		$	1,436			$	1,895			$	1,212

 

 

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

F-59

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   OBJECTWARE, INC.

STATEMENTS OF OPERATIONS

(Information for the Six Months Ended March 31, 2007 and 2006 is Unaudited)

(Dollars in thousands)

 

 

		For the Six Months Ended								For the Year Ended
		March 31,								September 30,
		2007				2006				2006				2005
Revenue:
Web services		$	2,071			$	1,591			$	3,101			$	2,265
Managed services			513				335				782				474
Reimbursable expense			40				17				19				23
Total revenue			2,624				1,943				3,902				2,762
Cost of revenue:
Web services			1,113				813				1,661				1,395
Managed services			66				41				103				48
Total Cost of revenue			1,179				854				1,764				1,443
Gross profit			1,445				1,089				2,138				1,319
Operating expenses:
Selling, general and administrative			1,474				820				1,341				743
Depreciation			34				29				59				41
Total operating expenses			1,508				849				1,400				784
Income (loss) from operations			(63	)			240				738				535
Gain on sale of investments			—				—				12				—
Other income (expense), net			40				18				46				(2	)
Interest income (expense), net			—				—				(1	)			(5	)
Income (loss) before provision for income taxes			(23	)			258				795				528
Provision for income taxes			—				98				309				156
Net income (loss)		$	(23	)		$	160			$	486			$	372

 

 

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

F-60

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OBJECTWARE, INC.

STATEMENTS OF SHAREHOLDER’S EQUITY

(Information as of and for the six months ended March 31, 2007 is Unaudited)

(Dollars in thousands except share amounts)

 

 

 

 

		Common Stock								Retained				Total Shareholder’s
		Shares				Amount				Earnings				Equity
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			—				—				486				486
Balance, September 30, 2006			1,600,000				2				924				926
Net loss			—				—				(23	)			(23	)
Balance, March 31, 2007			1,600,000			$	2			$	901			$	903

 

 

 

 

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

 

F-61

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OBJECTWARE, INC.

STATEMENTS OF CASH FLOWS

(Information for the Six Months Ended March 31, 2007 and 2006 is unaudited)

(Dollars in thousands)

 

 

		For the Six Months Ended								For the Year Ended
		March 31,								September 30,
		2007				2006				2006				2005
Cash flows from operating activities:
Net income (loss)		$	(23	)		$	160			$	486			$	372
Adjustments to reconcile income (loss) from operations to net cash (used in) provided by operating activities:
Depreciation			34				29				59				40
Loss on disposal of fixed assets			—				—				—				2
Gain on sale of investments			—				—				(12	)			—
Deferred tax expense (benefit)			—				(19	)			38				(29	)
Changes in operating assets and liabilities:
Accounts receivable			(192	)			(74	)			(165	)			(42	)
Long term receivable			59				(99	)			(85	)			(263	)
Prepaid expenses			(1	)			9				4				(12	)
Accounts payable			10				7				8				(6	)
Income taxes payable			(142	)			64				52				179
Accrued liabilities			(62	)			(28	)			6				26
Deferred revenue			(242	)			89				138				243
Net cash (used in) provided by operating activities			(559	)			138				529				510
Cash flows from investing activities:
Capital expenditures			(27	)			(40	)			(90	)			(88	)
Purchases of investments			—				—				(449	)			—
Proceeds from the sale of investments			—				—				461				—
Net cash used in investing activities			(27	)			(40	)			(78	)			(88	)
Cash flows from financing activities:
Advances (to) from shareholder, net			32				(5	)			(5	)			(103	)
Net cash provided by (used in) financing activities			32				(5	)			(5	)			(103	)
Net increase (decrease) in cash and cash equivalents			(554	)			93				446				319
Cash and cash equivalents, beginning of period			976				530				530				211
Cash and cash equivalents, end of period		$	422			$	623			$	976			$	530
Supplemental cash flow information:
Cash paid for interest		$	—			$	—			$	1			$	5
Cash paid for income taxes		$	142			$	4			$	219			$	6

 

 

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

F-62

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OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 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 interim consolidated balance sheet as of March 31, 2007, the consolidated statements of operations and cash flows for the six months ended March 31, 2007 and 2006, and the consolidated statement of shareholders’ equity for the six months ended March 31, 2007 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, 2006 and 2005 and include all adjustments, consisting of normal recurring adjustments and accruals, necessary for the fair presentation of the Company’s financial position at March 31, 2007 and its results of operations and its cash flows for the six months ended March 31, 2007 and 2006. The results for the six months ended March 31, 2007 are not necessarily indicative of the results to be expected for the year ending September 30, 2007.

 

2.	Summary of Significant Accounting Policies:

 

Revenue Recognition

 

Substantially all of the Company’s revenue is generated from two activities: Web Services and Managed Services.

The Company recognizes revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”) and Emerging Issues Task Force Issue No. 00-21, Accounting For Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). Revenue is recognized when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) delivery has occurred or 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 reasonably assured. Billings made or payments received in advance of providing services are deferred until the period these services are provided.

Web Services

 

Web Services include professional services primarily related to the Company’s Web development solutions that address specific customer needs such as information architecture and usability engineering, interface configuration, Web application development, rich media, e-Commerce, e-Learning and e-Training, search engine optimization, and content management.  Web Services engagements often include a hosting arrangement that provides for the use of certain hardware and infrastructure, generally at the Company’s network operating center; however, as described further below, revenue for these hosting arrangements is included in Managed Services. Web services engagements that include hosting arrangements are accounted for as multiple element arrangements as described below under “Multiple-Element Arrangements.”

F-63

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

 

For Web Services engagements sold on a stand alone basis, revenue is recognized in accordance with SAB 104.  Web Services are contracted for on either a fixed price or time and materials basis.  For its fixed price engagements, the Company applies the proportional performance model to recognize revenue based on cost incurred in relation to total estimated cost at completion. The Company has determined that labor costs are the most appropriate measure to allocate revenue among reporting periods, as they are the primary input when providing Web Services. Customers are invoiced monthly or upon the completion of milestones. For milestone based projects, since milestone pricing is based on expected hourly costs and the duration of such engagements is relatively short, this input approach principally mirrors an output approach under the proportional performance model for revenue recognition on such fixed priced engagements.  For time and materials contracts, revenues are recognized as the services are provided.

Web Services are often sold as part of multiple element arrangements wherein retained professional services and/or hosting (i.e., Managed Services) are provided subsequent to completion of the Web Services.  The Company’s revenue recognition policy with respect to these multiple element arrangements is described further below under the caption “Multiple Element Arrangements.”

Managed Services

 

Managed Services include retained professional services and hosting services.

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 professional services hours each month on a “use it or lose it” basis.   For retained professional services sold on a stand-alone basis, revenue is recognized in accordance with SAB 104.  The Company recognizes revenue as the services are delivered or over the term of the contractual retainer period.  These arrangements do not require formal customer acceptance and do not grant any future right to labor hours contracted for but not used.

Hosting arrangements provide for the use of certain hardware and infrastructure, generally at the Company’s network operating center.  For all periods presented, the only customers under contractual hosting arrangements have been previous Web Services customers. Hosting agreements are month-to-month arrangements that provide for termination for convenience by either party upon 30-days notice.  Revenue is recognized monthly as the hosting services are delivered. Revenues from any hosting setup fees are recognized ratably over 24 months.

Retained professional services are sold on a stand-alone basis or in multiple element arrangements with Web Services.  Hosting services are only sold in connection with Web Services and are not sold on a stand-alone basis.   The Company’s revenue recognition policy with respect to multiple element arrangements is described further below under the caption “Multiple Element Arrangements.”

 

Multiple Element Arrangements

 

As noted above, Web Services are often sold as part of multiple element arrangements.  Such arrangements include delivery of retained professional services and/or hosting services subsequent to completion of a Web Services engagement.  In accounting for these multiple element arrangements, the Company follows EITF 00-21 and, as described further below, has concluded that each element can be treated as a separate unit of accounting.

 

When Web Services engagements includes retained professional services and/or hosting, the Company has concluded that each element can be accounted for separately as the delivered elements (i.e., the Web

F-64

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

 

Services) have stand-alone value and there is objective and reliable third party evidence of fair value for each of the undelivered elements (i.e., the retained professional services and/or the hosting).   Web Services are available from other vendors and are regularly sold by the Company on a stand-alone basis pursuant to a standard price list.  Objective and reliable third party evidence of fair value for the undelivered elements has been established as the Company’s retained professional services and hosting services are sold pursuant to standard price lists.

The amount of revenue to be recognized in the multiple element arrangements described above is determined using the residual method whereby the value ascribed to the delivered element (i.e., the Web Services) is equal to the total consideration of the multiple element arrangement less the third party evidence of fair value of the undelivered elements (i.e., the retained professional services and/or the hosting).

Direct costs associated with web development services and retained professional services are recorded as the services are delivered and the corresponding revenue is recognized.  Direct costs associated with hosting services are expensed as incurred.

Customer Payment Terms

Except as described in Note 6, the Company’s payment terms with customers typically are “due upon receipt” or “net 30 days from invoice”. Payments terms may vary by customer but in all instances do not exceed 60 days from invoice date. For Web Services, the Company typically invoices project deposits of between 20% and 33% of the total contract value which are record as deferred revenue until such time the related services are completed. Subsequent invoicing for Web Services is either monthly or upon achievement of milestones and payment terms for such billings are within the standard terms described above. Invoices for hosting are issued monthly and are generally due upon receipt. The Company’s agreements with customers do not provide for any refunds for services or products and therefore no specific reserve for such is maintained. In the infrequent instances where customers raise concerns over delivered products or services, the Company has endeavored to remedy the concerns and all costs related to such matters have been insignificant in all periods presented.

Warranty

 

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. 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 related cost to satisfy the warranty obligation is estimated and accrued. Warranty claims to date have been immaterial.

Reimbursable Expenses

 

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’s accounts

F-65

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

 

receivable 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 customers who individually represented 17% of the Company’s total revenue for the six months ended March 31, 2007 and one customer who individually represented 16% of the Company’s total revenue for the year ended September 30, 2006 and no customers represented 10% or more of the Company’s total revenue for the fiscal year ended September 30, 2005.

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 6), as follows:

 

				September 30,
		March 31,  2007		2006		2005
Customer #1		*		26%		*
Customer #2		*		16%		25%
Customer #3		*		*		24%
Customer #4		*		*		11%
Customer #5		25%		*		*
Customer #6		19%		*		*
Customer #7		11%		*		*

            * 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 reserve for doubtful 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 proportional performance model affect the amounts of revenues and related expenses reported in the Company’s financial statements. A number of internal and external factors can affect the Company’s estimates including efficiency variances and specification and test requirement changes.

F-66

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

 

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.

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. Realized gains and losses are recorded using cost determined on a specific identification basis. The Company has no investments in marketable equity securities as of March 31, 2007. 

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. As described in Note 6, the Company’s long-term receivable has been recorded at a discount above the contractual rate. The Company believes the carrying value of its long term receivable approximates fair value. 

 

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 $58, 0, $9 and $3 for six months ended March 31, 2007 and 2006 and the years ended September 30, 2006 and 2005, respectively.

Stock-Based Compensation

 

The Company has a stock-based employee compensation plan that is described more fully in Note 9. Prior to the effective date of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, the Company had 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.

F-67

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

 

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. 

 

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 SFAS 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 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 value measurements shall be recognized in earnings for the period. The Company has not yet 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 is currently evaluating the impact of SFAS 157 on the financial statements.

 

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is

F-68

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

in the process of evaluating the impact of the adoption of this statement on the Company’s results of operations and financial condition.

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. The balance of the amount due from the shareholder was $0, $32 and $27 as of March 31, 2007 and September 30, 2006 and 2005, respectively. Interest paid in relation to advances from the shareholder totaled $0, $0, $1 and $5 for the six months ended March 31, 2007 and 2006 and for the years ended September 30, 2006 and 2005, respectively.

 

 

4.	Accounts Receivable:

Accounts receivable consisted of the following as of March 31, 2007 and September 30, 2006 and 2005:

						September 30,
		March 31, 2007				2006				2005
Accounts receivable		$	522			$	307			$	195
Unbilled accounts receivable			29				61				15
Allowance for doubtful accounts			(22	)			(23	)			(30	)
Accounts receivable, net		$	529			$	345			$	180

 

5.	Equipment and Improvements:

 

Equipment and improvements, net consisted of the following as of March 31, 2007 and September 30, 2006 and 2005:

 

F-69

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

						September 30,
		March 31, 2007				2006				2005
Computers, software and equipment		$	416			$	381			$	296
Furniture and fixtures			38				38				34
Leasehold improvements			20				20				20
			474				439				350
Less: Accumulated depreciation and  amortization			308				274				216
Equipment and improvements, net		$	166			$	165			$	134

 

 

 

6.	Long Term Receivable:

Commencing in the year ended September 30, 2005, the Company granted to a certain customer extended payment terms 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 Company recorded a discount on the long term receivable of $47 to reflect an imputed estimated fair market interest rate of 12% for the remaining term. The balance of the outstanding principal and interest 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. For the six months ended March 31, 2007 and 2006 and for the years ended September 30, 2006 and 2005, respectively, the Company recognized revenue of $187, $121, $250 and $166, respectively, under this arrangement.

 

 

7.	Accrued Liabilities:

Accrued liabilities consisted of the following as of March 31, 2007 and September 30, 2006 and 2005:

						September 30,
		March 31, 2007				2006				2005
Deferred rent		$	12			$	23			$	44
Accrued payroll			12				53				37
Other accruals			1				11				—
Total accrued liabilities		$	25			$	87			$	81

8.	Commitments:

Revolving Line of Credit

On January 9, 2002, the Company entered into a revolving line of credit (the “Facility”) with a commercial lender. The Facility provides borrowings of up to $250 and bears interest at the Wall Street Journal’s prime rate (8.25% at March 31, 2007 and September 30, 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.

 

F-70

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

      

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, 2006 were as follows:

Year Ended September 30,:
2007		$	164
2008			35

Rent expense under all operating leases was approximately $71, $68, $137 and $135 for the six months ended March 31, 2007 and 2006 and for the years ended September 30, 2006 and 2005, respectively.

 

 

9.	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, 2004			42,500				1.00
Granted			—
Cancelled			—
Exercised			—
Options outstanding at September 30, 2005			42,500				1.00
Granted			—
Cancelled			—
Exercised			—
Options outstanding at September 30, 2006			42,500				1.00
Granted			—
Cancelled			—
Exercised			—
Options outstanding at March 31, 2007			42,500				1.00

 

 

F-71

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

   

Summarized information about stock options outstanding at September 30, 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
$1.00		42,500		4.4		$1.00		42,500		4.4

 

 

 

10.	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 a contribution of $58 for the six months ended March 31, 2007 and has not made any other contributions to the plan since its inception.

      

11.	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. In addition, we evaluate the Company’s tax contingencies on an ongoing basis and recognize a liability when we believe that it is probable that a liability exists and that liability is measurable.

		September 30,
		2006				2005
Deferred tax assets:
Deferred revenues		$	81			$	77
Accounts payable and accrued liabilities			45				40
Deferred tax liabilities:
Accounts receivable, net			(115	)			(69	)
Tax over book depreciation			(20	)			(19	)
Net deferred taxes		$	(9	)		$	29
Recorded in balance sheet as follows:
Current assets		$	3			$	48
Long-term liabilities		$	(12	)		$	(19	)

 

 

F-72

---

OBJECTWARE, INC.

NOTES TO FINANCIAL STATEMENTS

(Information as of March 31, 2007 and for

the Six Months Ended March 31, 2007 and 2006 is Unaudited)

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

 

 

The components of the provision for income taxes for the years ended September 30, 2006 and 2005 are as follows:

 

		For the Year Ended September 30,
		2006				2005
Federal and state taxes:
Current:
Federal		$	230			$	158
State			41				27
Deferred			38				(29	)
Provision for income taxes		$	309			$	156

 

 

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,
		2006				2005
Income tax provision at the federal statutory rate of 34%		$	270			$	180
State income expense, net of federal benefit			31				21
Change in valuation allowance			—				(58	)
Other			8				13
		$	309			$	156

 

12.

Events Subsequent to September 30, 2006:

 

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-73

---

 

New Tilt, Inc.

 

Report of Independent Certified Public Accountants		F-75
Balance Sheets as of April 24, 2006 and December 31, 2005		F-76
Statements of Operations for the period January 1, 2006 thru April 24, 2006 and the year ended December 31, 2005		F-77
Statements of Shareholders’ Equity for the period January 1, 2006 through April 24, 2006 and the year ended December 31, 2005		F-78
Statements of Cash Flows for the period January 1, 2006 through April 24, 2006 and the year ended December 31, 2005		F-79
Notes to Financial Statements		F-80

 

 

 

 

 

 

 

 

 

 

F-74

---

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-75

---

NEW TILT, INC.

BALANCE SHEETS

(Dollars 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.

 

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NEW TILT, INC.

STATEMENTS OF OPERATIONS

(Dollars 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-77

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NEW TILT, INC.

STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars 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-78

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NEW TILT, INC.

STATEMENTS OF CASH FLOWS

(Dollars 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.

 

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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

(Dollars 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.

  

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:

F-80

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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

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

 

		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 the Company’s 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.

  

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. 

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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

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

 

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:

  

		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

F-82

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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

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

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.

 

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).

F-83

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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

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

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 7, 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, 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).

 

 

F-84

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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

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

 

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:

		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

 

 

F-85

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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

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

 

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.

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-86

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Below are screen shots of our Content Management software tool:

 

The diagram below shows an example of an author, approver and publisher roles as the building blocks of the workflow component our Content Management software tool.

 

 

 

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Until July 23, 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	3 7 8 11   22 22 23 23 24 25 27 29 32 56 79 86   90   91 92 96 98 100 100 100 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 Security Research Associates, Inc.   June 28, 2007