WWW.EXFILE.COM, INC. -- 14663 -- BRIDGELINE SOFTWARE, INC. -- FORM SB-2
As filed with the Securities and Exchange Commission on December 13, 2006
Registration No. 333-______


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form SB-2

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

Bridgeline Software, Inc.
(Name of small business issuer in its charter)

 
 
 
 
 
Delaware
 
7372
 
52-2263942
(State or other jurisdiction of
incorporation or organization)
 
(Primary Standard Industrial
Classification Code Number)
 
(IRS Employer
Identification Number)

10 Sixth Road
Woburn, Massachusetts 01801
(781) 376-5555
(Address and telephone number of principal executive offices and principal place of business)
 
Thomas Massie
President and Chief Executive Officer
10 Sixth Road
Woburn, Massachusetts 01801
(781) 376-5555
(Name, address and telephone number of agent for service)

Copy of all communications to:
 
 
 
Carl F. Barnes, Esq.
Joseph C. Marrow, Esq.
Morse, Barnes-Brown & Pendleton, P.C.
1601 Trapelo Road
Waltham, Massachusetts 02451
(781) 622-5930
(781) 622-5933 (fax)
 
Ralph V. De Martino, Esq.
F. Alec Orudjev, Esq.
Cozen O’Connor
1627 I Street, N.W., Suite 1100
Washington, D.C. 20006
(202) 912-4800
(202) 912-4830 (fax)
 
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. þ

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.      o

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.      o


If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement or the same offering.      o

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.     o

Calculation of Registration Fee
     
         
 
 
Title of Each Class of Securities to be Registered
 
 
Amount to be
Registered(1)
Proposed
Maximum
Offering Price
Per Share(2)
Proposed
Maximum
Aggregate
Offering Price(2)
 
 
Amount of
Registration Fee
Common stock(3):
3,450,000 shares
$ 6.00
$  20,700,000.00
$ 2,214.90
Warrants issued to the Underwriters (“Underwriters’ Warrants”)(4):
300,000 warrants
$    
$                    —
$           —
Shares of common stock underlying the Underwriters’ Warrants
300,000 shares
$ 6.00
$   1,800,000.00
$    192.60
Warrants for resale by existing warrant holders(4):
392,000 warrants
$    —
$                    —
$           —
Common stock for resale by existing warrant holders after exercise
392,000 shares
$ 6.00
$   2,352,000.00
$    251.66
Total Amount of Registration Fees:
$ 2,660.00

(1)         
In accordance with Rule 416 under the Securities Act of 1933, as amended (the “Securities Act”), in order to prevent dilution, a presently indeterminable number of shares of common stock are registered hereunder which may be issued in the event of stock splits, stock dividends, triggering of any anti-dilution provisions in the warrants and the Underwriters’ warrants for the purchase of common stock or similar transactions involving the common stock of the Registrant. No additional registration fee has been paid for these shares of common stock.

(2)         
Estimated solely for the purposes of calculating the registration fee pursuant to Section 6(b) of the Securities Act, and computed pursuant to Rule 457(a) promulgated under the Securities Act.

(3)         
Includes 450,000 shares which the Underwriters have the option to purchase from the Registrant to cover over-allotments, if any.

(4)         
No fee pursuant to Rule 457(g).

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act, as amended, or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

EXPLANATORY NOTE:

This registration statement contains two forms of prospectus: one for use in our underwritten initial public offering, and one for use by selling shareholders after completion of the underwritten initial public offering. The two prospectuses are identical in all respects except for the alternate pages for the selling shareholder prospectus, which are labeled “Alternate Page for Selling Shareholder Prospectus.”


 
The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. The prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
 
SUBJECT TO COMPLETION, DATED DECEMBER 13, 2006

PROSPECTUS
 
LOGO
 
Bridgeline Software, Inc.
3,000,000 shares of Common Stock
 

This is a firm commitment initial public offering of 3,000,000 shares of our common stock. This is our initial public offering and no public market currently exists for our common stock. The initial public offering price for the shares offered hereby is estimated to be between $5.00 and $6.00 per share.

We have applied for listing of our common stock on the Nasdaq Capital Market and the Boston Stock Exchange under the symbols “BLSW” and “BLS”, respectively.

Investing in our common stock involves risks. See “Risk Factors” beginning on page 9 for a discussion of certain factors that should be considered by prospective purchasers of our shares.

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

 
 
Price to the Public
 
Underwriting Discounts
and Commissions
 
Proceeds,
Before Expenses,
to the Company
 
 
 
 
 
 
 
Per Share
 
 
 
 
 
 
Total
 
 
 
 
 
 
     
We have granted the underwriters a 45-day option to purchase up to an additional 450,000 shares to cover over-allotments, if any. The shares are being offered by the underwriters named herein, subject to prior sale, when, as and if accepted by them and subject to certain conditions.


Joseph Gunnar & Co., LLC
 
The date of this prospectus is                     , 2007.
 


PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. You should read this summary together with the more detailed information, including our financial statements and the related notes, elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in “Risk Factors” on page 9. In addition, some of the statements made in this prospectus discuss future events and developments, including our future business strategy and our ability to generate revenue, income and cash flow. These forward-looking statements involve risks and uncertainties which could cause actual results to differ materially from those contemplated in these forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements” on page 17.

Unless the context indicates otherwise, the terms “our,” “we,” “us,” and “Bridgeline” refer to Bridgeline Software, Inc.

Bridgeline Software

Bridgeline Software is a developer of Web software tools and Web applications that help our customers to optimize business processes utilizing Web-based technologies. We help our customers attain the following objectives:

·     
Increased sales
·     
Improved customer service and customer loyalty
·     
Enhanced employee communication and training
·     
Reduced administrative and operational expenses

We develop award-winning Web applications and Web software tools for use over the Internet as well as for particular customers’ intranets and extranets. Our in-house team of Microsoft®-certified developers specializes in:

·     
Information architecture and usability engineering
·     
Web application development
·     
Rich media development
·     
e-Commerce applications
·     
e-Training applications
·     
Search engine optimization

To differentiate ourselves from our competition and improve our value proposition, we have developed our own Web software tools such as a Web content management system and an on-Demand Web-based platform that provide expandable modules such as eSurvey, eNewsletter, eCommerce, Content Management, Relationship Management, Event Registration and Integrated Grants Management. A description of our Web software tools and Web services can be found beginning on page 39 of this prospectus.

We have more than 70 active customers, including Nomura Securities, The Bank of New York, Pfizer, Depository Trust & Clearing Corporation and John Hancock, comprising approximately 23%, 9%, 6%, 6% and 5% of our revenues, respectively, for the ten months ended July 31, 2006.

We have received multiple industry awards, including WebAwards from the Web Marketing Association; MITX Awards from the Massachusetts Innovation & Technology Exchange; Axiem Awards; and One Show Interactive Awards. A description of these awards can be found on page 38 of this prospectus.

2


Market Opportunity

We believe the Web application development market is rapidly growing and fragmented, and that there is an opportunity for us to expand and significantly enhance our market share position by acquiring companies who specialize in Web application development, thereby potentially creating one of the largest interactive technology companies in North America. We believe that established yet small Web application development companies have the ability to market, sell and install Web-based software tools in their local metropolitan markets. In addition, we believe that these companies also have customer bases and a niche presence in the local markets in which they operate. We believe that by acquiring certain of these companies and applying our business practices and efficiencies, we can dramatically accelerate our time to market in geographic locations other than those in which we now operate.

We estimate, based on our experience in having made such acquisitions, that compounded annual growth rates of at least 20% per year for each acquired entity may be possible. We target certain established Web application development companies that we believe have both:

 
(1)
the complementary technical ability to market, sell and install Web-based software tools in their particular metropolitan market areas; and

 
(2)
an established base of customers with local market presence that can potentially accelerate our time to market in geographic areas where we do not currently operate.

In addition, we believe that even established Web application development companies we acquire could improve their profit margins by (i) licensing our Web software tools to their customer base, (2) reducing development costs by leveraging our Bangalore, India development center and (3) consolidating marketing, general and administrative functions at our corporate headquarters in Massachusetts. We believe this expansion strategy by which we grow primarily by acquiring profitable operating companies is a key component of our business model.

Acquisitions

Since our inception, we have consummated the acquisition of four Web application development companies:

·     
In December 2000, we acquired Streamline Communications, a Boston, Massachusetts-based company.
·     
In February 2002, we acquired Lead Dog Digital, Inc., a New York, New York-based company.
·     
In December 2004, we acquired Interactive Applications Group, Inc. (“iapps”), a Washington, D.C.-based company.
·     
In April 2006, we acquired New Tilt, Inc., a Cambridge, Massachusetts-based company.

In addition, on December 7, 2006, we signed a definitive merger agreement. Under this agreement, we intend to acquire all outstanding capital stock of Objectware, Inc., an Atlanta, Georgia-based Web application development company. The consideration for the acquisition of Objectware will be paid to Objectware’s sole stockholder, Erez M. Katz, and will consist of (i) $2,500,000 in cash, (ii) shares of our common stock having a value (based on the initial public offering price of our shares in this offering) of $2,700,000 and (iii) deferred, contingent consideration of up to $1,800,000, payable in cash and stock quarterly over the three years after we acquire Objectware, contingent upon Objectware generating positive earnings before interest, taxes and depreciation and amortization of at least $250,000 per calendar quarter during the 12 consecutive calendar quarters following this offering. In no event, however, will we issue shares to Mr. Katz in connection with this acquisition which would result in ownership by Mr. Katz of more than 19.9% of the total issued and outstanding shares of our common stock without the prior approval of our shareholders.

The acquisition of Objectware will close in escrow shortly before the completion of this offering. Prior to the completion of this offering all closing documentation other than the cash and stock consideration will be deposited with the escrow agent. Once this offering is completed, we will deposit the cash and stock consideration with the escrow agent. Upon receipt of the cash and stock consideration, the escrow agent will release all closing materials to the parties in accordance with the terms of the escrow agreement.

3

Summary Risk Factors

Our business is subject to various risks and challenges, including (without limitation or any specific order):

·       
our limited operating history on which to evaluate our operations and we have suffered losses since inception which may recur in the future as we expand;
·       
our licenses are renewable on a monthly basis and a reduction in our license renewal rate could significantly reduce our revenues;
·       
our inability to manage our future growth efficiently or profitably;
·       
our inability to complete the Objectware acquisition or to effeciently integrate Objectware into our operations;
·       
if our products fail to perform properly due to undetected errors or similar problems, our business could suffer, and we could face product liability exposure;
·       
if the security of our software, in particular the hosted Internet solutions products we have developed, is breached, our business and reputation could suffer;
·       
if we undertake future business combinations and acquisitions, they may be difficult to integrate into our existing operations, may disrupt our business, dilute stockholder value or divert management’s attention;
·       
our dependence on our management team and key personnel and the loss or inability to retain these individuals could harm our business; and
·       
intense and growing competition, which could result in price reductions, reduced operating margins and loss of market share.

For a detailed description of these and additional risk factors, please refer to “Risk Factors” beginning at page 9.
 
 
Corporate Information


Our principal executive offices are located at 10 Sixth Road, Woburn, Massachusetts 01801, and our telephone number is (781) 376-5555. We maintain offices in Cambridge, MA, New York, New York and in Washington, D.C., as well as a development center in Bangalore, India. We maintain a website at www.bridgelinesw.com. The information on our website is not part of this prospectus.
 
 
 

 
4

THE OFFERING

Securities Offered
 
3,000,000 shares of our common stock.
Over-Allotment Option
 
450,000 shares of our common stock.
Common Stock to be Outstanding After This Offering
 
7,273,833 shares (7,723,833 shares if the over-allotment option is exercised in full by the underwriters), of which 3,000,000 shares or approximately 41.2% would be held by persons purchasing in this offering (3,450,000 shares or approximately 44.7%, if the over-allotment option is exercised in full by the underwriters).
Use of Proceeds
 
We intend to use the net proceeds from this offering as follows:
·  Approximately $2,800,000 to repay all of our indebtedness;
·  Approximately $2,955,000 to pay the cash portion of the acquisition of Objectware, together with expenses associated with that acquisition; and
·  $8,380,000 for general corporate purposes, including working capital and to complete future acquisitions. See “Use of Proceeds” for additional information.
Trading Symbols
 
We have applied for listing of our common stock on the Nasdaq Capital Market and the Boston Stock Exchange under the symbols “BLSW” and “BLS,” respectively.
Risk Factors
 
You should consider carefully all of the information set forth in this prospectus, and, in particular, the specific factors set forth under “Risk Factors” beginning at page 9, before deciding whether to invest in our shares.

 
The number of shares of common stock to be outstanding after the offering is based on 4,233,833 shares outstanding as of July 31, 2006 and excludes:

·  
490,909 shares issuable upon the acquisition of Objectware;
·  
925,832 shares issuable upon the exercise of outstanding options at a weighted average price of $2.96 per share;
·  
618,269 shares issuable upon the exercise of outstanding warrants; and
·  
300,000 shares issuable upon exercise of underwriters’ warrants at a price equal to 125% of the offering price of the shares.

We are registering 4,142,000 shares, which, on a pro forma basis, would represent approximately 41% of our outstanding securities as of July 31, 2006 calculated as a fully-diluted basis, assuming the exercise of the over-allotment option granted to the underwriters.
 
     
Unless otherwise indicated, all information in this prospectus assumes no exercise of the over-allotment option granted to the underwriters.
_______________________

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

5

SUMMARY FINANCIAL DATA

You should read the following summary financial data together with our financial statements and related notes appearing at the end of this prospectus and the “Management’s Discussion and Analysis and Results of Operations” and “Risk Factors” sections included elsewhere in this prospectus. The summary financial data as of and for the years ended September 30, 2004 and September 30, 2005 set forth below are derived from, and are qualified by reference to, our financial statements that have been audited by UHY LLP, our independent registered public accounting firm, and are included elsewhere in this prospectus. The summary financial data as of July 31, 2006 and for the ten months ended July 31, 2006 and 2005 set forth below are derived from our unaudited financial statements that are included elsewhere in this prospectus. The unaudited related financial data includes all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of our financial position and results of operations for these periods. Historical results are not necessarily indicative of future results.


   
 
         
   
Ten Months Ended July 31,
 
Year Ended September 30,
 
   
2006 (c)
 
2005 (a)
 
2005 (a)
 
2004
 
Historical Statements of Operations Data:
                 
Revenues
 
$
6,603
 
$
4,645
 
$
5,769
 
$
4,888
 
Cost of revenue
   
2,924
   
2,527
   
3,113
   
2,290
 
Gross profit
   
3,679
   
2,118
   
2,656
   
2,598
 
Operating loss
   
(115
)
 
(373
)
 
(461
)
 
(132
)
Net loss
   
(698
)
 
(413
)
 
(517
)
 
(178
)
Basic and diluted loss per share
 
$
(0.17
)
$
(0.11
)
$
(0.14
)
$
(0.05
)
Weighted average shares
   
4,007,499
   
3,786,255
   
3,804,527
   
3,026,163
 
                           
                           
 
 
   
Unaudited
         
   
Ten Months Ended July 31,
 
Year Ended September 30,
 
Other Financial Data:
 
2006 (c)
 
2005 (a)
 
2005 (a)
 
2004
 
Net loss
 
$
(698
)
$
(413
)
$
(517
)
$
(178
)
Interest expense
   
583
   
40
   
56
   
46
 
Depreciation
   
141
   
86
   
107
   
78
 
Amortization of intangibles
   
97
   
75
   
94
   
30
 
EBITDA (b)
 
$
123
 
$
(212
)
$
(260
)
$
(24
)
                           
Capital expenditures
 
$
242
 
$
119
 
$
161
 
$
134
 







6

Bridgeline Software, Inc. Summary Finanical Data

   
Ten Months Ended
July 31, 2006 (d)
 
Year Ended
September 30, 2005 (d)
 
Unaudited Proforma Statements of Operations Data:
         
Revenues
   
10,658
 
$
11,111
 
Cost of revenue
   
5,275
   
6,305
 
Gross profit
   
5,383
   
4,806
 
Operating income
   
366
   
182
 
Net income
   
339
   
154
 
Earnings per share:             Basic
 
$
0.05
 
$
0.02
 
Diluted
 
$
0.04
 
$
0.02
 
Weighted average shares:  Basic
   
7,134,998
   
7,614,527
 
Diluted
   
7,705,893
   
7,978,917
 


Other Unaudited Proforma Financial Data:
 
Ten Months Ended
July 31, 2006 (d)
 
Year Ended
September 30, 2005 (d)
 
Net income
 
$
339
 
$
154
 
Income tax provision
   
46
   
27
 
Interest expense
   
13
   
3
 
Depreciation
   
106
   
166
 
Amortization of intangibles
   
176
   
228
 
EBITDA (b)
 
$
680
 
$
578
 
 

   
As of July 31, 2006
Historical
 
As of July 31, 2006
Pro Forma (d)
 
Balance Sheet Data:
         
Working capital
 
$
(1,092
)
$
10,713
 
Total assets
 
$
9,977
 
$
24,556
 
Total liabilities
 
$
3,596
 
$
1,604
 
Total shareholders’ equity
 
$
6,381
 
$
22,952
 
 
 
 
Notes to Summary Historical and Pro Forma Financial Data
 
(a)  
On December 15, 2004 we acquired iapps. The results of operations of iapps are included in our consolidated financial statements from the date of acquisition.

(b)  
“EBITDA” is defined as net income (loss), plus provision for income taxes, interest expense, depreciation and amortization of intangibles. EBITDA is a non-Generally Accepted Accounting Principle (“GAAP”) financial measure and is a numeric measure of our financial performance, financial position or cash flows. EBITDA is used here because we believe it is an effective indicator of our ability to fund growth and measure cash flows from operations. However, EBITDA should not be considered as an alternative to net income as a measure of operating results or cash flow as a measure of liquidity in accordance with GAAP. Similarly adjusted, our computation of EBITDA may not be comparable to comparable measures of other companies.

7



(c)  
On April 24, 2006 we acquired New Tilt. The results of operations of New Tilt are included in our consolidated financial statements from the date of the acquisition.

(d)  
On April 24, 2006 and December 15, 2004 we acquired New Tilt and iapps, respectively. The results of operations of New Tilt and iapps are included in our consolidated financial statements from the dates of the acquisitions. Subsequent to the sale of 3,000,000 shares of our common stock in this offering, we intend to acquire Objectware. A portion of the proceeds of this offering will be used to retire indebtedness. The accompanying summary financial data reflect the effect of these transactions as if they occurred at the beginning of the most recent fiscal year on October 1, 2004 and as of the beginning of the interim period as of October 1, 2005.



 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
8

RISK FACTORS

You should carefully consider and evaluate all of the information contained in this prospectus, including the following risk factors, before deciding to invest in our securities. Any of these risks could materially and adversely affect our business, financial condition and results of operations, which in turn could adversely affect the price of our common stock.

Risks Related to our Business

We have a limited operating history on which to evaluate our operations and may again incur losses in the future as we expand.

During the most recent three years of operations, in 2003, 2004, 2005 and for the first ten months of 2006, we had revenues of approximately $4.2 million, $4.9 million, $5.8 million and $6.6 million, respectively and net losses of $750,000, $178,000, $517,000 and $698,000, respectively. We have a limited operating history on which to base an evaluation of our business and prospects. Since 2003, we have funded operations through operating cash flows, when available, sales of equity securities, issuances of debt and lines of credit. Any investment in our company should be considered a high risk investment because you will be placing funds at risk in an unseasoned early stage company with unforeseen costs, expenses, competition and other problems to which such companies are often subject. Our revenues and operating results are difficult to forecast and our projected growth is dependent, in part, on our ability to complete future acquisitions of prospective target companies and the future revenues and operating results of such acquired companies. We therefore believe that period-to-period comparisons of our operating results thus far should not be relied upon as an indication of future performance.

As we have a limited operating history, we may be unable to accurately predict our future operating expenses, which could cause us to experience cash shortfalls in future periods.

The proceeds of this offering will be used to repay indebtedness in the aggregate principal amount of $2,800,000, together with accrued interest, to pay the $2,500,000 cash portion of the Objectware, Inc. purchase price, for general corporate purposes, including other acquisitions, as well as for general working capital purposes. In addition, in order to substantially grow our business both organically and through additional acquisitions, we may, from time to time, require additional funding. There can be no assurance that we will be able to raise any additionally needed funds, on acceptable terms or at all. The procurement of any such additional financing may result in the dilution of your ownership interest in our company.

Because most of our licenses are renewable on a monthly basis, a reduction in our license renewal rate could reduce our revenues. 

Our customers have no obligation to renew their monthly subscription licenses, and some customers have elected not to do so. Our license renewal rates may decline or fluctuate as a result of a number of factors, including customer dissatisfaction with our products and services, our failure to update our products to maintain their attractiveness in the market, or constraints or changes in budget priorities faced by our customers. A decline in license renewal rates could cause our revenues to decline which would have a material adverse effect on our operations.

Only a few customers account for a substantial portion of our revenues, and the loss of any of these customers could substantially reduce our net sales.
 
We derive a significant portion of our revenues from a small number of customers. For the ten months ended July 31, 2006, approximately 23% of our revenues were generated from Nomura Securities, 9% of our revenues were generated from The Bank of New York, 6% of our revenues were generated from Pfizer, 6% of our revenues were generated from Depository Trust & Clearing Corporation and 5% of our revenues were generated from John Hancock. The loss of business from any of these customers could substantially reduce our net sales and results of operations and could seriously harm our business.

9

We might not be able to manage our future growth efficiently or profitably. 

We anticipate that continued expansion of our business will be required to address potential market opportunities. For example, we will need to expand the size of our research and development, sales, corporate finance and operations staff. There can be no assurance that our infrastructure will be sufficiently flexible and adaptable to manage our projected growth or that we will have sufficient resources, human or otherwise, to sustain such growth. If we are unable to adequately address these additional demands on our resources, our profitability and growth might suffer. Also, if we continue to expand our operations, management might not be effective in expanding our physical facilities and our systems, procedures or controls might not be adequate to support such expansion. Our inability to manage our growth could harm our business and decrease our revenues.

We might not be able to complete our acquisition of Objectware.

On December 7, 2006, we signed a definitive merger agreement. Under this agreement, we expect to acquire Objectware, Inc. shortly before we complete this offering. The closing of our acquisition of Objectware is subject to several conditions customary to the acquisitions of this nature, including completion of satisfactory due diligence analysis. We cannot assure you that we will be able to satisfy the conditions to closing of the acquisition. If the acquisition of Objectware does not occur, our pro-forma revenue and earnings before interest and taxes at the initial public offering will be reduced significantly.

You will incur ownership dilution as a result of our proposed acquisition of Objectware.

The purchase price for Objectware consists of cash and shares of our common stock. Upon the closing of the acquisition and the release of the escrowed materials, we will issue to Objectware’s sole stockholder, Mr. Erez M. Katz, cash and shares of our common stock valued at (based on the initial public offering price of our shares in this offering) $2,700,000. These shares may not be sold or otherwise disposed of during a lock-up period of up to one year from the date of this prospectus. We have also agreed to pay Mr. Katz a deferred purchase price, contingent on Objectware’s future financial performance, payable in cash and stock quarterly over the three years after we acquire Objectware. See “Business - Growth and Expansion Strategy - Pending Acquisition - Objectware” at page 50. As a result of the issuance of shares of our common stock upon the closing of the acquisition, and the shares, if any, that we may issue to Mr. Katz in the future in payment of any deferred purchase price, you will experience ownership dilution.

Our acquisition of Objectware involves other risks, including our inability to integrate successfully its business and our assumption of liabilities.

We may not be able to integrate successfully Objectware’s business into our existing business. We cannot assure you that we will be able to market the services provided by Objectware with the other services we provide to customers. Further, integrating Objectware’s business may involve significant diversion of our management time and resources and be costly. Our acquisition of Objectware also involves the risks that the business acquired may prove to be less valuable than we expected and/or that Objectware may have unknown or unexpected liabilities, costs and problems. In entering into the Objectware definitive merger agreement, we relied on limited representations and warranties of Objectware’s sole stockholder. Although we have contractual and other legal remedies for losses that we may incur as a result of breaches of his agreements, representations and warranties, we cannot assure you that our remedies will adequately cover any losses that we incur.

If we undertake additional business combinations and acquisitions, they may be difficult to integrate into our existing operations, may disrupt our business, dilute stockholder value or divert management’s attention.

During the course of our history, we have acquired four businesses, and on December 7, 2006 we signed a definitive merger agreement with Objectware. Under this agreement, we intend to acquire all outstanding capital stock of Objectware. A key element of our growth strategy is the pursuit of additional acquisitions in the fragmented Web development/services industry in the future. These acquisitions could be expensive, disrupt our ongoing business and distract our management and employees. We may not be able to identify suitable acquisition candidates, and if we do identify suitable candidates, we may not be able to make these acquisitions on acceptable terms or at all. If we make an acquisition, we could have difficulty integrating the acquired technology, employees or operations. In addition, the key personnel of the
 
10

acquired company may choose not to work for us. Acquisitions also involve the risk of potential unknown liabilities associated with the acquired business. Each of these risks exists in connection with our acquisition of Objectware.

If our products fail to perform properly due to undetected errors or similar problems, our business could suffer, and we could face product liability exposure.

Complex applications software we sell may contain undetected errors, or bugs. Such errors can be detected at any point in a product’s life cycle, but are frequently found after introduction of new software or enhancements to existing software. We continually introduce new products and new versions of our products. Despite internal testing and testing by current and potential customers, our current and future products may contain serious defects. If we detect any errors before we ship a product, we might have to delay product shipment for an extended period of time while we address the problem. We might not discover software errors that affect our new or current products or enhancements until after they are deployed, and we may need to provide enhancements to correct such errors. Therefore, it is possible that, despite our testing, errors may occur in our software. These errors could result in:

·     
harm to our reputation;
·     
lost sales;
·     
delays in commercial release;
·     
product liability claims;
·     
contractual disputes;
·     
negative publicity;
·     
delays in or loss of market acceptance of our products;
·     
license terminations or renegotiations; or
·     
unexpected expenses and diversion of resources to remedy errors.

Furthermore, our customers may use our software together with products from other companies. As a result, when problems occur, it might be difficult to identify the source of the problem. Even when our software does not cause these problems, the existence of these errors might cause us to incur significant costs, divert the attention of our technical personnel from our product development efforts, impact our reputation or cause significant customer relations problems.

If we are unable to protect our proprietary technology and other intellectual property rights, our ability to compete in the marketplace may be substantially reduced.

If we are unable to protect our intellectual property, our competitors could use our intellectual property to market products similar to our products, which could decrease demand for such products, thus decreasing our revenues. We rely on a combination of copyright, trademark and trade secret laws, as well as licensing agreements, third-party non-disclosure agreements and other contractual measures, to protect our intellectual property rights. These protections may not be adequate to prevent our competitors from copying or reverse-engineering our products. Our competitors may independently develop technologies that are substantially equivalent or superior to our technology. To protect our trade secrets and other proprietary information, we require employees, consultants, advisors and collaborators to enter into confidentiality agreements. These agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. The protective mechanisms we include in our products may not be sufficient to prevent unauthorized copying. Existing copyright laws afford only limited protection for our intellectual property rights and may not protect such rights in the event competitors independently develop similar products. In addition, the laws of some countries in which our products are or may be licensed do not protect our products and intellectual property rights to the same extent as do the laws of the United States.

Policing unauthorized use of our products is difficult, and litigation could become necessary in the future to enforce our intellectual property rights. Any litigation could be time consuming and expensive to prosecute or resolve, result in substantial diversion of management attention and resources, and materially harm our business or financial condition.

11

If a third party asserts that we infringe upon its proprietary rights, we could be required to redesign our products, pay significant royalties or enter into license agreements.

A third party may assert that our technology or technologies of entities we acquire violates its intellectual property rights. As the number of software products in our markets increases and the functionality of these products further overlap, we believe that infringement claims will become more common. Any claims against us, regardless of their merit, could:

·     
be expensive and time consuming to defend;
·     
result in negative publicity;
·     
force us to stop licensing our products that incorporate the challenged intellectual property;  
·     
require us to redesign our products;  
·     
divert management’s attention and our other resources; or  
·     
require us to enter into royalty or licensing agreements in order to obtain the right to use necessary technologies, which may not be available on terms acceptable to us, if at all.

We believe that any successful challenge to our use of a trademark or domain name could substantially diminish our ability to conduct business in a particular market or jurisdiction and thus decrease our revenues and result in possible losses to our business.

If the security of our software, in particular the hosted Internet solutions products we have developed, is breached, our business and reputation could suffer. 

Fundamental to the use of our products is the secure collection, storage and transmission of confidential information. Third parties may attempt to breach our security or that of our customers and their databases. We might be liable to our customers for any breach in such security, and any breach could harm our customers, our business and reputation. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage, could harm our reputation, business and operating results. Computers, including those that utilize our software, are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We might be required to expend significant capital and other resources to protect further against security breaches or to rectify problems caused by any security breach, which, in turn could divert funds available for corporate growth and expansion or future acquisitions.
   
We are dependent upon our management team, and the loss of any of these individuals could harm our business.

We are dependent on the efforts of our key management personnel. The loss of any of our key management personnel, or our inability to recruit and train additional key management and other personnel in a timely manner, could materially and adversely affect our business, operations and future prospects. We do not maintain a key man insurance policy covering any of our employees. In addition, in the event that Thomas Massie, our founder, Chairman and Chief Executive Officer, is terminated by us without cause, he is entitled to receive severance payments equal to the greater of (a) three years’ total compensation, including bonus amounts, or (b) $1 million. In the event we are required to pay the severance payments to Mr. Massie, it could have a material adverse effect on our results of operations for the fiscal quarter and year in which such payments are made.
 
Our costs will increase significantly as a result of operating as a public Exchange Act reporting company, and our management will be required to devote substantial time to complying with public company rules and regulations.
 
Following this offering, as a public company, we will incur significant legal, financial, accounting and other costs and expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002 (SOX) and rules and regulations of the Securities and Exchange Commission and various exchanges, including the Nasdaq Stock Market, have imposed various requirements on public companies, including changes in corporate governance practices and disclosures. Our management and other personnel will need to devote a substantial amount of time to ensure ongoing compliance with these new requirements.

12

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.
 
Effective internal controls are necessary for us to provide reliable financial reports and effectively minimize the possibility of fraud and its impact on our company. If we cannot provide financial reports or effectively minimize the possibility of fraud, our business reputation and operating results could be harmed. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

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

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

Risks Related to Our Industry

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

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

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

13

Increasing government regulation could affect our business. 

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

·     
user privacy;  
·     
the pricing and taxation of goods and services offered over the Internet; 
·     
the content of Websites;  
·     
copyrights;  
·     
consumer protection, including the potential application of “do not call” registry requirements on customers and consumer backlash in general to direct marketing efforts of customers;
·     
the online distribution of specific material or content over the Internet; or  
·     
the characteristics and quality of products and services offered over the Internet.
 
Because competition for highly qualified personnel is intense, we might not be able to attract and retain the employees we need to support our planned growth. 

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

Risks Related to this Offering

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

·     
variations in our operating results;
·     
changes in the general economy and in the local economies in which we operate;
·     
the departure of any of our key executive officers and directors;
·     
the level and quality of securities analysts’ coverage for our common stock;
·     
announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or
 
14

  capital commitments;
·     
changes in the federal, state, and local laws and regulations to which we are subject; and
·     
future sales of our common stock.
 
Shares of common stock that are issuable pursuant to our stock option plan and our outstanding warrants could result in dilution to existing shareholders and could cause the market price of our common stock to fall.

We have reserved 1,400,000 shares of common stock that are issuable pursuant to our Amended and Restated Stock Incentive Plan. As of the date of this prospectus, we have issued 925,832 options under the plan. In addition, we have 618,267 shares that are issuable pursuant to our outstanding warrants. The existence of these options and warrants may reduce earnings per share under U.S. generally accepted accounting principles and, to the extent they are exercised and shares of our common stock are issued, dilute percentage ownership of existing shareholders, which result in a decline in the market price of our common stock.

Future sale of a significant number of our securities could cause a substantial decline in the price of our securities, even if our business is doing well.

Sales of a substantial number of shares of our common stock or the availability of a substantial number of such shares for sale could result in a decline of prevailing market price of our common stock. In particular, we are registering the resale of up to 392,000 shares of our common stock that may be acquired upon the exercise of certain warrants. These shares may not be sold or otherwise disposed of during a lock-up period of up to six months from the date of this prospectus; thereafter, holders of those shares will be able to sell them into the public market without restriction. In addition, we could issue other series or classes of preferred stock having rights, preferences and powers senior to those of our common stock, including the right to receive dividends and preferences upon liquidation, dissolution or winding-up in excess of, or prior to, the rights of the holders of our common stock. This could reduce or eliminate the amounts that would otherwise have been available to pay dividends on the common stock. In addition, all of our directors, officers and shareholders have executed lock-up agreements with the underwriters agreeing not to sell, transfer or otherwise dispose of any of their shares for a period of one year from the date of this prospectus. The lock-up agreements are subject to customary exceptions and may be waived by the underwriters. Sales of a substantial number of these shares in the public market could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.

The results of our operations could cause our stock price to decline.
      
Our operating results in the future may be affected by a number of factors and, as a result, fall below expectations. Any of these events could negatively affect our operating results which might cause our stock price to fall:

·     
Our inability to attract new customers at a steady or increasing rate;
·     
Our inability to provide and maintain customer satisfaction;
·     
Price competition or higher prices in the industry;
·     
Higher than expected costs of operating our business;
·     
The amount and timing of operating costs and capital expenditures relating to the expansion of our business, operations and infrastructure are greater and higher than expected;
·     
Technical, legal and regulatory difficulties with respect to our business occur; and
·     
General downturn in economic conditions that are specific to our market, such as a decline in information technology spending.

Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

The initial public offering price of our common stock is substantially higher than the net tangible book value per share of our common stock immediately after this offering. If you purchase our shares in this offering, you will incur an immediate dilution of $3.86 per share of common stock ($3.74 if the over-allotment option is exercised by the underwriters) in net tangible book value per share from the price you paid, based on an assumed initial mid-point
 
15

offering price between $5.00 and $6.00 per share. Upon the issuance of additional shares of our common stock to Objectware’s sole stockholder in the closing described at page 53 of this prospectus, dilution will be reduced by $0.01 per share of common stock ($0.00 if the over-allotment option is exercised by the underwriters) in net tangible book value per share from the price you paid, based on an assumed initial mid-point offering price between $5.00 and $6.00 per share.
 
We do not intend to pay dividends, which may limit the return on your investment.
 
We have never declared or paid cash dividends or distributions to our equity owners. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. You should not make this investment in our securities if you require dividend income from your investment. The success of your investment will likely depend entirely upon any future appreciation of the market price of our common stock, which is uncertain and unpredictable. There is no guarantee that our common stock will appreciate in value after this offering or even maintain the price at which you purchased your shares.

We have substantial discretion as to how to use the offering proceeds.
 
While we currently intend to use the net proceeds of this offering as set forth in “Use of Proceeds” on page 18 of this prospectus, we may choose, in our sole discretion, to use the net offering proceeds for different purposes. The effect of the offering will be to increase capital resources available to our management, and our management will allocate these capital resources as necessary to enhance shareholder value. You will be relying on the judgment of our management with regard to the use of the net proceeds of this offering.

Provisions in our charter documents or Delaware law might discourage, delay or prevent a change of control of our company, which could negatively affect your investment.
 
Our Amended and Restated Certificate of Incorporation (which will become effective shortly before the completion of this offering) and Amended and Restated By-laws will contain provisions that could discourage, delay, or prevent a change of control of our company or changes in our management that our shareholders may deem advantageous. These provisions include:

·     
authorizing the issuance of preferred stock that can be created and issued by our Board of Directors without prior shareholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock;
·     
limiting the persons who can call special shareholder meetings;
·     
establishing advance notice requirements to nominate persons for election to our Board of Directors or to propose matters that can be acted on by shareholders at shareholder meetings;
·     
the lack of cumulative voting in the election of directors;
·     
requiring an advance notice of any shareholder business before the annual meeting of our shareholders;
·     
filling vacancies on our Board of Directors by action of a majority of the directors and not by the shareholders, and
·     
the division of our Board of Directors into three classes with each class of directors elected for a staggered three year term. In addition, our organizational documents will contain a supermajority voting requirement for any amendments of the staggered board provisions.
 
These and other provisions in our organizational documents could allow our Board of Directors to affect your rights as a shareholder in a number of ways, including making it more difficult for shareholders to replace members of our Board of Directors. Because our Board of Directors is responsible for appointing members of our management team, these provisions could in turn affect any attempt to replace the current management team. These provisions could also limit the price that investors would be willing to pay in the future for shares of our common stock. We are also subject to the provisions of Section 203 of the Delaware General Corporation Law, which may discourage, delay, or prevent a change of control of our company. See “Description of Capital Stock” on page 70.

16

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the information in this prospectus contains forward-looking statements within the meaning of the federal securities laws. These statements are only predictions and you should not place undue reliance on them. Forward-looking statements typically are identified by use of terms such as “anticipate,” “believe,” “plan,” “expect,” “future,” “intend,” “may,” “will,” “should,” “estimate,” “predict,” “potential,” “continue,” and similar words, although some forward-looking statements are expressed differently. All forward-looking statements address matters that involve risks and uncertainties. There are many important risks, uncertainties and other factors that could cause our actual results, as well as trends and conditions within the markets we serve, levels of activity, performance, achievements and prospects to differ materially from the forward-looking statements contained in this prospectus. You should also carefully consider all forward-looking statements in light of the risks and uncertainties set forth under “Risk Factors” and elsewhere in this prospectus. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future developments or otherwise.

In light of the significant uncertainties inherent in the forward-looking statements made in this prospectus, particularly in view of our early stage of operations, the inclusion of this information should not be regarded as a representation by us or any other person that our objectives, future results, levels of activity, performance or plans will be achieved.

 
DETERMINATION OF OFFERING PRICE

The offering price of our common stock was arbitrarily determined by our management after consultation with our underwriters and was based upon consideration of various factors including our history and prospects, the background of our management and current conditions in the securities markets. As a result, the price of our common stock does not necessarily bear any relationship to our assets, book value, net worth or other economic or recognized criteria of value. In no event should the offering price of our common stock be regarded as an indicator of any future market price of our securities.
 
 
 
 
 

 
17

USE OF PROCEEDS 

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

We intend to use the net proceeds of this offering as follows: 
Use
   
Amount
(in thousands)
   
Percent 
 
Repayment of indebtedness (approximate)
 
$
2,800
   
19.8
%
Payment of cash portion in connection with the acquisition of Objectware, together with expenses associated with that acquisition
   
2,955
   
20.9
%
General corporate purposes, including working capital
   
8,380
   
59.3
%
Total
 
$
14,135
   
100.0
%
     
The amounts and timing of our actual expenditures will depend on numerous factors, including the results of our sales, marketing activities, competition and the amount of cash generated or used by our operations. For example, in the event that we do not complete the acquisition of Objectware, we will use the proceeds of this offering allocated to that acquisition for general corporate purposes, including working capital and to complete future acquisitions. The amount and timing of our actual expenditures may vary substantially from the foregoing estimates. We may find it necessary or advisable to use the net proceeds for other purposes, and we will have broad discretion in the application of the balance of the net proceeds. Pending the uses described above, we intend to invest the net proceeds in certificates of deposit, short-term obligations of the United States government, or other money-market instruments that are rated investment grade or its equivalent.
 
 
DIVIDEND POLICY

We have never paid cash dividends or distributions to our equity owners. We do not expect to pay cash dividends on our common stock, but, instead, intend to utilize available cash to support the development and expansion of our business. Any future determination relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including, but not limited to, future operating results, capital requirements, financial condition and the terms of any credit facility or other financing arrangements we may obtain or enter into, future prospects and other factors our Board of Directors may deem relevant at the time such payment is considered. There is no assurance that we will be able or will desire to pay dividends in the near future or, if dividends are paid, in what amount.

 
18

CAPITALIZATION

The following table sets forth our capitalization as of July 31, 2006. You should read this table in conjunction with “Management’s Discussion and Analysis” beginning on page 26 and the financial statements and accompanying notes included elsewhere in this prospectus. Such information is set forth on the following basis:

·     
“Actual” is based on our unaudited financial statements as of July 31, 2006.

·     
“Adjustments” gives the effect of the sale of shares in this offering and the application of the net proceeds from this offering as described under “Use of Proceeds” on page 18 and assumes that the underwriters do not exercise their over-allotment option and is further adjusted for issuances of shares and options pursuant to the completion of the acquisition of Objectware.

·     
“As Adjusted” gives the net effect of the adjustments to actual for the sale of shares in this offering and the application of the net proceeds from this offering as described under “Use of Proceeds” on page 18 assuming that the underwriters do not exercise their over-allotment option, and the effect for issuances of shares and options pursuant to the completion of the acquisition of Objectware.
 
 
 
   
July 31, 2006
(Amounts in thousands)
 
 
 
 
Actual
 
Adjustments (a)
 
As Adjusted
 
Long-term obligations, including current maturities
 
$
2,715
 
$
(2,546
)
$
169
 
Shareholders’ equity:
                 
Common stock $.001 par value: 15,000,000 shares authorized, 4,233,833 shares issued and outstanding (actual) and 20,000,000 shares authorized, 7,233,833 shares issued and outstanding (as adjusted)
   
4
   
3
   
7
 
Preferred stock, $.001 par value: 1,000,000 shares authorized, no shares issued and outstanding
   
   
   
 
Paid-in capital
   
9,790
   
17,015
   
26,805
 
Accumulated deficit
   
(3,413
)
 
(612
)(b)
 
(4,025
)
Total equity
   
6,381
   
16,406
   
22,787
 
 
                 
Total capitalization
 
$
9,096
 
$
13,860
 
$
22,956
 
 
             
_________________

(a)  
Gives effect to the sale of an aggregate 3,000,000 shares of common stock in this offering resulting in net proceeds of $14,135,000 to us, assuming no exercise of the underwriters’ over-allotment option, and issuance of an additional 490,909 contingent shares of common stock upon the completion of the acquisition of Objectware at an assumed price of $5.50 per share combined with $180 representing conversion of Objectware options to Bridgeline options.
(b)  
Includes expensing the unamortized debt discount of $254, unamortized values of Underwriter Debt Warrants, as defined, of $53, unamortized financing fees of $263, and deferred offering costs of $42.


 
 

 
19

UNAUDITED CONDENSED PRO FORMA FINANCIAL DATA

In accordance with Article 11 of Regulation S-X under the Securities Act of 1933, as amended, a condensed pro forma balance sheet as of July 31, 2006 and a condensed pro forma statement of operations for the ten months ended July 31, 2006 and for the year ended September 30, 2005 have been prepared based upon our historical financial statements and the historical financial statements of New Tilt, Inc. and Objectware, Inc. included elsewhere in this prospectus and should be read in conjunction therewith.

The unaudited condensed pro forma statement of operations for the year ended September 30, 2005 reflects the acquisitions of Interactive Applications Group, Inc. as if it had been completed on October 1, 2004, and New Tilt, Inc. and Objectware, Inc. as though such acquisitions had been completed on October 1, 2005. The pro forma figures, as adjusted, reflect the 3,000,000 shares of common stock to be issued in this offering effective as of July 31, 2006 and October 1, 2005, respectively.

The following unaudited condensed pro forma financial data should be read in conjunction with the audited and unaudited historical financial statements of our company, New Tilt, Inc. and Objectware, Inc. and the unaudited pro forma combined consolidated financial information, including the notes thereto, appearing elsewhere in this prospectus. The unaudited pro forma condensed combined information is presented for illustrative purposes only and is not necessarily indicative of the results of operations or financial position that would have occurred if the transactions had been completed at the dates indicated, nor is it necessarily indicative of future results of operations or financial position of the combined company.
 
Bridgeline Software, Inc. Unaudited Condensed Pro Forma Financial Data
                           
   
Unaudited Ten Months Ended July 31,
 
Year Ended September 30,
 
                   
Unaudited
     
   
Historical
 
Pro Forma
 
Historical
 
Historical
 
Pro Forma
 
Historical
 
   
2006
 
2006 (b)
 
2005
 
2005
 
2005 (a)
 
2004
 
Income Statement Data:
                         
Revenues
 
$
6,603
 
$
10,658
 
$
4,645
 
$
5,769
 
$
11,111
 
$
4,888
 
Cost of revenue
   
2,924
   
5,275
   
2,527
   
3,113
   
6,305
   
2,290
 
Gross profit
   
3,679
   
5,383
   
2,118
   
2,656
   
4,806
   
2,598
 
Income (loss) from operations
 
$
(115
)
$
366
 
$
(373
)
$
(461
)
$
182
 
$
(132
)
Net income (loss)
 
$
(698
)
$
339
 
$
(413
)
$
(517
)
$
154
 
$
(178
)
                                       
Net income (loss) per share:
                                     
Basic
 
$
(0.17
)
$
0.05
 
$
(0.11
)
$
(0.14
)
$
0.03
 
$
(0.06
)
Diluted
 
$
(0.17
)
$
0.04
 
$
(0.11
)
$
(0.14
)
$
0.02
 
$
(0.06
)
                                       
Balance Sheet Data:
                                     
Current assets
 
$
2,379
 
$
12,173
 
$
1,269
 
$
935
 
$
2,030
 
$
1,878
 
Total assets
 
$
9,977
 
$
24,556
 
$
7,119
 
$
6,739
 
$
14,820
 
$
4,959
 
                                       
Current liabilities
 
$
3,471
 
$
1,460
 
$
1,393
 
$
1,114
 
$
1,122
 
$
980
 
Total liabilities
 
$
3,596
 
$
1,604
 
$
1,424
 
$
1,147
 
$
1,423
 
$
1,085
 
                                       
Total shareholders’ equity
 
$
6,381
 
$
22,972
 
$
5,695
 
$
5,592
 
$
13,020
 
$
3,874
 
                                       
Total liabilities and shareholders’ equity
 
$
9,977
 
$
24,556
 
$
7,119
 
$
6,739
 
$
14,820
 
$
4,959
 
                                       
Cash Flow Data:
                                     
Net cash used in operating activities
 
$
(493
)
     
$
(661
)
$
(432
)
     
$
(378
)
Acquisitions, net of cash acquired
 
$
(554
)
     
$
(308
)
$
(308
)
     
$
 
Net cash used in investing activities
 
$
(754
)
     
$
(540
)
$
(543
)
     
$
(226
)
Proceeds from issuance of stock
 
$
       
$
 
$
       
$
1,640
 
Proceeds from issuance of short-term debt
 
$
2,433
       
$
 
$
       
$
 
Net increase (decrease) in cash for the period
 
$
833
       
$
(863
)
$
(818
)
     
$
858
 
 

(a)
Reflects the April 24, 2006 and December 15, 2005 acquisitions of New Tilt and iapps, respectively, and the probable acquisition of Objectware, and this offering.
(b)
Reflects the April 24, 2006 acquisition of New Tilt, the probable acquisition of Objectware and this offering.

21

DILUTION

If you invest in our common stock, the book value of your shares will be diluted to the extent of the difference between the public offering price for each share common stock and the adjusted net tangible book value per share of our common stock immediately following the completion of this offering.

The net tangible book value of our common stock as of July 31, 2006 was $(866,000), or $(0.20) per share. Net tangible book value per share before this offering has been determined by dividing net tangible book value (book value of total assets less intangible assets, less total liabilities) by the number of shares of common stock outstanding as of July 31, 2006. After (i) giving effect to the sale of our shares in this offering at an estimated initial public offering of $5.50 per share and (ii) deducting underwriting discounts and commissions, the non-accountable expense allowance to the representatives of the underwriters and estimated offering expenses payable by us, our net tangible book value as of July 31, 2006 would have been $13,269,000 or $1.84 per share. This represents an immediate increase in net adjusted tangible book value of $3.34 per share to existing holders of common stock and an immediate dilution of net tangible book value of $3.66 per share to purchasers of common stock in this offering. Giving effect to the release of the closing escrow related to the acquisition of Objectware immediately after this offering, our net tangible book value as of July 31, 2006 would have been $14,722,000 or $1.91 per share. This represents an immediate additional increase in net adjusted tangible book value of $3.48 per share to existing holders of common stock and an immediate additional dilution of net tangible book value of $3.59 per share to purchasers of common stock in this offering, as illustrated in the following table:
 
   
Without giving effect
to the release of the
closing escrow in
connection with the
acquisition of
Objectware
 
After giving effect
to the release of the
closing escrow in
connection with the
acquisition of
Objectware
 
Assumed initial public offering price per share
 
$
5.50
 
$
5.50
 
Net tangible book value (deficit) per share before the offering
   
(0.20
)
 
(0.20
)
Reduction in deficit in net tangible book value per share attributable to the offering
   
2.04
   
2.04
 
Reduction in deficit in net tangible book value per share attributable to the acquisition of Objectware
   
   
0.07
 
Pro forma net tangible book value per share after the offering
   
1.84
   
1.91
 
 
Dilution per share to new investors
 
$
3.66
 
$
3.59
 

Assuming the underwriters exercise their over-allotment option in full, existing shareholders would have an immediate increase in adjusted tangible book value of $3.92 per share and investors in this offering would incur an immediate dilution of $3.45 per share or 63%, without giving effect to the release of the closing escrow in connection with the acquisition of Objectware, and existing shareholders would have an immediate increase in adjusted tangible book value of $3.06 per share and investors in this offering would incur an immediate dilution of $3.41 per share or 62%, giving effect to the release of the closing escrow in connection with the acquisition of Objectware.

Assuming the exercise of all outstanding stock options and warrants as of July 31, 2006 with exercise prices equal to or below the estimated initial public offering price of $5.50 per share, the net tangible book value of our common stock as of July 31, 2006 would have been $7,633,000 or $1.32 per share. After (i) giving effect to the sale of our shares in this offering at an estimated initial public offering of $5.50 per share, (ii) deducting underwriting discounts and commissions, the non-accountable expense allowance to the representatives of the underwriters, and estimated offering expenses payable by us, our net tangible book value as of July 31, 2006 would have been
 
22

$21,156,000 or $2.41 per share ($23,361,000 if the over-allotment option is exercised by the underwriter or $2.56 per share). This represents an immediate increase in net adjusted tangible book value of $5.00 ($5.58 if the over-allotment option is exercised by the underwriter) per share to existing holders of common stock and an immediate dilution of net tangible book value of $3.09 ($2.94 if the over-allotment option is exercised by the underwriters) per share to purchasers of common stock in this offering.

The following table summarizes, on a pro forma basis after the closing of this offering, the differences in total consideration paid by persons who are shareholders prior to completion of this offering and by persons investing in this offering as of December 11, 2006:
 
                       
Consideration
 
     
Shares
   
Purchased
   
Total
         
Price/Share
 
     
Number
   
Percent
   
Amount
   
Percent
   
Average
 
Officers, directors, promoters and affiliated persons
   
1,523,863
   
20.95
%
$
1,549,675
   
8.59
%
$
1.02
 
Other existing shareholders
   
2,749,970
   
37.81
%
 
9,293,409
   
33.99
%
$
3.38
 
New Investors
   
3,000,000
   
41.24
%
 
16,500,000
   
91.41
%
$
5.50
 
Total
   
7,273,833
   
100.0
%
$
27,343,084
   
100.0
%
$
3.76
 
 
                     
     
The foregoing presentation does not give effect to the issuance of an additional (i) 474,824 shares of common stock pursuant to the exercise of outstanding options held by persons or entities other than officers, directors, promoters and affiliated persons, (ii) 474,169 shares of common stock pursuant to the exercise of outstanding warrants held by persons or entities other than officers, directors, promoters and affiliated persons, and (iii) 467,089 shares of common stock reserved for issuance under our Amended and Restated Stock Incentive Plan.







 
 
 


 
23

SELECTED FINANCIAL DATA

The summary below sets forth certain selected historical financial data. The financial data below should be read in conjunction with the historical financial statements and the notes thereto of our company, New Tilt, Inc. and Objectware, Inc. appearing elsewhere in this prospectus. The selected financial data for the year ended September 30, 2004 and as of and for the year ended September 30, 2005 set forth below are derived from, and are qualified by reference to, our financial statements that have been audited by UHY LLP, our independent registered public accounting firm, and are included elsewhere in this prospectus. The selected financial data as of July 31, 2006 and 2005 for the ten months ended July 31, 2006 and 2005 set forth below are derived from our unaudited financial statements that are included elsewhere in this prospectus. The unaudited related financial data includes all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of our financial position and results of operations for these periods. Historical results are not necessarily indicative of future results.

When you read the selected financial data below, it is important that you also read our audited and unaudited consolidated financial statements and the notes to those statements appearing elsewhere in this prospectus, as well as the section of this prospectus entitled Management’s Discussion and Analysis and Results of Operations” and “Risk Factors.”
 
Bridgeline Software, Inc.
Selected Financial Data

   
Unaudited Ten Months
Ended July 31,
 
Year Ended September 30,
 
   
(in thousands)
 
(in thousands)
 
                   
   
2006 (a)
 
2005
 
2005
 
2004
 
Income Statement Data:
                 
Revenues
 
$
6,603
 
$
4,645
 
$
5,769
 
$
4,888
 
Cost of revenue
   
2,924
   
2,527
   
3,113
   
2,290
 
Gross profit
   
3,679
   
2,118
   
2,656
   
2,598
 
Loss from operations
 
$
(115
)
$
(373
)
$
(461
)
$
(132
)
                           
Net loss
 
$
(698
)
$
(413
)
$
(517
)
$
(178
)
                           
Net loss per share:
                         
Basic and diluted
 
$
(0.17
)
$
(0.11
)
$
(0.14
)
$
(0.06
)
                           
Balance Sheet Data:
                         
Current assets
 
$
2,379
 
$
1,269
 
$
935
 
$
1,878
 
Definite-lived intangible aseets, net
 
$
325
 
$
349
 
$
331
 
$
72
 
Goodwill
 
$
6,310
 
$
5,097
 
$
5,097
 
$
2,740
 
Total assets
 
$
9,977
 
$
7,119
 
$
6,739
 
$
4,959
 
                           
Senior notes payable, net of discount
 
$
2,546
 
$
 
$
 
$
 
Current liabilities
 
$
3,471
 
$
1,393
 
$
1,114
 
$
980
 
Total liabilities
 
$
3,596
 
$
1,424
 
$
1,147
 
$
1,085
 
                           
Total shareholders’ equity
 
$
6,381
 
$
5,695
 
$
5,592
 
$
3,874
 
                           
Total liabilities and shareholders’ equity
 
$
9,977
 
$
7,119
 
$
6,739
 
$
4,959
 

 

24

Bridgeline Software, Inc.
Selected Financial Data

       
Unaudited
 
   
Unaudited Ten
 
Year Ended
 
   
Months Ended
 
September 30,
 
   
July 31, 2006 (b)
 
2005 (c)
 
   
Pro Forma
 
Pro Forma
 
   
(in thousands)
 
(in thousands)
 
Income Statement Data:
         
Revenues
 
$
10,658
 
$
11,111
 
Cost of revenue
   
5,275
   
6,305
 
Gross profit
   
5,383
   
4,806
 
Sales and marketing expense
   
2,270
   
2,197
 
Technology development
   
140
   
43
 
General and administrative expense
   
2,607
   
2,384
 
Income from operations
 
$
366
 
$
182
 
               
Net income
 
$
339
 
$
154
 
               
Net income per share:
             
Basic
 
$
0.05
 
$
0.02
 
Diluted
 
$
0.04
 
$
0.02
 
               
Balance Sheet Data:
             
Current assets
 
$
12,173
 
$
2,030
 
Definite-lived intangible aseets, net
 
$
734
 
$
831
 
Goodwill
 
$
10,440
 
$
11,003
 
Total assets
 
$
24,556
 
$
14,638
 
               
Short-term debt, net of discount
 
$
 
$
151
 
Current liabilities
 
$
1,460
 
$
1,499
 
Total liabilities
 
$
1,604
 
$
1,800
 
               
Total shareholders’ equity
 
$
22,952
 
$
12,838
 
               
Total liabilities and shareholders’ equity
 
$
24,556
 
$
14,638
 
 
_______________________
 
(a)  
On April 25, 2006, we acquired New Tilt. The operations of New Tilt have been included in our consolidated financial statements from the date of acquisition.

(b)  
Reflects the probable acquisition of Objectware and the offering.

(c)  
On December 15, 2004, we acquired iapps, on April 24, 2006, we acquired New Tilt and, subsequent to the sale of 3,000,000 shares of our common stock in this offering, we intend to acquire Objectware. A portion of the proceeds will be used to retire indebtedness. The accompanying pro forma adjustments reflect these transactions as if they occurred at the beginning of the most recent fiscal year on October 1, 2004 and as of the beginning of the interim period as of October 1, 2005.
 
25

MANAGEMENT’S DISCUSSION AND ANALYSIS
(Amounts in thousands)

 The following Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the historical financial statements and other financial information appearing elsewhere in this prospectus, including “Summary Financial Data,” “Capitalization” and “Selected Financial Data” on pages 6, 19 and 24, respectively.
 
Overview

We are developers of award-winning Web applications and Web software tools. Our team of Microsoft®-certified developers specializes in information architecture and usability engineering, Web applications, rich media development, e-commerce application development, e-training application development, and search engine optimization. We have developed our own quality Web tools such as Content Management, Relationship Management, eSurvey, eNewsletter, eCommerce, and Event Registration. By providing award-winning Web application development capabilities with our own Web tools, we help our customers to optimize business processes utilizing Web-based technologies.

Although our revenues have increased substantially on an annual basis since fiscal 2003, and our EBITDA currently is positive, we have experienced net losses and negative cash flows from operations in each fiscal period since inception, and as of July 31, 2006, we had an accumulated deficit of $3,413 and a working capital deficit of $1,092. Since inception, we have significantly increased our revenues through a combination of factors including (i) obtaining new customers, (ii) expanding existing customer relationships, (iii) acquiring complementary businesses, (iv) expanding the features of our software tools, and (v) offering new and improved products and services.

Sources of Revenue

We generate the majority of our revenue from four different sources: (a) Web Services, (b) Managed Services, (c) Software Licenses and (d) Subscriptions. We primarily enter into Web Services engagements that are typically six months or more in duration. Our customers pay us fees as products or services are delivered. Revenues are recognized for our fixed fee engagements in proportion to the extent of progress toward completion of the project and on an incurred basis for monthly time and materials projects. Managed Service and Subscription Revenue is generally recognized monthly or ratably over the period in which the service is provided. We also sell software licenses under either perpetual or fixed term subscription licenses. Revenue for perpetual licenses is included in Web Services revenue and is generally recognized upon delivery of the software. Revenue for licensed subscription agreements is include in Subscription Revenue and is generally recognized over the term of the agreements. We offer maintenance and post contract support (PCS) to our customers, however the revenues from these support services are not material to the periods presented. During the fiscal ten months ended July 31, 2006 and 2005 and the fiscal years ended September 30, 2005 and 2004 the composition of our revenue was as follows:
 
   
 Fiscal Ten Months Ended July 31
 
 Fiscal Year Ended September 30,
   
 2006 
 
 2005 
 
 2005
 
 2004
 Web Services  
   81.1%
 
   72.7%
 
   72.5%
 
   78.2%
 Managed Services  
 13.6 
 
21.3
 
 21.6 
 
 21.8 
 Subscription Revenue  
 5.3
 
 6.0
 
 5.9
 
 
   
 100.0%
 
 100.0%
 
 100.0%
 
 100.0%
 
The demand for our services has been affected in the past, and may continue to be affected in the future, by various factors, including but not limited to, the following:
 
·  
economic conditions affecting the budget priorities of our customers;
·  
the acquisition or cancellation of significant clients;
·  
worldwide acts of terrorism effecting U.S. markets; and
 
26

 
·  
seasonality.
 
For these and other reasons, our revenue and results of operations in fiscal 2005 and prior periods may not necessarily be indicative of future revenues and results of operations.

We define our significant customers as those that generate in excess of ten percent of total revenues. These significant customers in aggregate generated 43.1%, 42.1%, 37.1% and 63.2% of our revenues in the ten months ended July 31, 2006 and 2005 and the fiscal years ended September 30, 2005 and 2004, respectively. One customer generated greater than 10% of total revenue in the ten months ended July 31, 2006 and three customers generated greater than 10% of total revenue in the ten months ended July 31, 2005 and the fiscal years ended September 30, 2005 and 2004.

Cost of Revenue and Operating Expenses

Cost of Revenue. Cost of revenue includes salaries, benefits and related expenses of operations and database support, implementation and support services and the amortization of intangible assets resulting from prior acquisitions. Gross profit represents revenue less the costs of revenue for personnel directly involved in Web development and support activities. Gross profit percentage is highly dependent on contract agreements and overhead allocations. We do not believe that historical gross profit margins are a reliable indicator of future gross profit margins. As our Subscription Revenue increases, we expect our gross margins to also increase.
 
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries, commissions, benefits and related expenses of personnel engaged in selling, marketing and customer support functions, as well as public relations, advertising and promotional costs, and overhead costs of our various locations. Sales and marketing expenses include stock-based compensation allocable to certain personnel performing sales and marketing activities.
 
General and Administrative Expenses. General and administrative expenses consist primarily of personnel-related expenses, depreciation, legal and other professional fees, facilities and communication expenses and expenses to maintain our information technology infrastructure. General and administrative expenses include stock-based compensation allocable to certain personnel performing general and administrative activities.
 
 Acquisitions
 
Acquisitions have been an important part of our growth and expansion to date. Our acquisitions have enabled us to increase our product and service offerings and expand into other geographies. We may continue to acquire companies that provide us with proprietary technology, access to key accounts, or personnel with significant experience in the Web development industry. During 2004, we completed the acquisition of Interactive Applications Group, Inc. (“iapps”) giving us further exposure and access into the foundation and non-profit industry. During 2006, we completed the acquisition of New Tilt, Inc., expanding our exposure and access into the life sciences segment of our industry.
 
From time to time, in connection with business acquisitions, we agree to make additional future payments to sellers contingent upon achievement of specific performance-based milestones by the acquired entities. Pursuant to the provisions of SFAS No. 141, Business Combinations, such amounts are accrued, and therefore, recorded by us as liabilities when the contingency is probable and estimatable and, hence, the additional consideration becomes payable.
 
Business Enterprise Segments

We are structured and operate internally as one reportable operating segment as defined in 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 we had three U.S. operating locations and an Indian
 
27

subsidiary at September 30, 2005, under the aggregation criteria set forth in SFAS 131, we operate in only one reportable operating segment since each location has similar economic characteristics.
 
Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses in the reporting period. We regularly make estimates and assumptions that affect the reported amounts of assets and liabilities. The most significant estimates included our valuation of accounts receivable and long-term assets, including intangibles and deferred tax assets, amounts of revenue to be recognized on service contracts in progress, unbilled receivables, and deferred revenue. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

 We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment:

·  
Allowance for doubtful accounts;
·  
Revenue recognition;
·  
Accounting for goodwill and other intangible assets; and
·  
Accounting for stock-based compensation.
 
  Allowance for doubtful accounts. We maintain an allowance for doubtful accounts which represents estimated losses resulting from the inability, failure or refusal of our clients to make required payments. We analyze historical percentages of uncollectible accounts and changes in payment history when evaluating the adequacy of the allowance for doubtful accounts. We use an internal collection effort, which may include our sales and services groups as we deem appropriate. Although we believe that our reserves are adequate, if the financial condition of our clients deteriorates, resulting in an impairment of their ability to make payments, or if we underestimate the allowances required, additional allowances may be necessary, resulting in increased expense in the period in which such determination is made.

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

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

          Managed Services also include on-going retained professional services and hosting arrangements. Our Managed Services typically include on-going retained professional services that are either contracted for on an “on-call” basis or for a certain amount of hours each month. We also enter engagements that provide for a guaranteed
28

number of hours each month on a “use it or lose it” basis. These arrangements do not require formal customer acceptance and we do not grant any future rights to labor hours contracted for but not used.

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

         We recognize revenue for Web Services and Managed Services when the services are performed or when they are complete. We follow the Proportional Performance Model and recognize revenue from fixed-fee development contracts when delivery has occurred in relation to the extent of progress toward completion. We allocate revenue between reporting periods based on the actual labor dollars incurred each period in proportion to total estimated labor dollars necessary to deliver the services under the arrangement. Billings on uncompleted contracts may be less than or greater than the revenues recognized and are recorded as either unbilled receivables (an asset) or deferred revenue (a liability) in our consolidated financial statements.

         We sell software licenses under fixed-term and perpetual license agreements. For perpetual licenses, we generally recognize revenue upon delivery of the software in accordance with SOP 97-2. Revenue for licensed subscription agreements is generally recognized over the term of the agreements. We provide maintenance and post contract support (PCS); however our revenues from PCS are not material to all periods presented. Subscription Revenue often includes hosting and other support services such as help desk, site or solution usage reporting.

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

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

Accounting for Goodwill and Other Intangible Assets. Goodwill and other intangible assets require us to make estimates and judgments about the value and recoverability of those assets. We have made several acquisitions of businesses that resulted in both goodwill and intangible assets being recorded in our financial statements.
 
Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. The amounts and useful lives assigned to other intangible assets impact the amount and timing of future amortization, and the amount assigned to in-process research and development is expensed immediately. The value of our intangible assets, including goodwill, could be impacted by future adverse changes such as: (i) any future declines in our operating results, (ii) a decline in the value of technology company stocks, including the value of our common stock, (iii) any failure to meet the performance projections included in our forecasts of future operating results. We evaluate goodwill and other intangible assets deemed to have indefinite lives on an annual basis in the quarter ended September 30 or more frequently if we believe indicators of impairment exist. Application of the goodwill impairment test requires judgment including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units and determining the fair value of each reporting unit. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), management has determined that there was only one reporting unit to be tested. The goodwill impairment test compares the implied fair value of the reporting unit with the carrying value of the reporting unit. The implied fair value of goodwill is determined in the same manner as in a business combination. Determining the fair value of the implied goodwill is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions, including projection and timing of future cash flows, discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, determination of appropriate market comparables, and determination of
29

whether a premium or discount should be applied to comparables. It is reasonably possible that the plans and estimates used to value these assets may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.
 
The results of the assessments performed to date was that the fair value of the reporting unit exceeded its carrying amount; therefore, no impairment charges to the carrying value of goodwill have been recorded since inception.
 
We also assess the impairment of our long-lived assets, including definite-lived intangible assets and equipment and improvements when events or changes in circumstances indicate that an asset’s carrying value may not be recoverable. An impairment charge is recognized when the sum of the expected future undiscounted net cash flows is less than the carrying value of the asset. Any impairment charge would be measured by comparing the amount by which the carrying value exceeds the fair value of the asset being evaluated for impairment. Any resulting impairment charge could have an adverse impact on our results of operations.
 
Stock Based Compensation
 
Effective October 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payments (“SFAS 123R”), using the modified prospective transition method. Under that transition method, compensation expense that we recognize 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 No. 123, Accounting for Stock-Based Compensation (“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 No. 123R. Results for prior periods will not be restated. At July 31, 2006, there was approximately $382 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all equity compensation plans.

We estimate the fair value of options granted using the Black-Scholes-Merton option valuation model (the “Model”) and the assumptions shown in Note 1 to our financial statements. We estimate the expected term of options granted based on the history of grants and exercises in our option database. We estimate the volatility of our common stock at the date of grant based on both the historical volatility as well as the implied volatility of publicly traded options on our common stock, consistent with SFAS No. 123R and Securities and Exchange Commission Staff Accounting Bulletin No. 107, Share Based Payment. We base the risk-free interest rate that we use in the Model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with equivalent remaining terms. We have never paid any cash dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Model. We amortize the fair value ratably over the vesting period of the awards, which is typically three years. We may elect to use different assumptions under the Model in the future or select a different option valuation model altogether, which could materially affect our net income or loss and net income or loss per share in the future.

         Since inception in August 2000, there has been no public market for our common stock from which to observe its stock price for use in estimating the fair value of the stock when granting stock options. Therefore, for purposes of applying the intrinsic value method of accounting for stock-based compensation, we estimated the stock price based on the guidance in the American Institute of Certified Public Accountants Practice Alert No. 00-1, Accounting for Certain Equity Transactions. We executed six private placement transactions between August 2000 and December 2004 selling common stock to related and independent third parties in exchange for cash that provided the capital necessary to complete our business combination transactions. In addition, approximately half of the purchase consideration in each business combination was common stock. We did not obtain contemporaneous valuations by an unrelated valuation specialist as neither the investors or the selling shareholders in the business combinations required them. These private placements and business combination transactions provided objective and contemporaneous evidence for our stock price that we used to estimate the fair value of stock options at the time the option grants were made. When stock options were granted through July 2005, we used the value of the most recent private placement as representative of the estimated fair value of our common stock on the grant date for purposes of applying the intrinsic value method.
30

         For periods beginning in August 2005 and thereafter, we estimated the fair value of the stock price on the date of grant for purposes of applying the intrinsic value method after weighing a variety of different quantitative and qualitative factors including, but not limited to, the status of business development, our financial position, the composition and ability of our engineering, operations and management team, the economic climate in the marketplace, the illiquid nature of our common stock, contemporaneous and anticipated private sales of our common stock, the probability of a liquidation event such as an initial public offering or the sale of Bridgeline, and our analysis of a peer group of comparable public company trading prices. In addition, during October 2005 we engaged an investment banking firm to provide us and our board of directors strategic growth and financing advice regarding the potential valuation of Bridgeline and our common stock. Since August 2005, we have estimated the value of common stock using this combination of valuation methodologies, including income, market and transaction approaches. We believe that its valuation of the stock price on the date of grant represents fair value and that the practices and approach employed by us is consistent with the practices recommended by the American Institute of Certified Public Accountants Audit and Accounting Practice Aid Series: Valuation of Privately-Held-Company Equity Securities Issued as Compensation, issued in 2004.

Comparison of Fiscal Ten Months Ended July 31, 2006 and 2005
 
Results of Operations
 
The following table sets forth certain Consolidated Statements of Operations data expressed as a percentage of revenue for the periods indicated:
 
   
Fiscal Ten Months
Ended July 31,
 
 
2006
 
  2005
 
Revenue
   
100
%
 
100
%
Cost of revenue 
   
44
   
54
 
Gross profit
   
56
   
46
 
Operating expenses:
             
Sales and marketing
   
34
   
35
 
General and administrative
   
22
   
18
 
Technology development
   
2
   
1
 
Loss from operations
   
(2
)
 
(8
)
Interest income (expense), net
   
(9
)
 
(1
)
Net loss
   
(11
%)
 
(9
%)
 
31

Revenue, Cost of Revenue and Gross Profit

The following table presents revenue, cost of revenue and gross profit for the fiscal ten months ended July 31, 2006 and 2005:
 
   
 
 
 
 
 
Net change
2006 vs. 2005
 
Fiscal Ten Months Ended July 31,
 
2006
 
2005
 
$ 
 
%
 
Total revenue
 
$
6,603
 
$
4,645
 
$
1,958
   
42
%
Cost of revenue
   
2,924
   
2,527
   
397
   
16
 
Gross profit
 
$
3,679
 
$
2,118
 
$
1,561
   
74
 
 
Revenue. Our revenue is generated principally by fees paid for Web Services, Managed Services and Subscription Revenue. The following table presents revenue from each of our revenue streams and their respective contribution to the increase in revenue in the fiscal ten months ended July 31, 2006 and 2005:
 
             
 Net change
2006 vs. 2005
 
Fiscal Ten Months Ended July 31,
 
2006
 
2005
 
$ 
 
%
 
Web Services
 
$
5,355
 
$
3,377
 
$
1,978
   
59
%
Managed Services
   
898
   
989
   
(91
)
 
(9
)
Subscription Revenue
   
350
   
279
   
71
   
25
 
Revenue
 
$
6,603
 
$
4,645
 
$
1,958
   
42
%
 
Web Services revenue consists primarily of revenue generated from the architecture, design and development of our customers Web application projects. Depending on the nature of the contract, this revenue may have been accounted for utilizing the proportionate performance model or may be recognized as delivered. Revenue from Web services increased 59% to $5,355 in 2006 from $3,377 in 2005. This growth was primarily due to engagements with new customers and new work with existing customers, combined with increased revenues resulting from the acquisitions of iapps ($632) and New Tilt ($404) in December 2004 and April 2006, respectively.
 
Managed Services revenue consists primarily of retained maintenance services agreements and Web hosting arrangements. Revenues from managed services decreased 9% to $898 in 2006 from $989 in 2005 due to lower revenues on retainer services with one financial services customer.
 
Subscription Revenue consists primarily of on-demand license rentals of our Orgitecture product in the foundation and non-profit sector of our business. Revenues from Subscription Revenue increased 25% to $350 in 2006 from $279 in 2005, reflecting the full ten months of revenue from iapps in 2006 as compared to 7.5 months in 2005.
 
Cost of Revenues and Gross Profit. Cost of revenue increased to $2,924 in 2006 from $2,527 in 2005 primarily due to increases in staff related costs associated with the delivery of Web services. The cost of revenue also increased as a result of the iapps and NewTilt acquisitions. Specifically, we recognized $97 and $76 in amortization of intangibles related to these two acquisitions for the ten months ended July 31, 2006 and 2005, respectively. Gross margin during 2006 of 56% of revenue increased from 2005 gross margin of 46% driven primarily by better billable utilization in the ten month period ended July 31, 2006 as compare to the ten month period ended July 31, 2005.
  
Sales and Marketing Expenses. Sales and marketing expenses increased to $2,193 or 34% of revenue, in 2006 from $1,605, or 34% of revenue in 2005. The increase in selling and marketing expenses was primarily due to the costs associated with the additional personnel acquired in the iapps and NewTilt acquisitions.
32

General and Administrative Expenses. General and administrative expenses increased to $1,461, or 22% of revenue, in 2006 compared to $849, or 18% of revenues, in 2005. The total increase resulted primarily from an increase of $163 attributed to an increase in headcount resulting from direct hires and acquisitions. We also had an increase in computer maintenance purchases, increased compensation levels, and an increase in travel and related expenses and an increase in training for our employees.
 
Technology Development Expenses. Technology development expenses increased to $140, or 2% of revenues, in 2006 compared to $37, or 0.8% of revenues, in 2005. The increase resulted primarily from product enhancement activities for the netEDITOR content management product.

Comparison of Fiscal Years Ended September 30, 2005 and 2004

The following table sets forth certain Consolidated Statements of Operations data expressed as a percentage of revenue for the periods indicated:
 
   
Fiscal Years
Ended September. 30,
 
 
 
2005
 
  2004
 
Revenue
   
100
%
 
100
%
Cost of revenue 
   
54
   
47
 
Gross profit
   
46
   
53
 
Operating expenses:
             
Sales and marketing
   
36
   
38
 
General and administrative
   
17
   
17
 
Technology development
   
1
   
1
 
Loss from operations
   
(8
)
 
(3
)
Interest income (expense), net
   
(1
)
 
(1
)
Net loss
   
(9
%)
 
(4
%)


Revenue, Cost of Revenue and Gross Profit

The following table presents revenue, cost of revenue and gross profit for the fiscal years ended September 30, 2005 and 2004:
 
 
         
Net change
2005 vs. 2004    
 
Fiscal Year Ended September 30,   
 
2005
 
2004
 
$
 
%
 
                           
Total revenue
 
$
5,769
 
$
4,888
 
$
881
   
18
%
Cost of revenue
   
3,113
   
2,290
   
823
   
36
 
Gross profit
 
$
2,656
 
$
2,598
 
$
58
   
2
%
                     
 
Revenue. Our revenue is generated principally by fees paid for Web Services, Managed Services and Subscription Revenue. The following table presents revenue from each of our revenue streams and their respective contribution to the increase in revenue in the fiscal years ended September 30, 2005 and 2004:
33

 
           
Net change
2005 vs. 2004     
 
Fiscal Year Ended September 30,    
 
2005 
 
2004 
 
$ 
 
% 
 
                     
Web Services
 
$
4,182
 
$
3,820
 
$
362
   
9
%
Managed Services
   
1,244
   
1,068
   
176
   
16
 
Subscription Revenue
   
343
   
   
343
   
343
 
Revenue
 
$
5,769
 
$
4,888
 
$
881
   
18
%
 
Web Services revenue consists primarily of revenue generated from architecture, design and development of our customers Web application projects. Depending on the nature of the contract, this revenue may have been accounted for utilizing the proportionate performance model or may be recognized as delivered. Revenue from Web services increased 9% to $4,182 in 2005 from $3,820 in 2004. This growth was primarily due to the ongoing signing of new or expanded customer accounts requiring Web services.
 
Managed Services revenue consists primarily of retained maintenance services agreements and Web maintenance and hosting arrangements. Revenues from managed services increased 16% to $1,244 in 2005 from $1,068 in 2004 primarily due to increased hosting and retained services revenue with three financial services customers.

Subscription Revenue consists primarily of on-demand license rentals of our Orgitecture product in the foundation and non-profit sector of our business. Revenues from Subscription Revenue increased $343,000 in 2005, primarily due to the acquisition of iapps in December 2004.
 
Cost of Revenues and Gross Profit. Cost of revenues increased to $3,113 in 2005 from $2,290 in 2004 primarily due to increases in staff related costs associated with the delivery of Web services. The cost of revenues also increased as a result of the iapps acquisition. Specifically, we recognized $94 and $30 in amortization of intangibles related to this acquisition for the years ended September 30, 2005 and 2004, respectively. Gross margin during 2005 of 46% of revenues decreased from 2004 gross margin of 53% driven primarily by the increased direct labor incurred and associated inefficiencies of ramping up sales resulting in lower billable utilization and overrun in costs on certain engagements.
 
Sales and Marketing Expenses. Sales and marketing expenses increased to $2,060 in 2005 from $1,874 in 2004, but as a percentage of revenue decreased from 38% in 2004 to 35% in 2005. The increase in selling and marketing expenses was primarily due to the costs associated with the additional personnel acquired in the iapps acquisition.
 
General and Administrative Expenses. General and administrative expenses increased to $1,014 in 2005 compared to $830 in 2004. The increase resulted primarily from an increase in headcount resulting from direct hires and acquisitions. We also had an increase in computer maintenance purchases and increased compensation levels.

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

We have historically funded our operations principally through issuances of short-term debt and private equity. In April 2006, we completed a private placement financing in the amount of $2,800 and received net proceeds of $2,433 after financing fees. In connection with this debt, we issued 280,000 warrants exercisable at $0.001 and 112,000 warrants exercisable at the initial public offering price of our shares in this offering. These warrants have been valued at $646 and are recorded as a debt discount and prepaid finance costs. This debt carries an interest rate of
34

10% per annum for the first six months and 12% per annum thereafter. The effective interest rate, considering the amortization of the debt discount and other debt issuance costs, is 47%. The debt was subordinated to certain debt that was retired in July 2006. The debt carries default provisions including: (1) failure to pay principal or accrued interest when due, (2) failure to observe or perform various positive and negative covenants as set forth in the loan document, (3) failure to expeditiously process our initial public offering and (4) the occurrence of a bankruptcy or similar event. In the event of loan default, the interest rate will increase to 15% per annum and in case of default in payment of the principal, the interest rate would increase to 18% per annum. This debt carries a one-year term and will be retired upon the successful completion of this offering. If this offering is not completed, we expect to request an extension on the payment date of the notes. If we are unable to extend the maturity of these obligations, we may be forced to raise additional funds to pay them, through the issuance of additional debt or equity securities.
 
Cash Flows
 
Operating Activities
 
Our net cash used in operating activities was $493 for the fiscal ten months ended July 31, 2006 compared to $661 for the fiscal ten months ended July 31, 2005. For the ten fiscal months ended July 31, 2006, the increase in revenue was the primary reason for the decrease in cash used in operating activities. We used cash in operating activities of $432 for the fiscal year ended September 30, 2005 as compared to $378 for the fiscal year ended September 30, 2004.
 
At July 31, 2006, we had a working capital deficit of $1,092 compared to a working capital deficit of $179 at September 30, 2005. This increase was primarily a result of the $2,800 private placement completed in April 2006 net of an increase in cash and accounts receivable resulting from an increase in revenue.
 
At July 31, 2006, we had trade accounts receivable of $1,073. This compares to $605 in trade accounts receivable at September 30, 2005. The level of trade accounts receivable at July 31, 2006 represented approximately 48 days of revenues as compared to 38 days at September 30, 2005. We typically require 30-day terms from our customers. Our receivables can vary dramatically due to overall sales volumes, the timing of implementation of services, receipts from large customers, and other contract payments.
 
Investing Activities
 
Net cash used in investing activities was $754 for the ten fiscal months ended July 31, 2006. This was primarily the result of the cash utilized in the purchase of New Tilt in April 2006 of $554. This compares to net cash used in investing activities in the ten fiscal months ended July 31, 2005 of $540 which included a cash payment of $308 used to acquire iapps in December 2004. We expect to incur more costs for future acquisitions and capital expenditures as well as contingent earn-out payments related to our prior acquisitions.
 
Financing Activities
 
During the fiscal ten months ended July 31, 2006 and the fiscal years ended September 30, 2005 and 2004, we financed our working capital requirements primarily through short-term debt. In March 2005, we entered into a short term credit facility with Sand Hill Finance, LLC whereby we pledged certain receivables and received an 80% advance against these receivables with the additional 20% being received upon collection of the receivable. This credit facility carried 1.7% interest per month and certain fees and was terminated subsequent to the successful completion of the April 2006 private placement financing.
 
Net cash provided by financing activities was $2,080 for the fiscal ten months ended July 31, 2006, which as stated above, was primarily provided by the private placement of short-term debt of $2,025 offset by $367 in associated fees. The net cash provided by financing activities in the ten months ended July 31, 2005 of $338 was primarily provided by the Sand Hill Finance LLC credit facility described above.
 
The short-term notes have a one-year term and are payable on April 20, 2007. If we are unsuccessful in completing this offering, and if we are unable to extend the maturity of these obligations, we may be forced to raise additional funds to pay them through the issuance of additional debt or equity securities. Particularly in light of our limited operating
35

history and losses incurred, there can be no assurance that we will be able to obtain the necessary additional capital on a timely basis, on acceptable terms or at all. In any of such events, our business prospects, financial condition and results of operations would be materially and adversely affected. As a result of any such financing, the holders of our common stock may experience substantial dilution.
 
If we are unable to increase our revenues and decrease our expenses, we will need to raise additional funds to finance our future capital needs. We may need additional financing earlier than we anticipate.
 
We currently do not have any variable interest entities. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

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

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

We do not have any off-balance sheet arrangements, financings or other relationships with unconsolidated entities or other persons.
 
Contractual Obligations
 
We lease our corporate headquarters in Woburn, Massachusetts. We also lease facilities in New York, New York; Washington, D.C.; and Bangalore, India.
 
Our other purchase obligations include certain equipment acquired under capitalized lease agreements that begin to expire in fiscal year 2009. We have no contractual obligations extending beyond five years.
 
The following summarizes our long-term contractual obligations as of July 31, 2006:
 
 
Payment Obligations by Year
   
Remainder
FY 2006
   
FY 07
   
FY 08
   
FY 09
   
FY 10
   
FY 11
   
Totals
Operating leases
  
$
80
 
$
259
  
$
234
  
$
237
  
$
239
 
$
230
  
$
1,279
Capital lease obligations
  
 
11
 
 
66
  
 
67
  
 
40
  
 
13
 
 
1
  
 
198
Short-term debt (including interest)
  
 
47
 
 
2,991
  
 
  
 
  
 
 
 
  
 
3,038
Total
  
$
138
 
$
3,316
  
$
301
  
$
277
  
$
252
 
$
231
  
$
4,515
 
Recent Accounting Requirements
 
         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
36

focuses primarily on the impact of a misstatement on the income statement — including the reversing effect of prior year misstatements — but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of a company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods. We have evaluated SFAS 108 and believe its adoption will not materially impact our consolidated financial statements.
 
         In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United State of America, and expands disclosures about fair value measurements. SFAS 157 prioritizes the inputs to valuation techniques used to measure fair value into a hierarchy containing three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined on the lowest level input that is significant to the fair value measurement in its entirety. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability. SFAS No. 157 is effective for interim and annual financial statements for fiscal years beginning after November 15, 2007. Upon initial adoption of SFAS 157, differences between the carrying value and the fair value of those instruments shall be recognized as a cumulative-effect adjustment to the opening balance of retained earnings for that fiscal year, and the effect of subsequent adjustments resulting from recurring fair measurements shall be recognized in earnings for the period. We have not completed our evaluation of SFAS 157.
 
         In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that we 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. We have evaluated FIN 48 and believes its adoption will not materially impact the consolidated financial statements.

Quantitative and Qualitative Disclosure about Market Risk

We do not use derivative financial instruments. We place our cash and cash equivalents in institutions that meet high credit quality standards. Our cash and cash equivalents are not subject to significant interest risks due to the short-term maturities of these instruments. As of September 30, 2005 and June 30, 2006, the carrying value of our cash and cash equivalents approximated fair value and we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required.
37

BUSINESS

Overview
 
Bridgeline Software is a developer of Web service applications, for which we have received several awards, and Web software tools. Examples are (i) netEDITOR-proTM, our Web content management system and (ii) OrgitectureTM, our 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. Our in-house team of Microsoft®-certified developers specializes in information architecture and usability engineering, Web application development, rich media development, e-Commerce application development, and e-Training application development and search engine optimization. We believe that our competitive strength is in being able to provide our customers with complete end-to-end solutions to assist them with optimizing business processes utilizing Web-based technologies. A description of our Web software tools and Web services is included below.

We have more than 70 active customers, including Nomura Securities, The Bank of New York, Pfizer, Depository Trust & Clearing Corporation and John Hancock, which each comprised approximately 23%, 9%, 6%, 6% and 5% of our revenues, respectively, during the ten months ended July 31, 2006.

We have received multiple industry related awards. Awards and similar recognition we have achieved since 2002 include:

·  
a Standard of Excellence Award and Outstanding Website Awards in the Web Marking Association’s WebAward Competition, an annual competition that names the best Web applications in 96 industries;
·  
being selected as a finalist for numerous MITX Awards from the Massachusetts Innovation & Technology Exchange, which acknowledge the best creative and technological accomplishments in interactive technology emerging from New England;
·  
being among the winners of several Axiem Awards, an international award program created to honor those who produce the best in all forms of interactive technology; and
· 
winning Bronze and Merit Awards at the One Show Interactive Awards from The One Club for Art and Copy, Inc., which honor creativity and effectiveness in global communications in the area of interactive technology.
 
We maintain offices twelve miles north of Boston, Massachusetts; in New York, New York; and in Washington, D.C., as well as a development center in Bangalore, India. Our principal executive office is at 10 Sixth Road, Woburn, Massachusetts 01801, and our telephone number at that location is (781) 376-5555.
 
Market Opportunity

Based on industry data provided by Harte-Hanks (a data intelligence firm), we believe that the Web development market is rapidly growing and is fragmented. Consequently, we believe there is an opportunity for us to expand and dramatically enhance our market share by acquiring many such companies, grow the acquired businesses under the Bridgeline Software name and thereby potentially create one of the largest interactive technology companies in North America. We believe that established yet small Web application development companies have the ability to market, sell and install Web-based software tools in their local metropolitan markets. In addition, we believe that these companies also have customer bases and a niche presence in the local markets in which they operate. We believe that by acquiring certain of these companies and applying our business practices and efficiencies, we can dramatically accelerate our time to market in geographic locations other than those in which we now operate.

We estimate, based on our experience in having made such acquisitions, that compounded annual growth rates of at least 20% per year for each acquired entity may be possible. We target certain established Web application development companies that we believe have both:

 
(1)
the complementary technical ability to market, sell, and install Web-based software tools in their particular metropolitan market areas; and

 
(2)
an established base of customers with local market presence that can potentially accelerate our time to market in geographic areas where we do not currently operate.

38

In addition, we believe that even established Web application development companies we acquire could improve their profit margins by (1) licensing our web software tools to their customer base, (2) reducing development costs by leveraging our Bangalore, India development center and (3) consolidating marketing, general and administrative functions at our corporate headquarters in Massachusetts. We believe this expansion strategy, by which we grow primarily by acquiring profitable operating partner companies, is a key component of our business model.

Acquisitions

Since our inception, we have consummated the acquisitions of four Web application development companies:

·  
In December 2000, we acquired Streamline Communications, a Boston, Massachusetts-based company.
·  
In February 2002, we acquired Lead Dog Digital, Inc., a New York, New York-based company.
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In December 2004, we acquired Interactive Applications, Inc., a Washington, D.C.-based company.
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In April 2006, we acquired New Tilt, Inc., a Cambridge, Massachusetts-based company.

In addition, on December 7, 2006, we signed a definitive merger agreement. Under this agreement, we intend to acquire all outstanding capital stock of Objectware, Inc., an Atlanta, Georgia-based Web application development company. The terms of the proposed acquisition of Objectware, Inc. are described further under “Growth and Expansion Strategy” beginning on page 50.

The Web Services and Web Tools Marketplace
 
Web Services Market
 
The word “Web” is shorthand for the TCP/IP (or Transmission Control Protocol / Internet Protocol) standard that carries Internet traffic around the world and also the networking standard for the integration of the corporate enterprise, from the manufacturing floor and sales office to the boardroom and across the global span of the enterprise’s manufacturing, sales, and service locations. Web design and development is no longer just about creating attractive and functional Web sites; it has evolved to bear a very practical, commercial importance to many companies.

We believe that several ongoing developments have contributed to the complexity of the Web. Existing client-server applications with connections to resources - mainframes, minicomputers, and legacy data sources - have been redesigned using Web technology. ERP (enterprise resource planning), CRM (customer relationship management), SCM (supply chain management) and other enterprise-scale applications have been reconfigured as enterprise wide application services (Web services) with custom portals for each of the various corporate departments.

We believe that Web properties and Web applications will continue to increase in number and complexity. In order to differentiate themselves from competitors, we expect many companies to increase the use of sophisticated technologies in their Web sites in order to provide users with an enhanced experience, either with content that is graphically enhanced with motion video or with user interfaces that provide the look and feel of a desktop application without constant interaction with servers. We believe the trend toward increases in the use of sophisticated technology could accelerate if companies have access to tools that make the development of such client user interfaces easier and make Web site development an integral part of the broader information technology (“IT”) development life cycle.
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International Data Corporation (IDC) estimates that the number of Internet users continues to grow substantially, especially in emerging economies. According to IDC estimates, in the next four years, 400 million new users will come online and commerce will double. By the end of 2006, IDC estimates that 50% of Internet households will be broadband and less than 5% of total commerce will be conducted online.

IDC estimates spending on Web services software was $2.33 billion in 2004, more than doubling from the prior year. With application developers continuing to enable and introduce more native Web service solutions, and a market for hosted services unfolding, IDC believes that applications will continue to represent a significant growth area for years to come.

Annual investments in Web services-based technologies are increasing. IDC’s Web Services Total Opportunity Model estimates that worldwide companies spent approximately $4.11 billion on Web services software in 2005, nearly double the amount spent in the prior year. Because Web services still represent an emerging market, growth rates appear high, but this volume represented only 2% of the total worldwide software market in 2005. The model further forecasts that worldwide spending will reach close to $15 billion by 2009. The chart below represents IDC’s 2004 to 2009 projections for Web services revenue in North America; IDC estimates that the North American market share consistently remains greater than 55% of the world wide spending. 
 
GRAPH
             
IDC identifies the following trends influencing the level of spending for Web services technology:

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Many of the existing Web applications were developed from 1999 to 2003, utilizing older Web development technologies such as HTML. The Web applications developed were limited and did not provide significant operational efficiencies. Since 1999, there have been technological advancements in dynamic Web logic, open source standards, and broadband technologies. We believe these technological advancements combined with a resurgence in information technology spending will fuel strong investments towards redeveloping legacy Web applications.

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Many organizations will likely continue to experiment and expand their use of Web services by utilizing their existing base of technologies until volume and levels of complexity force review and investment, in particular for service-oriented management solutions.

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A heavy influence on the timing and amounts of when organizations may determine to invest relates to the waves of major versions released by key vendors. For example, organizations may determine to wait until Microsoft meets market commitments on its Longhorn releases, and SAP customers may be interested in investing as prior versions of software are retired from support.
 
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·  
The conversion of software pricing models from traditional license models to more subscription-oriented methods will influence the rate of growth and overall size of the market, especially in the context of hosted applications and service, creating a normalizing effect.

According to IDC, one of the larger trends in the North American Web services market is the resurrection of the application service provider (“ASP”) model, empowered and enhanced via Web services standards and technologies. Our subscription-based OrgitectureTM Web platform provides customers with an integrated suite of on-demand Web-based tools designed to maximize organizational effectiveness, streamline Web site management and reduce operating costs. See “Products and Services - OrgitectureTM - Modular On-Demand Web Tools,” below.

According to IDC, the Web services applications marketplace is expected to show the most significant growth during the next three years, originating from the least of the three primary software markets, to reach $5.13 billion by 2009. In 2005, this specialized marketplace represented less than 1% of the worldwide applications software market. Yet by 2009, it is expected to increase to more than 5% of the worldwide applications software market. The chart below represents IDC’s 2006 to 2009 projections for total Web services revenue in North America as well as our estimate, based on information from IDC, of Web services revenue by primary category. IDC estimates that the North American market share will consistently remain greater than 55% of the worldwide spending.
 
GRAPH
 
             
 
The Content Management Market

An organization’s Web properties (Internet, intranet, and extranets) can be among its most valuable assets. To maintain the value of these assets, the content within the sites must be current, accurate and dynamic. Product features, prices, investor information, press releases, customer communications, employee communications, and other content need frequent updating. These ongoing editing requirements can be time-consuming and costly. As a result, many organizations fall behind on content updates, greatly reducing the effectiveness of their Web properties. We believe that the combination of these critical communications requirements with heightened compliance requirements will result in a high demand for powerful, easy-to-use Web content management systems that have integrated work flow controls.

During the economic downturn in 2000, many companies de-emphasized Web content management for their Web properties, and, instead, focused their attention on cost containment and internal efficiency. We believe, however, that companies are again turning to Web content management to support their growth strategies, such as selling products via the Web and creating or supporting new products and services through the delivery of content.
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During the downturn, we believe many chief information officers interested in Web content management decided their custom-built Web sites were sufficient to meet their business objectives and postponed replacing them with Web content management systems. Based on information provided in a report released by Forrester Research in February 2006, we believe many chief information officers and architecture groups are revisiting their past enterprise content management strategies and are planning to replace their custom Web sites with Web content management systems during the next 18 months.

We believe many of the new systems being planned will be second-generation Web sites, i.e., they will support and synchronize complex Web environments consisting of multiple Web sites housed in difference physical locations. The newer systems will be required to manage changes to code and to distribute content and code from multiple Web content management vendors within a network of Web sites.

The chart below projects the North American revenues derived from licensed Web content management systems. The projections exclude other service revenue that can also be derived from training, consulting, and system integration.
 
N. American Content Management Software Forecast
 
GRAPH
 
 
Source: IDC, May 2006 
 
We believe that a new class of applications is now expanding that combines data and content in support of business processes or new content-related products, and, accordingly, a growing number of companies have now prototyped or piloted these applications and are looking to expand them. Examples of content-related applications include a restaurant that plans to use digital content instead of traditional photographs to show food items, a hotel that using its Web site as an extension of its concierge service, or an automotive manufacturer that uses its Web site for customers to buy, service, maintain, and track payments for their vehicles.

IDC reports that a growing number of companies are turning their attention to digital assets such as digital photographs, graphics, and logos. In certain cases, organizations need a specialized digital asset management product to support high volumes of digital assets, searching for assets based on the content itself - in addition to metadata, displaying thumbnails, and managing video and audio. IDC states that a number of companies are using their Web content management systems to manage digital assets rather than buying a specialized digital asset management product and expects this trend to increase in 2006 and beyond.

The Web Analytics Tool Market

Web analytics, the measurement of the behavior of visitors to a website, generally focus on a single Web site or an individual visiting a single Web site rather than the surfing habits of individuals as they move from site to site.
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Site-independent analytics can be used to build a file of total surfing behavior for panels of known or anonymous individuals for marketing personalization. Web analytics provide real-time, actionable reporting that measures the effectiveness of Web sites and on-line marketing initiatives. Web analytics tools identify and track the factors that uniquely affect a Web sites success, providing insight needed to optimize marketing efforts and drive company online business success.

IDC estimates there are approximately 8.4 million active Web sites globally; 3.1 million are classified as public Web sites (i.e., a Web site that offers content that is freely accessible to the general public). We believe that over the past five years Web sites have evolved from being brochure-ware type Web sites to highly functional Web applications. Increasingly, organizations are demanding statistical data from their Web applications fueling a growing Web analytics market.
 
According to IDC, on-demand Web analytics constitute an increasing proportion of new business among the larger vendors. We believe that this growth constitutes penetration into previously installation-only verticals, such as financial institutions. In addition, we believe that the on-demand implementation short circuits much of the negotiation process that marketers would otherwise have to conduct with their IT departments. An interesting side effect of the on-demand business model is the ability to glean information on actual adoption and feature usage far beyond the limits of focus groups, labs, and survey questionnaires.
 
According to IDC, the Web analytics market is a growing market expected to reach more than $600 million by the end of 2010. (See chart below.)

Worldwide Web Analytics Software Applications Forecast
 
GRAPH
 
  Source: IDC, June 2006 
 
We are currently developing an on-Demand Web analytics software tool. We currently expect to launch and introduce this native .NET on-Demand Web analytics product to our customer base in early calendar 2007.

Products and Services

Web Development Services

We provide an explanation of each term below. By providing scalable Web software tools with award-winning Web development capabilities, we provide our customers with complete solutions that optimize business processes through Web-based technologies.

We believe this strategy enhances our competitive advantage by creating a stronger relationship with our customer base, creating and maintaining a repeatable business model.
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Information Architecture

Information architecture is a design methodology focused on structuring information to ensure that users can find the appropriate data and complete their desired transactions within a Web site or a Web application. Understanding users and the context in which they will be using a Web application is core information architecture. Information architects try to put themselves in the position of a typical application’s user to better understand a user’s characteristics, behaviors, intentions and motivations. At the same time, the information architect develops an understanding of a Web application’s functionality and data structures. The understanding of these components enables the architect to make more educated decisions about the end user and then translate those decisions into site maps, wire frames and clickable prototypes.

Information architecture forms the foundation of a Web application’s usability. The extent to which a Web application is user-friendly and is widely adopted by a user base is primarily dependent on the success of the information architecture. Information architecture defines how well users can navigate through a Web site or application and how easily they can find the desired information or function. As Web application development becomes more standard and commoditized, information architecture will increase as a differentiator for application developers.

We provide information architecture for most of the Web applications we develop.

Usability Engineering

The Web was originally conceived as a “hypertextual” information space, in which users could store data through computer programs that allow other users to create and link fields of information at will and to retrieve the data nonsequentially. The development of increasingly sophisticated user interfaces and applications, however, has fostered the Web’s use as a remote software interface. This dual nature has led to much confusion, as user experience has been mixed. Today, usability engineering is a critical component towards developing any successful Web-based application.

We believe that a majority of Internet users leave a Web site after viewing the first page. A Web property (Internet Web site, intranet site, or extranet site) has one chance to make a first impression on a potential user. By integrating usability into traditional Web development life cycles, we believe our usability engineers can significantly enhance a user experience. Our usability professionals provide the following:

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Usability audits
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Information architecture
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Process analysis and optimization
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Interface design
·   User testing
 
Our systematic and user-centered approach to Web development focuses on developing Web properties that are intuitive, accessible, engaging, and effective. Our goal is to produce a net effect of increased traffic, improved visitor retention, increased user productivity, reduced user error, lower support cost, and reduced long-term development cost.

Web Application Development

Our in-house team of Microsoft®-certified developers develops award-winning custom Web applications. These Web applications include business-to-business Web properties such as broker-dealer extranets, employee intranets, case management systems, eRecruiting applications, on-line performance evaluation systems, and dynamic eCommerce sites. Our development teams utilize programming tools such as ASP, .NET, HTML, XML, Cold Fusion, Java Script, CGI/Perl, and Flash. Our Web development expertise includes:

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Internet sites
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Intranet sites
 
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Extranet sites
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eCommerce
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Database development
 
Our developers are proficient in C, C++, J2EE and Microsoft .NET development frameworks for back-end integration. We use these and other tools to integrate with back-end databases (SQL, Oracle, DB/2, mySQL), application servers (IIS/MTS, Oracle, WebSphere, Apache/Tomcat, J2EE servers, Sun), Web services and legacy systems. While our front-end design teams provide the appropriate look and feel for the display of the data, it is the job of the back-end teams to ensure that the data is available to the front-end systems. Depending on business requirements and goals for the Web application, our technical design teams employ data caching, parallelism, threading and other techniques to ensure that the data is made available to the front-end in the most efficient and reliable manner.

We develop Web applications utilizing our own Web software tools such as netEDITOR® or OrgitectureTM, providing a complete end to end Web-based solution.
 
Rich Media Development

Rich media is a combination of interactive digital media such as video, audio, and animation that often includes user interaction. Rich media with its movement, sound and emotive quality provides designers with a tool set more powerful than text and graphics alone. Its dynamic movement and sound is compelling and engaging to users. The more emotive a message, the more appropriate rich media is for communicating it.

Rich media impact on the Web is much wider than online advertising. E-Training applications often use animations to convey processes more effectively than text and diagrams. Rich media content and rich media interactions are becoming more common in Web applications user interfaces and when used appropriately provide a richer user experience.

We develop custom rich media applications such as sales training, product launches, and enhanced corporate communication via the Web.

e-Training Applications

We believe e-Training is both a valuable tool for employee development and to enhance and extend relationships with customers. We believe effective e-Training solutions must go beyond formatting existing content to fit on a computer screen. Our experience in developing e-Training applications helps