WWW.EXFILE.COM, INC. -- 888-775-4789 -- BRIDGELINE SOFTWARE, INC. -- FORM 10-K

Item 8. Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm

To the Board of Directors of

Bridgeline Software, Inc:

We have audited the consolidated balance sheets of Bridgeline Software, Inc. (the “Company”) as of September 30, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bridgeline Software, Inc. as of September 30, 2009 and 2008, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ UHY LLP

December 28, 2009

Boston, Massachusetts

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED BALANCE SHEETS

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

ASSETS	September 30,
	2009			2008
Current assets:
Cash and cash equivalents	$	3,060		$	1,911
Accounts receivable and unbilled receivables, net		3,468			5,662
Prepaid expenses and other current assets		320			467
Total current assets		6,848			8,040
Equipment and improvements, net		1,448			1,763
Intangible assets, net		1.490			2,980
Goodwill, net		13,899			10,725
Other assets		570			751
Total assets	$	24,255		$	24,259


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	714		$	1,770
Accrued liabilities		1,194			1,529
Line of credit		1,000			1,000
Capital lease obligations, current		77			105
Deferred revenue		890			1,176
Total current liabilities		3,875			5,580
Capital lease obligations, net of current portion		62			139
Other long term liabilities		414			350
Total liabilities		4,351			6,069

Commitments and contingencies

Stockholders’ equity:
C Preferred stock - $0.001 par value; 1,000,000 shares authorized; none issued and outstanding		—			—
Common stock -$0.001 par value; 20,000,000 shares authorized;11,182,209 and 10,665,553 shares issued and outstanding, respectively		11			11
Additional paid-in capital		35,620			34,647
Accumulated deficit		(15,611	)		(16,369	)
Accumulated other comprehensive income		(116	)		(99	)
Total stockholders’ equity		19,904			18,190
Total liabilities and stockholders’ equity	$	24,255		$	24,259

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

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

	Year Ended September 30,
	2009			2008
Revenue:
Web application development services	$	20,272		$	18,231
Managed service hosting		2,202			2,188
Subscription and perpetual licenses		1,427			876
Total revenue		23,901			21,295
Cost of revenue:
Web application development services		9,422			9,579
Managed service hosting		595			444
Subscription and perpetual licenses		516			282
Total cost of revenue		10,533			10,305
Gross profit		13,368			10,990
Operating expenses:
Sales and marketing		6,192			6,294
General and administrative		4,001			3,531
Research and development		1,124			619
Depreciation and amortization		1,222			1,051
Impairment of intangible assets		—			76
Impairment of goodwill		—			9,752
Total operating expenses		12,539			21,323
Income (loss) from operations		829			(10,333	)
Other income (expense) net		—			85
Interest income (expense) net		(40	)		(61	)
Income (loss) before income taxes		789			(10,309	)
Income taxes		31			—
Net income (loss)	$	758		$	(10,309	)

Net income (loss) per share:
Basic	$	.07		$	(1.09	)
Diluted	$	.07		$	(1.09	)
Number of weighted average shares:
Basic		11,008,879			9,473,408
Diluted		11,272,190			9,473,408

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

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in thousands)

										Accumulated
	Common Stock				Additional					Other			Total
			Par		Paid in		Accumulated			Comprehensive			Stockholders’
	Shares		Value		Capital		Deficit			Income			Equity
Balance at September 30, 2007		8,648,950	$	9	$	28,908	$	(6,060	)	$	18		$	22,875
Stock based compensation expense		—		—		425		—			—			425
Exercise of stock options		6,667		—		—		—			—			—
Exercise of stock warrants		160,000		—		—		—			—			—
Issuance of common stock and options for acquisitions		1,767,758		2		5,047		—			—			5,049
Issuance of common stock and options for earnouts		82,158		—		267		—			—			267
Comprehensive loss
Net loss		—		—		—		(10,309	)		—			(10,309	)
Foreign currency translation adjustment		—		—		—		—			(117	)		(117	)
Total comprehensive loss		—		—		—		(10,309	)		(117	)		(10,426	)
Balance at September 30, 2008		10,665,533		11		34,647		(16,369	)		(99	)		18.190
Stock based compensation expense		—		—		538		—			—			538
Issuance of common stock for earnouts		516,676		—		435		—			—			435
Comprehensive income
Net income		—		—		—		758			—			758
Foreign currency translation adjustment		—		—		—		—			(17	)		(17	)
Total comprehensive income		—		—		—		758			(17	)		741
Balance at September 30, 2009		11,182,209		11		35,620		(15,611	)		(116	)		19,904

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

BRIDGELINE SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

	Year Ended September 30,
	2009			2008
Cash flows from operating activities:
Net income (loss)	$	758		$	(10,309	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Impairment of goodwill and intangible assets		—			9,828
Amortization of intangible assets		517			537
Depreciation		795			578
Other amortization		180			135
Stock based compensation		538			425
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable and unbilled receivables		1,771			(993	)
Prepaid expenses and other assets		181			(560	)
Accounts payable and accrued liabilities		(1,518	)		(156	)
Deferred revenue		(286	)		(152	)
Other liabilities		64			280
Total adjustments		2,242			9,922
Net cash provided by (used in) operating activities		3,000			(387	)

Cash flows from investing activities:
Equipment and improvements		(453	)		(980	)
Software development		(30	)		(397	)
Acquisitions, net of cash acquired		—			(1,812	)
Contingent acquisition payments		(1,250	)		(528	)
Net cash used in investing activities		(1,733	)		(3,717	)

Cash flows from financing activities:
Proceeds from bank line of credit		4,250			1,000
Principal payments of bank line of credit		(4,250	)		—
Principal payments on capital leases		(105	)		(202	)
Net cash provided by (used in) financing activities		(105	)		798
Net (decrease) increase in cash and cash equivalents		1,162			(3,306	)
Effect of exchange rate changes on cash		(13	)		(2	)
Cash and cash equivalents at beginning of period		1,911			5,219
Cash and cash equivalents at end of period	$	3,060		$	1,911
Supplemental disclosures of cash flow information:
Cash paid for:
Interest	$	59		$	54
Income taxes	$	133		$	—
Non cash activities:
Purchase of equipment through capital leases	$	—		$	71
Equipment and other assets included in accounts payable	$	31		$	—
Issuance of common stock for acquisitions	$	—		$	5,049
Issuance of common stock for contingent acquisition payments	$	435		$	267
Accrued contingent consideration	$	408		$	327

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

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

1. Description of Business

Overview

Bridgeline is a developer of web application management software and award-winning interactive technology solutions that help organizations optimize business processes. Bridgeline’s iAPPS® software combined with its interactive development capabilities assist customers in maximizing revenue, improving customer service and loyalty, enhancing employee knowledge, and reducing operational costs by leveraging web based technologies.

Bridgeline’s iAPPS® product suite offers solutions that unify web Content Management, web Analytics, eCommerce, and eMarketing capabilities deep within the website or web applications in which they reside; enabling business users to enhance and optimize the value of their web properties. Combined with award-winning interactive development capabilities, Bridgeline helps customers cost-effectively accommodate the changing needs of today’s websites, intranets, extranets, portals, and mission-critical web applications.

Locations

The Company’s corporate office is located north of Boston, Massachusetts in Woburn, Massachusetts. This office also houses the Company’s New England business unit. The Company maintains regional offices serving the following geographical locations: Atlanta, GA, Chicago, IL; Cleveland, OH; Denver, CO; New York, NY; and Washington, DC. The Company has a wholly owned subsidiary, Bridgeline Software Pvt. Ltd,, located in Bangalore, India which serves as its .Net development center.

Other Information

The Company’s stock is traded on NASDAQ under the symbol BLSW. The Company maintains its website at www.bridgelinesw.com.

2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned India subsidiary. All significant inter-company accounts and transactions have been eliminated. Certain amounts from the prior period financial statements have been reclassified to conform to the current presentation.

Effective for interim and annual periods ending after September 15, 2009, The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification™ (the “Codification”) became the single source of authoritative nongovernmental U.S. generally accepted accounting principles (US GAAP). The Company adopted the Codification during the quarter ending September 30, 2009. The adoption had no effect on the Company's consolidated financial statements.

The Company evaluated subsequent events through December 28, 2009 and concluded there were no material subsequent events requiring adjustment to or disclosure in these financial statements, other than those disclosed.

Use of Estimates

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

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

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Revenue Recognition

The Company enters into arrangements to sell web application development services (professional services), software licenses or combinations thereof. Revenue is categorized into (i) Web Application Development Services (ii) Managed Service Hosting, and (iii) Subscription and Perpetual Licenses.

The Company recognizes revenue as required by the Revenue Recognition Topic of the Codification. Revenue is recognized when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) delivery has occurred or the services have been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of the fees is reasonably assured. Billings made or payments received in advance of providing services are deferred until the period these services are provided.

Web Application Development Services

Web application development services include professional services primarily related to the Company’s Web development solutions that address specific customer needs such as information architecture and usability engineering, interface configuration, application development, rich media, e-Commerce, e-Learning and e-Training, search engine optimization, and content management.

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

Web application development services also include retained professional services contracted for on an “on call” basis or for a certain amount of hours each month. Such arrangements generally provide for a guaranteed availability of a number of professional services hours each month on a “use it or lose it” basis. For retained professional services sold on a stand-alone we recognize revenue as the services are delivered or over the term of the contractual retainer period. These arrangements do not require formal customer acceptance and do not grant any future right to labor hours contracted for but not used.

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

Managed Service Hosting

Managed service hosting includes hosting arrangements that provide for the use of certain hardware and infrastructure, generally at the Company’s network operating centers. The majority of the customers under contractual hosting arrangements have been previous application development services customers. Set-up costs associated with hosting arrangements are not significant and when charged are recognized ratably over the expected period of performance, generally twenty-four months. Hosting agreements are either annual or month-to-month arrangements that provide for termination for convenience by either party generally upon 30-days notice. Revenue is recognized monthly as the hosting services are delivered. As described below, hosting revenue associated with the Company’s subscriptions are included in subscription and perpetual license revenue.

Hosting services are typically sold in connection with application development services but also may be sold on a stand-alone basis. The Company’s revenue recognition policy with respect to multiple element arrangements is described further below under the caption “Multiple Element Arrangements.”

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Subscriptions and Perpetual Licenses

The Company licenses its software on a perpetual and subscription basis. Customers who license the software on a perpetual basis receive rights to use the software for an indefinite time period. For arrangements that consist of a perpetual license and PCS, the PCS revenue is recognized ratably on a straight-line basis over the period of performance and the perpetual license is recognized on a residual basis. Under the residual method, the fair value of the undelivered elements are deferred and the remaining portion of the arrangement fee is allocated to the delivered elements and recognized as revenue, assuming all other revenue recognition criteria have been met. Revenue recognition for perpetual licenses sold as part of a multiple element arrangement is described further below under the caption “Multiple Element Arrangements.”

Customers also license the software on a subscription basis, which can be described as “Software as a Service” or “SaaS”. SaaS is a model of software deployment where an application is hosted as a service provided to customers across the Internet. Subscription agreements include access to the Company’s software application via an internet connection, the related hosting of the application, and PCS. Customers receive automatic updates and upgrades, and new releases of the products as soon as they become available. Subscription agreements are either annual or month-to-month arrangements that provide for termination for convenience by either party upon 30 to 45 days notice. Revenue is recognized monthly as the services are delivered. Any up front set-up fees are amortized over 24 months. We have concluded that our Subscription Agreements should be accounted for differently from software sales since the software is only accessible through a hosting arrangement with us and the customer cannot take possession of the software. Revenue recognition for Subscriptions sold as part of a multiple element arrangement is described further below under the caption “Multiple Element Arrangements.

Multiple Element Arrangements

As described above, application development services are often sold as part of multiple element arrangements. Such arrangements may include delivery of a perpetual license for the Company’s software products at the commencement of an application development services engagement or delivery of retained professional services, hosting services and/or subscriptions subsequent to completion of such engagement, or combinations thereof. In accounting for these multiple element arrangements, we follow either Codification Topic 605-985 Revenue Recognition Software or Codification Topic 605-25 Revenue Recognition Multiple Element Arrangements, as applicable. As described further below, the Company has concluded that each element can be treated as a separate unit of accounting when following Codification Topic 605-25.

As permitted by Codification Topic 605-25-65-1, the Company adopted on a retrospective basis Accounting Standards Update No. 2009-13, Revenue Recognition: Multiple Deliverable Arrangements. This adoption had no impact on previously reported financial information.

When the Company licenses its software on a perpetual basis in a multiple element arrangement that also includes application development services and PCS, VSOE of each element is considered. VSOE is established for PCS and is based on the price of PCS when sold separately, which has been established via annual renewal rates. Revenue recognition for perpetual licenses sold with application development services are considered on a case by case basis. The Company has not established VSOE for perpetual licenses or fixed price development services and therefore in accordance with ASC Section 605-985, when perpetual licenses are sold in a multiple element arrangements including application development services where VSOE for the services has not been established, the license revenue is deferred and recognized under the proportional performance model along with the associated

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

application development services. For the year ended September 30, 2009, the Company has recognized revenue of $304 thousand for perpetual licenses. In determining VSOE for the application development services element, the separability of the application development services from the software license and the value of the services when sold on a standalone basis is considered. The Company also considers the categorization of the services, the timing of when the services contract was signed in relation to the signing of the perpetual license contract and delivery of the software, and whether the services can be performed by others. The Company has concluded that its application development services are not required for the customer to use the product but, rather enhance the benefits that the software can bring to the customer. In addition, the services provided do not result in significant customization or modification of the software and are not essential to its functionality, and can also be performed by the customer or a third party. If an application development services arrangement does qualify for separate accounting, the Company recognizes the perpetual license on a residual basis. If a application development services arrangement does not qualify for separate accounting, the Company recognizes the perpetual license under the proportional performance model as described above.

When subscription arrangements are sold with application development services, the Company follows Codification Topic 605-25 Revenue Recognition Multiple Element Arrangements and have concluded that each element can be treated as a separate unit of accounting. In determining separability, the timing of the commencement of the subscription period to the services delivery is considered.

If the subscription period begins after the services delivery then the Company generally recognizes the services as delivered and then commences revenue recognition for the subscription after the services have been delivered. To date, all subscription periods have commenced after the services delivery. If the application development services arrangement does not qualify for separate accounting, the application development services revenue and related costs are deferred and recognized over the subscription period. Subscriptions also include a PCS component, and the Company has determined that the two elements cannot be separated and must be recognized as one unit over the applicable service period.

Customer Payment Terms

Payment terms with customers typically require payment 30 days from invoice date. Payment terms may vary by customer but generally do not exceed 45 days from invoice date. Invoicing for Application Development Services are either monthly or upon achievement of milestones and payment terms for such billings are within the standard terms described above. Invoices for subscriptions and hosting are typically issued monthly and are generally due in the month of service.

The Company’s agreements with customers do not provide for any refunds for services or products and therefore no specific reserve for such is maintained. In the infrequent instances where customers raise concerns over delivered products or services, the Company has endeavored to remedy the concern and all costs related to such matters have been insignificant in all periods presented.

Warranty

Certain arrangements include a warranty period of 30 days from the completion of work. In hosting arrangements, the Company may provide warranties of up-time reliability. The Company continues to monitor the conditions that are subject to the warranties to identify if a warranty claim may arise. If the Company determines that a warranty claim is probable, then any related cost to satisfy the warranty obligation is estimated and accrued. Warranty claims to date have been immaterial.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Reimbursable Expenses

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

Cash and Cash Equivalents

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

Fair Value of Financial Instruments

The carrying amounts of financial instruments, including cash and cash equivalents, receivables, accounts payable, bank line of credit and senior notes payable approximate their fair value because of the short-term maturity of these instruments. Based on rates available to the Company at September 30, 2009 and 2008 for loans with similar terms, the carrying values of capital lease obligations approximate their fair value.

Allowance for Doubtful Accounts

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

Equipment and Improvements

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

Internal Use Software

Cost incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. The Company also capitalizes costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Capitalized costs are recorded as part of equipment and improvements. Training costs are expensed as incurred. Internal use software is amortized on a straight-line basis over its estimated useful life, generally three years.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Intangible Assets

Intangible assets with definite –lives are amortized over their useful lives, generally three to ten years, and are subject to impairment tests as described below under Impairment of Long-Lived and Intangible Assets.

Impairment of Long-Lived and Intangible Assets

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

In addition, the Company’s evaluation considers non-financial data such as market trends, product development cycles and changes in management’s market emphasis. For the definite-lived intangible asset impairment review, the carrying value of the intangible assets is compared against the estimated undiscounted cash flows to be generated over the remaining life of the intangible assets.

Goodwill

The excess of the cost of an acquired entity over the amounts assigned to acquired assets and liabilities is recognized as goodwill. Goodwill is tested for impairment annually and more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the fair value calculated at the reporting unit level. The Company aggregates its operating locations as a single reporting unit due to their similar economic characteristics.

The goodwill impairment test consists of two steps. First, the estimated fair value of the reporting unit is compared it to its carrying amount. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is estimated by allocating the estimated fair value of the reporting unit in a manner similar to a purchase price allocation.

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

In evaluating goodwill impairment, the Company considers a number of factors such as market capitalization value, discounted cash flow projections, guideline public company comparisons and acquisition transactions of comparable third party companies. Evaluating the potential impairment of goodwill is highly subjective and requires management to make significant estimates and judgment at many points during the analysis, especially with regard to the Company’s future cash flows.

The Company evaluates goodwill for impairment on an annual basis during the fourth fiscal quarter of each year. Management places significant weighting in its evaluation on the fair value derived using the Direct Market Data Method or market capitalization value as this Level 1 input to valuation is afforded the highest consideration as it is based upon quoted prices of the Company’s common stock in the active market.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Contingent Consideration

For all acquisitions completed before September 30, 2009, the Company records contingent consideration as additional purchase price and goodwill when paid. Such contingent consideration is unrelated to continuing employment with the Company and meets all other relevant criteria. Such consideration is paid when the contingency is resolved subsequent to acquisition.

Research and Development Costs

Research and development expenditures for technology development are charged to operations as incurred. Certain software development costs incurred subsequent to the establishment of technological feasibility are capitalized and amortized to cost of sales. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. Certain costs incurred between completion of a working model and the point at which the product is ready for general release are capitalized if significant. The Company capitalized $30 thousand and $397 thousand of costs in 2009 and 2008, respectively.

Advertising Costs

Advertising costs are expensed when incurred. Such costs were $302 thousand and $258 thousand for the years ended September 30, 2009 and 2008, respectively.

Stock-Based Compensation

The Company accounts for stock compensation awards in accordance with the Compensation-Stock Compensation Topic of the Codification. Share-based payments (to the extent they are compensatory) are recognized in the consolidated statements of operations based on their fair values.

Valuation of Options and Warrants Issued to Non-Employees

The Company measures expense for non-employee stock-based compensation and the estimated fair value of options exchanged in business combinations and warrants issued for services using the fair value method for services received or the equity instruments issued, whichever is more readily measured. The Company estimated the fair value of stock options and warrants issued to non-employees using the Black-Scholes-Merton option valuation model (the “Model”).

Employee Benefits

The Company sponsors a contributory 401(k) plan covering all full-time employees who meet prescribed service requirements. The Company is not required to make matching contributions, although the plan provides for discretionary contributions by the Company. The Company made no contributions in either fiscal 2009 or 2008.

Income Taxes

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

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

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding. Diluted net income per share is computed using the weighted average number of common shares outstanding during the period plus the dilutive effect of outstanding stock options and warrants using the “treasury stock” method. The computation of diluted earnings per share does not include the effect of outstanding stock options and warrants that are anti-dilutive. The Company has excluded 316,750 and 1,908,018 of equity instruments from the calculation of diluted weighted average shares outstanding as of September 30, 2009 and 2008, respectively, with exercise prices less than market values because these securities were anti-dilutive.

Segment Information

The Company operates internally as one reportable operating segment because all of the Company’s locations have similar economic characteristics.

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

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

The Company did not have any customer that individually represented 10% or more of the Company’s total revenue for the year ended September 30, 2009 and 2008.. The Company did not have any customer with an accounts receivable balance that individually represented 10% or more of the Company’s total accounts receivable at September 30, 2009 and 2008.

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

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Recent Accounting Pronouncements

The Business Combination Topic of the Codification requires the Company to record separately and expense the direct costs of an acquisition. These costs were previously included in the total allocated cost of the acquisition. This Codification Topic also requires the Company to recognize as an asset or liability at fair value certain contingencies, either contractual or non-contractual, if certain criteria are met. Finally, this Codification Topic requires that the Company recognize contingent consideration at the date of acquisition, based on the fair value at that date. These Codification Topic changes are effective and will impact any acquisitions completed by the Company after September 30, 2009.

3. Accounts Receivable and Unbilled Receivables

Accounts and unbilled receivables consists of the following:

	September 30,
	2009			2008
Accounts receivable	$	3,399		$	4,466
Unbilled receivables		349			1,576
Subtotal		3,748			6,042
Allowance for doubtful accounts		(280	)		(380	)
Accounts and unbilled receivables, net	$	3,468		$	5,662

4. Equipment and Improvements

Equipment and improvements consists of the following:

	September 30,
	2009			2008
Furniture and fixtures	$	647		$	590
Purchased software		731			551
Computers and peripherals		1,556			1,527
Leasehold improvements		585			375
Total cost		3,519			3,043
Less accumulated depreciation		(2,071	)		(1,280	)
Equipment and improvements, net	$	1,448		$	1,763

Included above are assets acquired under capitalized leases of $511 thousand at both September 30, 2009 and 2008, respectively, with accumulated depreciation thereon of $442 thousand and $295 thousand, respectively.

The Company has $344 thousand and $501 thousand of net property and equipment at September 30, 2009 and 2008, respectively, for use in its hosting and SaaS subscription arrangements.

5. Acquisitions

Indigio Group, Inc.

On July 1, 2008, the Company acquired all the outstanding stock of Indigio Group, Inc. (“Indigio”), a Denver, Colorado-based web development company that provided web application development, web design, usability, and search engine optimization services. Consideration for the acquisition consisted of (i) $600,000 in cash, (ii) 1,127,810 shares of Bridgeline common stock, (iii) the payment of $195,000 of indebtedness owed by Indigio, and (iv) contingent consideration of up to $2.1 million in cash payable quarterly over 14 calendar quarters after the acquisition based upon the achievement of certain defined operating metrics. The Company accounts for contingent payments as additional purchase price which is allocated to goodwill. For the years ended September 30, 2009 and 2008, $278 thousand and $-0-, respectively, were recorded as an increase to goodwill under this arrangement. At September 30, 2009, the maximum remaining future consideration payable is approximately $1.8 million.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Tenth Floor, Inc.

On January 31, 2008, the Company acquired all the outstanding stock of Tenth Floor, Inc. (“Tenth Floor”), a Cleveland, Ohio based web application development company that developed its own SaaS-based web application management software product named BASE-10. Tenth Floor was acquired for approximately $4 million, which included the purchase of approximately $650,000 of net working capital (cash and accounts receivable less certain liabilities). Consideration consisted of (i) $504,000 in cash, (ii) $96,000 of indebtedness owed by Tenth Floor, (ii) 640,000 shares of Bridgeline common stock, and (iv) contingent consideration of up to up to $1.2 million in cash payable quarterly over 12 calendar quarters after the acquisition based on the achievement of certain defined operating metrics. For the years ended September 30, 2009 and 2008, $400 thousand and $267 thousand, respectively, were recorded as an increase to goodwill under this arrangement. At September 30, 2009, the maximum remaining future consideration is approximately $533 thousand.

Indigio and Tenth Floor Net Assets Acquired

The estimated fair value of net assets acquired from the acquisitions of Tenth Floor and Indigio are summarized as follows:

Net assets acquired:	Amount
Cash	$	38
Other current assets		1,399
Equipment		314
Other assets		88
Intangible assets		1,179
Goodwill		5,617
Total assets		8,635
Current liabilities		1,547
Capital lease obligations		189
Total liabilities assumed		1,736
Net assets acquired	$	6,899

Purchase price:
Cash paid	$	1,430
Equity exchanged		4,992
Options issued and exchanged		81
Closing costs and fees		396
Total purchase price	$	6,899

Of the $1.2 million in intangible assets, $737 thousand was assigned to customer relationships with an average useful life of five years, $175 thousand was assigned to noncompetition agreements with an average estimated life of five years and $267 thousand was assigned to acquired technology with an average estimated life of three years.

Other Acquisitions

The Company is obligated to pay contingent consideration in the form of earn-outs to former shareholders of companies acquired prior to fiscal 2008, based upon the achievement of certain defined operating metrics. The Company accounts for such contingent payments as additional purchase price which is allocated to goodwill. For the year ended September 30, 2009, $1.1 million was recorded as goodwill under these arrangements. At September 30, 2009, the maximum remaining future consideration payable for these acquisitions is approximately $935 thousand.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

6. Intangible Assets and Goodwill

Intangible Assets

Changes in the carrying amount of intangible assets follows:

	At September 30, 2009
	Gross		Accumulated			Impairment			Net
	Asset		Amortization			(a)			Amount
Intangible assets:
Domain and trade names	$	39	$	(26	)	$	(13	)	$	—
Customer related (b)		2,676		(1,242	)		(63	)		1,371
Acquired software		362		(243	)		—			119
Total intangible assets	$	3,077	$	(1,511	)	$	(76	)	$	1,490


	At September 30, 2008
	Gross		Accumulated			Impairment			Net
	Asset		Amortization			(a)			Amount
Intangible assets:
Domain and trade names	$	39	$	(18	)	$	(13	)	$	8
Customer related		3,649		(822	)		(63	)		2,764
Acquired software		362		(154	)		—			208
Total intangible assets	$	4,050	$	(994	)	$	(76	)	$	2,980

____________
(a) Impairment charge taken during year ended September 30, 2008
(b) Reflects $973 purchase price allocation adjustment resulting from final valuation

There was an impairment charge of $76 thousand for intangible assets for the year ended September 30, 2008. This charge was based on a comparison of the carrying value of intangible assets to the estimated undiscounted cash flows to be generated over the remaining life of the intangible assets.

Total amortization expense related to intangible assets for the years ended September 30, 2009 and 2008 follows:

	September 30,
Amortization expense charged to:	2009		2008

Cost of revenue	$	90	$	64
Operating expense	$	427	$	473
Total	$	517	$	537

The estimated amortization expense for fiscal years 2010, 2011, 2012, 2013, and 2014 is $536 thousand, $470 thousand, $390 thousand, $94 thousand and -0-, respectively.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Goodwill

Changes in the carrying amount of goodwill follows:

	September 30,
	2009		2008
Balance at beginning of period	$	10,725	$	14,426
Acquisitions		—		4,658
Contingent acquisition payments		1,765		1,323
Purchase price allocation adjustments		1,409		70
Permanent impairment adjustment		—		(9,752	)
Balance at end of period	$	13,899	$	10,725

The Company recorded purchase price allocation adjustments of approximately $1.4 million during the year ended September 30, 2009. These purchase price allocation adjustments affected previously recorded amounts for unbilled receivables, customer relationships and non-compete agreements, principally related to the Company’s acquisition of Tenth Floor, Inc. and Indigio Group, Inc. completed January 31, 2008 and July 1, 2008, respectively. The Company engaged a third party valuation firm to assist management in determining the fair value of the definite-lived intangible assets.

There was no impairment charge for goodwill for the year ended September 30, 2009. The Company recorded an impairment charge for goodwill for the year ended September 30, 2008 in the amount of $9.8 million. This impairment charge resulted from (i) economic factors impacting the Company’s business (ii) an overall decline in organic revenue growth in the second half of fiscal 2008, and (iii) a material decline in the Company’s stock price since September 30, 2007. The Company recorded an estimated impairment charge at September 30, 2009 and finalized the charge during the quarter ended March 31, 2009 resulting in no change from the original estimate.

7. Accrued Liabilities

Accrued liabilities consists of the following:

	September 30,
	2009		2008
Compensation and benefits	$	374		$	552
Subcontractors		24			6
Accrued contingent consideration		408			327
Professional fees		176			184
Deferred rent		149			136
Other		63			324
Total	$	1,194		$	1,529

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

8. Debt

Credit Facility Borrowings

In September 2008, the Company entered into a Loan and Security Agreement with Silicon Valley Bank that provided for a revolving working capital line of credit of up to the lesser of (i) $1.25 million and (ii) 80% of eligible accounts receivable, subject to specified adjustments. Borrowings under the credit line were due in September 2009 and subject to interest at prime plus 1.0%. The prime rate was 5.0% at September 30, 2008. Borrowings were secured by all of the Company’s accounts receivable, investment property and financial assets. At September 30, 2008, the Company had an outstanding balance under the credit line of $1 million which was repaid in October 2008.

In December 2008, the Company amended its Loan and Security Agreement with Silicon Valley Bank. The amendment extended the term of the Agreement to December 28, 2009 and increased availability under credit line to the lesser of (i) $3.0 million and (ii) 80% of eligible accounts receivable, subject to specified adjustments. Borrowings bear interest at prime plus 2.0%, with a minimum interest rate of 8.0% and are secured by all of the Company’s assets. At September 30, 2009, the Company had an outstanding balance under the credit line of $1 million at 8% (prime was 3.25%) which was repaid in October 2009.

Capital Lease Obligations

Capital lease obligations consists of the following:
	September 30,
	2009			2008
Capital lease obligations	$	139		$	244
Less: Current portion		(77	)		(105	)
Capital lease obligations	$	62		$	139

As of September 30, 2009, the Company had the following minimum lease payments remaining under capitalized lease obligations:

Year Ending September 30,	Amount
2010	$	90
2011		55
2012		11
2013		—
2014		—
Total		156
Less interest at a weighted average of 11%		17
Total capital lease obligations	$	139

9. Commitments and Contingencies

Guarantees and Indemnifications

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

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Litigation

The Company is subject to ordinary routine litigation and claims incidental to its business. At September 30, 2009 the Company is not aware of any material legal proceedings against it.

Operating Lease Commitments

The Company maintains its executive offices in Woburn, Massachusetts and operating offices in several locations throughout the United States and India. Future minimum rental commitments under non-cancelable operating leases with initial or remaining terms in excess of one year at September 30, 2009 were as follows:

Year Ending September 30,	Amount
2010	$	1,113
2011		998
2012		640
2013		333
2014		130
2015 and beyond		—
Total	$	3,214

Rent expense for the years ended September 30, 2009 and 2008 was approximately $1.3 million and $1.2 million, respectively, exclusive of sublease income of $54 thousand and $112 thousand for the years ended September 30, 2009 and 2008, respectively. In April, 2009, the Company entered into a sublease for excess office space assumed in connection with the acquisition of Tenth Floor, Inc. Both the lease and the sublease expire in June 2010. In January 2007 the Company entered into a sublease for excess office space assume in connection with an acquisition. Both the lease and the sublease expired in March 2009.

Other Commitments

The Company frequently warrants that the technology solutions it develops for its clients will operate in accordance with the project specifications without defects for a specified warranty period, subject to certain limitations that the Company believes are standard in the industry. In the event that defects are discovered during the warranty period, and none of the limitations apply, the Company is obligated to remedy the defects until the solution that the Company provided operates within the project specifications. The Company is not typically obligated by contract to provide its clients with any refunds of the fees they have paid, although a small number of its contracts provide for the payment of liquidated damages upon default. The Company has purchased insurance policies covering professional errors and omissions, property damage and general liability that reduce its monetary exposure for warranty-related claims and enable it to recover a portion of any future amounts paid.

The Company’s contracts typically provide for testing and client acceptance procedures that are designed to mitigate the likelihood of warranty-related claims, although there can be no assurance that such procedures will be effective for each project. The Company has not paid any material amounts related to warranties for its solutions. The Company sometimes commits unanticipated levels of effort to projects to remedy defects covered by its warranties. The Company’s estimate of its exposure related to warranties on contracts is immaterial as of September 30, 2009 and 2008.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

10. Shareholder’s Equity

The Company has granted common stock, common stock warrants, and common stock option awards (the “Equity Awards”) to employees, consultants, advisors and debt holders of the Company and to former owners and employees of acquired companies that have become employees of the Company. At September 30, 2009, the Company maintained two stock option plans.

2000 Stock Incentive Plan

The Company’s 2000 Stock Incentive Plan, as amended, (the “Plan”) provides for the issuance of up 2.0 million shares of common stock. The Plan authorizes the award of incentive stock options, non-statutory stock options, restricted stock, unrestricted stock, performance shares, stock appreciation rights and any combination thereof to employees, officers, directors, consultants, independent contractors and advisors of the Company. Options granted under the Plan may be granted with contractual lives of up to ten years. There were 1,462,788 options outstanding under the Plan as of September 30, 2009 and 537,212 shares available for future issuance.

2001 Lead Dog Stock Option Plan

In connection with the Company’s merger with Lead Dog in February 2002, the Company assumed Lead Dog’s 2001 Stock Option Plan (the “Lead Dog Plan”). Options under the Lead Dog Plan may be granted for periods of up to ten years and at prices no less than the fair market value of the shares on the date of grant. There were 7,419 options reserved for issuance under the Lead Dog Plan as of September 30, 2009. The Company does not Plan to issue any more options under the Lead Dog Plan.

Common Stock Warrants

In 2006, the Company issued 280,000 warrants to note holders of Senior Secured Notes issued in a private placement (which have been repaid) (the “Debt Warrants”) and issued 112,000 warrants to the underwriters of the debt offering (the “Underwriter’s Debt Warrants”). The Debt Warrants are exercisable into shares of the Company’s common stock at $0.001 per share any time within five years from the date of grant. The Underwriter’s Debt Warrants are exercisable at $5.00 per share any time within five years from the grant date provided, however, that no such exercise could take place prior to the earlier of the date of an initial public offering or April 21, 2008. The costs of the both the Debt Warrants and the Underwriter’s Debt Warrants were fully amortized over the term of the Senior Notes. As of September 30, 2009, (i) 240,000 Debt Warrants have been exercised and 40,000 Debt Warrants are outstanding, and (ii) 112,000 Underwriter’s Debt Warrants are outstanding.

In July 2007, the Company issued 150,000 warrants to the underwriter’s of the Company’s initial public offering (the “IPO Warrants”). Each IPO Warrant has an exercise price of $7.50 and can be exercised at any time from January 2008 through July 2012. The Company recorded the grant date fair value of these IPO Warrants using the Black-Scholes-Merton option valuation model directly to additional paid in capital as part of the costs of the initial public offering. At September 30, 2009, there were 150,000 IPO Warrants outstanding.

At September 30, 2009 there were 302,000 Debt Warrants, Underwriter’s Warrants and IPO Warrants outstanding.

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Option and Warrant Activity and Outstanding Shares

A summary of combined option and warrant activity follows:

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

Outstanding, September 30, 2007		1,077,831		$	3.430		467,000		$	3.610
Granted		823,300		$	1.850		—			—
Exercised		(6,667	)	$	0.003		(160,000	)	$	0.001
Forfeited or expired		(165,773	)	$	3.680		—			—
Outstanding, September 30, 2008		1,728,691		$	3.060		307,000		$	5.490
Granted		1,917,989		$	0.900		—			—
Exercised		—		$	—		(5,000	)	$	0.001
Forfeited or expired		(2,176,473	)	$	2.550		—			—
Outstanding, September 30, 2009		1,470,207		$	0.910		302,000		$	5.580

Options granted above include 1.6 million options issued in connection with the October 2008 Repricing Plan (the “Repricing Plan”). Pursuant to the Repricing Plan, each holder of Bridgeline options was offered the opportunity to have their outstanding options modified by (i) reducing the granted exercise price to a lower exercise price equal to the current fair market of the common stock on the date of the modification and (ii) starting a new three year vesting schedule. The fair value of the modified options of $300 thousand was calculated using the difference in value between the original terms and the new terms as of the modification date. The incremental cost of the modified option over the original option is being recognized as additional compensation expense over a three year vesting period that began on the date of the modification.

There were no options exercised during the year ended September 30, 2009. The intrinsic value of the warrants exercised during the year ended September 30, 2009 was $4 thousand, or $.88 per share.

The intrinsic value of options and warrants exercised during the year ended September 30, 2008 was $24 thousand and $558 thousand, respectively. Options and warrants exercised during the year ended September 30, 2008 had an intrinsic value of $3.59 and $3.49 per share, respectively.

A summary of the status of Bridgeline’s nonvested shares follows:

	Shares			Weighted Average Grant-Date Fair Value
Nonvested at September 30, 2008		830,439		$	2.80
Granted		1,917,989			0.90
Vested		(1,499	)		2.74
Forfeited		(1,292,558	)		2.50
Nonvested at September 30, 2009		1,454,371		$	0.91

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Price ranges of outstanding and exercisable options as of September 30, 2009 are summarized below:

Outstanding Options						Exercisable Options
Exercise Price		Number of Options		Weighted Average Remaining Contractual Life (Years)		Number of Options Exercisable		Aggregate Intrinsic Value
$	0.0030		6,667		3.00		6,667	$	8
$	0.3573		3,220		2.41		3,220	$	3
$	0.6400		45,000		9.37		—		—
$	0.7500		60,500		9.30		—		—
$	0.8100		21,500		9.29		—		—
$	0.9000		1,193,203		9.03		—		—
$	1.0600		121,167		9.46		—		—
$	1.0716		4,200		2.41		4,200	$	1
$	1.2200		10,000		9.05		−		—
$	2.5000		3,500		8.53		1,166		—
$	3.0000		250		4.75		250		—
$	3.5900		1,000		8.21		333		—
			1,470,207		9.03		15,836	$	12

Compensation Expense

The Company estimates the fair value of stock options using the Black-Scholes-Merton option valuation model (the “Model”). The assumptions used to calculate compensation expense follows:

	Year Ended September 30,
	2009	2008
Expected option life in years	6.5	3.0 to 10.0
Expected volatility	61.0%	54.0% to 70.0%
Expected dividend rate	0.0%	0.0%
Risk free interest rate	1.36% to 2.82%	2.72% to 4.04%
Option exercise prices	$.64 to $1.24	$1.76 to $3.69
Weighted average fair value of options granted during the year	$.90	$1.85

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Compensation expense is generally recognized on a graded straight-line basis over the vesting period of grants. During the years ended September 30, 2009 and 2008, the Company recognized $538 thousand and $425 thousand, respectively as compensation expense related to share based payments. As of September 30, 2009, the Company had approximately $379 thousand of unrecognized compensation costs related to unvested options which the Company expects to recognize through fiscal 2012.

The total fair value of shares vested during the years ended September 30, 2009 and 2008 was $4 thousand and $764 thousand, respectively.

11. Income Taxes

The Company’s income tax provision was computed based on the federal statutory rate and average state statutory rates, net of the related federal benefit. The provision differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The sources and tax effects of the differences are as follows:

	Year Ended September 30,
	2009			2008
Income tax benefit at the federal statutory rate of 34%	$	258		$	(3,493	)
Permanent differences, net		544			3,395
State income expense (benefit), net of federal benefit		19			(23	)
Change in valuation allowance attributable to operations		(748	)		195
Other		(42	)		(74)
Total	$	31		$	—

As of September 30, 2009, the Company has net operating loss carryforwards (“NOLs”) of approximately $3.5 million for federal purposes. The state NOL carryforwards vary by state with NOLs existing in some jurisdictions and not other. Approximately $1.2 million of the Company’s net operating losses is attributable to acquired entities. These net operating losses were fully reserved for at the respective acquisition dates. In the event the Company realizes these assets in the future, the benefit will be recorded as a reduction of goodwill. If not used, the federal carryforwards will expire between 2020 and 2027 and the state carryforwards will expire between 2009 and 2027.

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

	September 30,
	2009			2008
Deferred tax assets:
Current:
Contract loss reserve	$	—		$	45
Bad debt reserve		106			145
Deferred revenue		374			403
Long-term
AMT carryforward		32			—
Net operating loss carryforwards		1,618			1,907
Intangibles		1,210			—
Total deferred tax assets		3,340			2,500
Deferred tax liabilities:
Current:
Contract loss reserve		(3	)		—
Long-term:
Intangibles		—			(459	)
Depreciation		(91	)		(171	)
Total deferred tax liabilities		(94	)		(630	)
Total deferred tax assets, net, before valuation allowance		3,246			1,870
Valuation allowance		(3,246	)		(1,870	)
Net deferred tax assets	$	—		$	—

BRIDGELINE SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

For the year ended September 30, 2009 the valuation allowance for deferred tax assets increased $1,376 which was mainly due to increases in deferred revenue and certain allowances, intangibles and reserves. For the year ended September 30, 2008 the valuation allowance for deferred tax assets increased $678 thousand which was mainly due to increases in deferred revenue and certain allowances and reserves.

The Company has net operating loss carryforwards and other deferred tax benefits that are available to offset future taxable income. A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Accordingly, the Company has established a full valuation allowance against its net deferred tax asset at September 30, 2009 and 2008.

In January 2003, the Company established Bridgeline Software Pvt. Ltd in Bangalore India under the Software Technology Parks of India law. This law establishes a tax holiday for the first ten years of operations; therefore the Company has not incurred any foreign taxes. To date, the foreign taxes not incurred as a result of this tax holiday have not been significant.

Undistributed earnings of the Company’s foreign subsidiary amounted to approximately $375 thousand and $517 thousand at September 30, 2009 and 2008, respectively. These earnings are considered to be indefinitely reinvested; accordingly, no provision for US federal and state income taxes has been provided thereon. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to both US income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the applicable foreign tax authority. Determination of the amount of unrecognized deferred US income tax liability is not material and detailed calculations have not been performed. As of September 30, 2009, there would be minimal withholding taxes upon remittance of all previously unremitted earnings.

12. Related Party Transactions

In connection with the acquisition of Purple Monkey Studios, Inc. in fiscal 2007, the Company entered into a short-term lease with Purple Monkey Realty LLC. The owners of Purple Monkey Realty LLC were previously employees of the Company. The Company relocated to a new space in September 2008 after the terms of the initial lease expired. The Company paid $-0- and $137 thousand and in rent expense for the years ended September 30, 2009 and 2008, respectively, under this agreement.

13. Subsequent Event

On November 25, 2009, the Company amended its Loan and Security Agreement with Silicon Valley Bank to extend the maturity date to March 31, 2010. All other terms and conditions remained the same.

Delaware	52-2263942
State or Other Jurisdiction of Incorporation	IRS Employer Identification No.

10 Sixth Road
Woburn, Massachusetts	01801
(Address of Principal Executive Offices)	(Zip Code)

Title of each class	Name of exchange on which registered
Common Stock, $0.001 par value per share	The NASDAQ Stock Market, LLC


Large accelerated filer o	Accelerated filer o	Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company x

· Code of Business Ethics
· Committee Charters for the following Board committees:
§ Nominating and Corporate Governance committee
§ Audit committee
§ Compensation committee

·	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.

·	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.

Geographic Location	Address	Size
Atlanta, Georgia	5555 Triangle Parkway Norcross, Georgia 30092	8,547 square feet, professional office space
Bangalore, India	71 Sona Towers, West Wing Millers Road, Bangalore 560 052	7,800 square feet professional office space
Boston, Massachusetts	10 Sixth Road Woburn, Massachusetts 01801	9,335 square feet, professional office space
Chicago, Illinois	30 N. LaSalle Street, 20th Floor Chicago, IL 60602	4,880 square feet, professional office space
Cleveland, Ohio	2077 East 4th Street, 2nd Floor Cleveland, OH 44115	5,705 square feet, professional office space
Denver, Colorado	410 17th Street, Suite 600 Denver, CO 80202	12,270 square feet, professional office space
New York, New York	104 West 40th Street New York, NY. 10018	4,400 square feet, professional office space
Washington, DC	4,300 Wilson Boulevard Arlington, VA 22203	4,801 square feet, professional office space

Year Ended September 30, 2009	High		Low

Fourth Quarter	$	1.65	$	0.80
Third Quarter		1.79		0.92
Second Quarter		1.52		0.36
First Quarter		1.39		0.50

Year Ended September 30, 2008	High		Low

Fourth Quarter	$	2.48	$	1.18
Third Quarter		3.66		2.25
Second Quarter		3.65		2.45
First Quarter		4.34		3.00

·	We released iAPPS® Content Manager in September 2008 and iAPPS® Analytics in February 2009.

·	We increased investments in iAPPS research and development in 2009.

·	We did not record any impairment charges for intangible assets or goodwill in 2009. We recorded total non-cash impairment charges of $9.8 million for intangible assets and goodwill in 2008.

·	Tenth Floor, Inc., now Bridgeline Cleveland, was acquired on January 31, 2008 and the financial impact of this acquisition was included for a full year in fiscal 2009 as compared with only eight months for fiscal 2008.

	For the Year Ending September 30,
(in thousands)	2010		2011		2012		2013		2014		2015		Total
Payment obligations by year
Bank line of credit	$	1,000	$	—	$	—	$	—	$	—	$	—	$	1,000
Capital leases		90		55		11								156
Operating leases (a)		1,113		998		640		333		130		—		3,214
Contingent acquisition payments (b)		1,900		793		585		—		—		—		3,278
Total	$	4,103	$	1,846	$	1,236	$	333	$	130	$	—	$	7,648

·	Revenue recognition;
·	Allowance for doubtful accounts;
·	Accounting for cost of computer software to be sold, leased or otherwise marketed;

·	Accounting for goodwill and other intangible assets; and
·	Accounting for stock-based compensation.

Name	Age	Position

Thomas Massie	48	Chairman, Chief Executive Officer and President

John Cavalier	70	Director(1)(2)(3)(4)

William Coldrick	67	Director (1)(2)(3)(4)

Kenneth Galaznik	58	Director (1)(4)

Robert Hegarty	46	Director(2)(3)(4)

Ronald Levenson	53	Executive Vice President, Chief Financial Officer and Treasurer

Brett Zucker	37	Executive Vice President and Chief Technical Officer

(1)	Member of the Audit Committee.
(2)	Member of the Compensation Committee.
(3)	Member of the Nominating and Governance Committee.
(4)	Independent director.

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)		Weighted average exercise price of outstanding options, warrants and rights (b)		Number of securities remaining available for future issuance under equity compensation plans (a)/(c)

Equity compensation plans approved by security holders		1,470,207	$	.91		537,212

EquiEquity compensation plans not approved by security holders (1)		302,000		5.58		—

Total		1,772,207	$	3.50		537,212

	Item			Title

	2.1			Objectware, Inc. Acquisition Agreement (incorporated by reference to Exhibit 2.3 to our Registration Statement on Form S-B2, File No. 333-139298)
	2.2			First Amendment to Agreement and Plan of Merger filed as Exhibit 2.3, dated as of March 29, 2007 (incorporated by reference to Exhibit 10.55 to our Registration Statement on Form S-B2, File No. 333-139298)
	2.3			Second Amendment to Agreement and Plan of Merger filed as Exhibit 2.3, dated June 14, 2007 (incorporated by reference to Exhibit 10.63 to our Registration Statement on Form S-B2, File No. 333-139298)
	2.4			Purple Monkey Studios, Inc. Acquisition Agreement (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed on September 5, 2007)
	2.5			Tenth Floor, Inc Agreement (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed on February 1, 2008)
	2.16			Indigio Group, Inc., Agreement (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed on July 2, 2008)
	3.1(i)			Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1(ii) to our Registration Statement on Form S-B2, File No. 333-139298)
	3.1(ii)			Amended and Restated By-laws (incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed on October 30, 2007)

	4.1			Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.1			Office Building Lease between Sixth Road Woburn, LLC and Bridgeline Software, Inc., dated May 5, 2005 (incorporated by reference to Exhibit 10.1 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.2			Office Building Lease between 104 West 40th Street Partners LLC and Bridgeline Software, Inc., dated November 26, 2003 (incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.3			Office Building Lease between Valliappa Software Technological Park Pvt. Ltd. and Bridgeline

				Software Enterprises Pvt. Ltd. dated December 5, 2005 (incorporated by reference to Exhibit 10.5 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.4			Office Building Lease between North LaSalle L.P. and Bridgeline Software, Inc. dated May 27, 2008.
	10.5			Office Building Lease between NHD II Point LLC and Bridgeline Software, Inc., dated August 7, 2008 (incorporated by reference to Exhibit 10.40 to our Annual Report on Form 10-KSB filed on December 29, 2008)
	10.6			Employment Agreement with Thomas Massie, dated October 1, 2001 (incorporated by reference to Exhibit 10.7 to our Registration Statement on Form S-B2, File No. 333-139298)*
	10.7			Employment Agreement between Bridgeline Software, Inc. and Ronald M. Levenson (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on May 15, 2009)*
	10.8			Amendment to Employment Agreement between Bridgeline Software, Inc. and Ronald M. Levenson (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on May 15, 2009)*
	10.9			Employment Agreement with Brett Zucker, dated January 1, 2006 (incorporated by reference to Exhibit 10.9 to our Registration Statement on Form S-B2, File No. 333-139298)*
	10.10			Form of Warrant to Purchase Common Stock of Bridgeline Software, Inc. issued to the investors listed on Schedule A attached thereto, as amended (incorporated by reference to Exhibit 10.23 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.11			Form of Warrant to Purchase Common Stock of Bridgeline Software, Inc. issued to Placement Agent in April 2006 offering, as amended (incorporated by reference to Exhibit 10.24 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.12			Form of Warrant to Purchase Common Stock of Bridgeline Software, Inc., issued to the underwriters (incorporated by reference to Exhibit 10.65 to our Registration Statement on Form S-B2, File No. 333-139298)
	10.13			Amended and Restated Stock Incentive Plan (incorporated by reference to Appendix B to our Definitive Proxy Statement filed on February 25, 2008)*
	10.14			Lead Dog Digital, Inc. 2001 Stock Option Plan (incorporated by reference to Exhibit 10.34 to our Registration Statement on Form S-B2, File No. 333-139298)*
	10.15			Loan and Security Agreement dated as of September 29, 2008, between Bridgeline Software, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed on December 31, 2008)*
	10.16			First Loan Modification Agreement between Silicon Valley Bank and Bridgeline Software, Inc., dated December 29, 2008 (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on December 31, 2008)
	10.17			Intellectual Property Security Agreement dated as of December 29, 2008, between Bridgeline Software, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on December 31, 2008)
	10.18			Second Amendment to Loan and Security Agreement dated as of November 19, 2009, between Bridgeline Software, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on December 1, 2009)
	21.1			Subsidiaries of the Registrant
	31.1			CEO Certification, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2			CFO Certification, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1			CEO Certification, Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2			CFO Certification, Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	*			Management compensatory plan.

	BRIDGELINE SOFTWARE, INC.
	a Delaware corporation


	By:	/s/ Thomas Massie Name: Thomas Massie Title: Chief Executive Officer and Director

Signature	Title	Date

/s/ Thomas Massie	Chief Executive Officer and Director	December 29, 2009
Thomas Massie	(Principal Executive Officer)

/s/ Ronald Levenson	Chief Financial Officer	December 29, 2009
Ronald Levenson	(Principal Financial Officer)

/s/ John Cavalier	Director	December 29, 2009
John Cavalier

/s/ William Coldrick	Director	December 29, 2009
William Coldrick


/s/ Kenneth Galaznik	Director	December 29, 2009
Kenneth Galaznik

/s/ Robert Hegarty	Director	December 29, 2009
Robert Hegarty