**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549





**Form
      10-KSB**





(Mark
      One)


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


For
      the
      fiscal year ended September 30, 2007





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


For
      the
      transition period from ______________ to ______________





*Commission
      File Number 333-139298*







**Bridgeline
      Software, Inc.**


(Exact
      name of registrant as specified in its charter)




**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)





**(781)
                376-5555**(Issuer’s
                telephone number)





Securities
      registered under Section 12(b) of the Exchange Act:


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





Securities
      registered under Section 12(g) of the Exchange Act:


None





Check
      whether issuer is not required to file reports pursuant to Section 13 or 15(d)
      of the Exchange Act   o.





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days.   Yes  x     
No  o.





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of the registrant's knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this Form 10-KSB   o.





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





The
      issuer's revenues for its most recent fiscal year $11,200,000.





The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates was $24,367,324 based on the closing price of $3.71 of the
      issuer’s common stock, par value $.001 share, as reported by NASDAQ on December
      11, 2007.





As
      of
      December 11, 2007, there were 8,653,949 shares of common stock
      outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE: Portions of the definitive proxy statement for our
      2007 annual meeting of stockholders, which is to be filed within 120 days after
      the end of the fiscal year ended September 30, 2007, are incorporated by
      reference into Part III of this Form 10-KSB, to the extent described in Part
      III.





Transitional
      Small Business Disclosure Format (check one):   Yes  o    
No x











**Forward
      Looking Statement**


*Statements
      contained in this Annual Report on Form 10-KSB that are not based on historical
      facts are “forward-looking statements” within the meaning of the Private
      Securities Litigation Reform Act of 1995.  Forward-looking statements
      may be identified by the use of forward-looking terminology such as “should,”
“could,” “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,”
“intends,” “continue,” or similar terms or variations of those terms or the
      negative of those terms.  These statements appear in a number of
      places in this Form 10-KSB and include statements regarding the intent, belief
      or current expectations of Bridgeline Software, Inc. Forward-looking statements
      are merely our current predictions of future events. Investors are cautioned
      that any such forward-looking statements are inherently uncertain, are not
      guaranties of future performance and involve risks and uncertainties. Actual
      results may differ materially from our predictions. Important factors that
      could
      cause actual results to differ from our predictions include our limited
      operating history, our license renewal rate, our inability to manage our future
      growth efficiently or profitably, our inability to find, complete and integrate
      additional acquisitions, the acceptance of our products, the performance of
      our
      products, our dependence on our management team and key personnel, our ability
      to hire and retain future key personnel or the impact of competition and our
      ability to maintain margins or market share.  Although we have sought
      to identify the most significant risks to our business, we cannot predict
      whether, or to what extent, any of such risks may be realized, nor is there
      any
      assurance that we have identified all possible issues which we might face.
      We
      assume no obligation to update our forward-looking statements to reflect new
      information or developments. We urge readers to review carefully the risk
      factors described in the other documents that we file with the Securities and
      Exchange Commission. You can read these documents at
      www.sec.gov.*




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





**PART
      I**








**Item
      1.    Business.**




**Overview**





Bridgeline
        Software is a developer of web application management software and award-winning
        web applications that help organizations optimize business
        processes.  Bridgeline’s software and services help customers maximize
        revenue, improve customer service and loyalty, enhance employee knowledge,
        and
        reduce operational costs by leveraging web based
        technologies.





Bridgeline’s
        iAPPS®Framework
        and Product Suite are SaaS (software as a service)
        solutions that unify Content Management, Analytics, eCommerce, and eMarketing
        capabilities; enabling business users to enhance and optimize the value of
        their
        web properties. Combined with award-winning application development services,
        Bridgeline believes they helps customers cost-effectively accommodate the
        changing needs of today’s websites, intranets, extranets, and mission-critical
        web applications.





The
      iAPPS®Product
      Suite is delivered through a SaaS business model, in which we deliver our
      software over the Internet while providing maintenance, daily technical
      operation and support.





Bridgeline
        Software’s team of Microsoft®-certified
        developers specialize in end-to-end web application development, information
        architecture, usability engineering, SharePoint development, rich media
        development, search engine optimization, and fully-managed application
        hosting.





***Products
      and Services***





***Software
      Products***





*On-Demand
      (SaaS) Web Application Management Software - iAPPS®*





Business
        processes, regardless of industry or vertical market, fall into common
        categories.  Our research found companies must consistently address
        issues surrounding security, workflow, version control, and user
        management.  While the processes of individual entities may vary, the
        underlying elements mentioned above share common
        characteristics.  Over the last two and a half years, we have
        developed a very powerful and scalable .NET application development framework
        based on leveraging these common characteristics.  We call our
        framework iAPPS®.  In
        August 2007, we released the iAPPS®
        framework.
  -
            2
            -
 The
        iAPPS®
        framework offers a unified, common set of shared services that are critical
        to
        today’s business web environments.  The iAPPS® framework
        empowers
        companies and developers to create websites and web applications with advanced
        business logic, state-of-the-art graphical user interfaces, and improved
        quality
– all in a shorter timeframe with
        less
        coding than is typically required by comparable products.  The
        iAPPS®  framework
        allows our application development teams to develop web applications based
        on
        analyzing and optimizing our customers’ business processes, and then map the
        results to a common software component solution. While a very powerful concept
        on its own, the real synergies come together when the iAPPS® framework
        is
        combined with the iAPPS® product
        suite of
        website and application management products.  The iAPPS® product
        suite
        includes:




·
              iAPPS®
                  Content
                  Manager (released in October 2007) allows non-technical users to
                  create,
                  edit, and publish content via a browser-based interface. The advanced,
                  easy-to-use interface will allow businesses to keep content and
                  promotions
                  fresh - whether for a public commercial site or a company intranet.
                  The
                  iAPPS®
                  Content Manager will handle the presentation of content based on
                  a
      sophisticated indexing and security scheme that includes
                  management of
                  front-end access to online applications. The system will provide
                  a robust
                  library functionality to manage permissions, versions and organization
                  of
                  different content types, including multimedia files and images.
                  Administrators will be able to easily configure a simple or advanced
                  workflow.  The system can accommodate the complexity of larger
                  companies with strict regulatory policies. In addition, the open
                  nature of
                  the iAPPS®  Framework
                  allows for the integration of this content management system functionality
                  into any .NET-based web
                  application.


·
              iAPPS®
                  Analytics
                  (planned release in February 2008) will provide Bridgeline Software
                  customers the ability to manage, measure and optimize their web
                  presence
                  by recording detailed events and subsequently mine data within
                  a web
                  application for statistical analysis. Our customers will have access
                  to
                  information regarding where their visitors are coming from, what
                  content
                  and products their viewers are most interested in, and how they
                  navigate
                  through a particular web application. Through user-definable web
                  reports,
                  iAPPS®  Analytics
                  will provide insight into areas like visitor usage, content access,
                  age of
                  content, actions taken, and event triggers, and will report on
                  both client
                  and server-side events. iAPPS®  Analytics
                  will also be used to track events and create integrated reports
                  across the
                  entire iAPPS®
                  product suite
                  including campaign management (iAPPS®  Marketier),
                  content management (iAPPS®  Content
                  Manager) and commerce (iAPPS®  Commerce).


·
              iAPPS®
                  Commerce
                  (planned released in mid 2008) will provide an online eCommerce
                  solution
                  to assist Bridgeline's customers in maximizing and managing all
                  aspects of
                  their commerce initiatives. The customizable dashboard will provide
                  customers with a real-time overview of the performance of their
                  online
                  stores, such as sales trends, demographics, profit margins, inventory
                  levels, inventory alerts, fulfillment deficiencies, average check
                  out
                  times, potential production issues, and delivery times. Commerce
                  will also
                  provide backend access to payment and shipping gateways. In combining
                  iAPPS®  Commerce
                  with Analytics and Marketier, our customers can take their commerce
                  initiatives to a new level by personalizing their product offerings,
                  improving their marketing effectiveness, and providing value-added
                  services or cross selling products.


·
              iAPPS®
                  Marketier
                  (planned release at the end of 2008) will provide a marketing lifecycle
                  management tool that will include customer transaction analysis,
                  email
                  management, surveys and polls, event registration and issue tracking
                  to
                  measure campaign return on investments and client satisfaction.
                  Web site
                  content and user profiling will be leveraged to deliver targeted
                  campaigns
                  and stronger customer relationships. The email management features
                  will
                  provide comprehensive reporting capabilities including success
                  rate, and
                  recipient activity such as click-thrus and opt-outs. The iAPPS®
                  Marketier
                  will integrate with leading customer relationship management systems
                  (CRM's) such as Salesforce.com and leading ad banner engines such
                  as
                  Google.


The
        iAPPS®
        framework and product suite are available as a Software-as-a-Service (SaaS)
        business model, with associated maintenance, daily technical operation, and
        support, or as a commercially licensed and supported internal solution for
        customers preferring a dedicated server environment (within their firewall
        or at
        one of our facilities).  Due to the flexibility of the core
        architecture, the iAPPS® framework
        and
        product suite can also be sold as a traditional perpetual software license
        arrangement.
  *On-Demand
        (SaaS) Web Tools - OrgitectureTM*





Our
        Orgitecture**TM
        platform,
        developed several years ago, provides customers with an integrated suite
        of
        on-demand (SaaS) Web-based tools designed to streamline Web site management
        and
        reduce web related development costs. Orgitecture offers the stability,
        reliability and economies of scale of a subscription-based service.
  -
            3
            -


Developed
        on open source standards, Orgitecture facilitates the development and deployment
        of Web properties. Web solutions developed on Orgitecture are modular by
        design,
        so customers can add functionality as their needs evolve. Every Orgitecture
        Web
        site is customized by our developers to meet the unique needs of our customers.
        Software modules include: Web content management, survey tools,
        calendaring, email newsletters, online registration, and
        ecommerce.
  Our
        newly
        developed iAPPS® web application
        management software will replace Orgitecture.  We plan to migrate
        Orgitecture customers to the iAPPS® Framework
        over the
        next 18-24 months.




Revenue
      from sales of on-demand SaaS web tools are reported as *Subscriptions* in
      the accompanying financial statements.




**Web
      Application Development Services**





*Web
      Application Development*





Web
      application development services address specific customer needs such as
      usability engineering, information architecture, application development, rich
      media development, and search engine optimization.  We sell these
      custom services through our internal direct sales force.  Web
      application development engagements often include our software products or
      hosting arrangements that provide for the use of certain hardware and
      infrastructure at one of our co-managed network operating
      centers.  Web application development services are often sold as part
      of multiple element arrangements wherein retained professional services and/or
      hosting (i.e., Managed Services) are provided subsequent to completion of the
      web application development.





*Information
      Architecture*





Information
      Architecture is a design methodology focused on structuring information to
      ensure that users can find the appropriate data and can complete their desired
      transactions within a Web site or a Web application.  Understanding
      users and the context in which users will be initiating with a Web application
      is central to information architecture.  Information architects try to
      put themselves in the position of a typical user of an application 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 customer centric 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.





*Usability
      Engineering*





The
      Web
      was originally conceived as a hypertextual information space, but the
      development of increasingly sophisticated user interfaces and applications
      has
      fostered its 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.





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
      services:  usability audits, information architecture, process
      analysis and optimization, interface design and user testing.





Our
      systematic and user-centered approach to Web development focuses on developing
      Web applications 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.





*Search
      Engine Optimization (SEO)*





Bridgeline
      Software helps**customers maximize the effectiveness of their
      online marketing activities to ensure that their web applications can be exposed
      to the potential customers that use search engines to locate products and
      services. Bridgeline’s SEO services include competitive analysis, website
      review, keyword generation, proprietary leading page technology, ongoing
      registration, monthly reports, and monitoring.





Revenue
      from the above Web application development services is reported as *Web
      Development Services* in the accompanying financial statements.





-
          4
          -


**Managed
      Services***(**including H**osting)*





Many
        of
        our customers hire us to host and manage the web applications we develop. 
Bridgeline provides a complete outsourcing solution through our fully managed
        hosting services.  Our hosting facility includes dedicated
        in-house
 production
        and development servers, as well as a dedicated, 24-hour
        monitored co-location facility for mission critical
        applications.
  Through
        our partnership with Savvis and Internap, we offer co-location services in
        state-of-the-art data centers.  We provide 24/7 application monitoring,
        emergency response, version control, load balancing, managed firewall security,
        and virus protection services.  We provide shared hosting, dedicated
        hosting, and SaaS hosting for our customers.




We
      also
      offer our customers retained professional services.   These
      services are either contracted for on an “on call” basis or for a certain amount
      of hours each month.  Such arrangements generally provide for a
      guaranteed availability of a number of processional services hours each month
      on
      a “use it or lose it” basis.




Revenue
      from Managed Services are reported as *Managed Services*in the
      accompanying financial statements.




**Sales
      and Marketing**





Bridgeline
        Software employs a direct sales force and each sale is typically a time
        intensive sale taking anywhere from 30 days to 180 days on average to
        consummate.  Our direct sales force focuses its efforts selling to
        medium-sized business and large business. These businesses are typically
        in the
        following vertical markets:  Financial services, life sciences, high
        technology, foundations, and government agencies.
  We
        have
        five geographic locations in the United States with full-time professional
        direct sales staffs.  Our geographic locations are in the Atlanta
        area, Boston area, Chicago area, New York area, and Washington DC
        area.




*Four
      phase engagement methodology*





We
      use an
      accountable, strategic engagement process developed specifically for target
      companies that require a technology based professional approach, such as middle
      market type companies.  We believe it is critical to qualify each
      opportunity and to assure our skill set and tools match up well with the
      customer’s needs. As an essential part of every engagement, we believe our four
      phase engagement methodology streamlines our customer qualification process,
      strengthens our relationship with our customer, ensures our skill set and tools
      match the customer’s needs, and we believe results in the submission of accurate
      proposals.





*Organic
      growth from existing customer base*





We
      have
      specific programs that consistently market our brand, web application
      development software, and our services. Our business development professionals
      seek ongoing business opportunities within our customer base and within other
      operating divisions or subsidiaries of our existing customer base.





*New
      customer acquisition*





In
      the
      geographies in which we operate, we identify target customers within our
      vertical expertise (financial services, life sciences, high technology,
      foundations, and government). Our business development professionals develop
      an
      annual territory plan identifying various strategies to engage our target
      customers.





*Customer
      retention programs*





We
      use
      email marketing capabilities when marketing to our customer base. We email
      eNewsletters, internally generated whitepapers, and Company announcements to
      our
      customers. In addition we host educational on-line seminars on a regular
      basis.





*New
      lead generation programs*





We
      generate targeted leads and new business opportunities by leveraging on-line
      marketing strategies. We receive leads by maximizing the search engine
      optimization of our own web site. Through our web site, we provide various
      educational white papers and promote upcoming on-line seminars. In addition
      we
      pay for banner advertisements on various independent newsletters, and paid
      search advertisements that are linked to our web site. We also participate
      and
      exhibit at targeted events.





-
          5
          -


**Acquisitions**





Bridgeline
      Software plans to expand its distribution of iAPPS® and its
      web
      application development services throughout North America.  Due to the
      individualized nature of our sales process and delivery requirements, we believe
      local staff is required in order to maximize market-share results.




We
      believe the Web application development market in North America is growing
      and
      is fragmented. We believe that established yet small Web application development
      companies have the ability to market, sell and install our iAPPS® Framework
      and web
      application management software in their local metropolitan
      markets.  In addition, we believe that these companies also have a
      customer base and a niche presence in the local markets in which they operate.
      We believe there is an opportunity for us to acquire multiple companies that
      specialize in Web application development and are based in other large North
      American cities in which we currently do not operate.  We believe by
      acquiring certain of these companies and applying our business practices and
      efficiencies, we can accelerate our time to market in areas other than those
      in
      which we currently operate.





Since
      our
      initial public offering on June 29, 2007, we have completed the following two
      acquisitions:





·
            In
                July 2007, we acquired Objectware, Inc., an Atlanta, Georgia-based
                company.


·
            In
                August 2007, we acquired Purple Monkey Studios, Inc., a Chicago,
                Illinois-based company.





We
      believe these acquisitions contribute to our business strategy by providing
      us
      with new geographical distribution opportunities, an expanded customer base,
      an
      expanded sales force and an expanded developer force. In addition, integrating
      the acquired businesses into our existing operations allowed us to consolidate
      the finance, human resources, legal marketing, research and development, and
      other expenses of the acquired businesses with our own, reducing the aggregate
      of these expenses for the combined businesses, and resulting in improved
      over-all operating results.





**Research
        and Development**


Our
        software development efforts reside in our development center located in
        Bangalore, India.  We invested approximately $791 thousand in research
        and development activities for the fiscal year ended September 30, 2007,
        and we
        invested approximately $176 thousand in research and development activities
        for
        the fiscal year ended September 30, 2006.  We believe the cost of
        India based software developers are 70% lower than the cost of United States
        based software developers.


**Employees**


We
        employed 138 employees worldwide as of September 30,
        2007.  Substantially all of those employees are full time
        employees.


**Customers**


We
        primarily serve five markets that we believe have a history of investing
        in
        information technology enhancements and initiatives.  These markets
        are:


·
              Financial
                  services


·
              Life
                  sciences


·
              High
                  technology


·
              Foundations
                  and non profit organizations


·
              Federal
                  and state government agencies


We
        have
        more than 355 customers of which one customer, Nomura Securities, generated
        more
        than 15% of revenue in the fiscal year ended September 30, 2007.  No
        other customer generated more than 5% of revenue during such
        period.
  **Competition**




The
      market for our products and services, including Web application development
      software and Web application development services is highly competitive,
      fragmented, and rapidly changing. Barriers to entry in such markets remain
      relatively low. The markets are significantly affected by new product
      introductions and other market activities of industry participants. With the
      introduction of new technologies and market entrants, we expect competition
      to
      persist and intensify in the future.




We
      believe that we compete adequately with the others and distinguish ourselves
      from the competitors in a number of ways.  We believe that our
      competitors generally offer their Web application development software without
      directly providing Web application development services.  In addition
      our competitors that offer their Web application development software typically
      offer only single point of entry type products as compared to a unified
      framework approach.  Our ability to develop applications on multiple
      platforms and the existence of our own Web application development software
      distinguishes us from our competition.  We also believe that our
      products have been designed for ease of use without substantial technical
      skills.  In addition to the above factors, we believe our Web
      application development software has a lower cost of ownership than the
      solutions provided by most of our competitors.




-
          6
          -


**Available
      Information**




This
      Annual Report on Form 10-KSB, as well as our quarterly report on Form 10-Q
      and
      current reports on Form 8-K, along with any amendments to those reports, are
      made available free of charge, on our website (www.bridgelinesw.com) as
      soon as reasonably practicable after such material is electronically filed
      with
      or furnished to the Securities and Exchange Commission.  Copies of the
      following are also available free of charge through our website under the
      caption “Governance” and are available in print to any shareholder who requests
      it:




·
              Code
                  of Business Ethics


·
              Committee
                  Charters for the following Board committees: Nominating and Corporate
                  Governance, Audit and Compensation committees
                  respectively.
  The
        public may read and copy any materials that we file with the SEC at the SEC’s
        Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
        20549.  Information regarding the SEC’s Public Reference Room can be
        obtained by calling the SEC at 1-800-SEC-0330.  The SEC also maintains
        an Internet site that contains reports, proxy and information statements,
        and
        other information and can be found at (http://www.sec.gov).




**Item
      2.    Description of Properties**


Our
        headquarters are located twelve miles north of Boston, Massachusetts at 10
        Sixth
        Road, Woburn, Massachusetts 01801.This office also serves as our New England
        business unit. The following table lists our offices, all of which are
        leased:





**Location**
            
            **Address**
            
            **Size**Woburn,
                  Massachusetts
            
            10
                  Sixth Road
                Woburn,
                  Massachusetts 01801
            
            9,335
                  square feet,
                professional
                  office spaceNew
                  York, New York
            
            104
                  West 40thStreet
                New
                  York, New York 10018
            
            4,400
                  square feet,
                professional
                  office spaceWashington,
                  D.C.
            
            2639
                  Connecticut Ave., NW
                Washington,
                  D.C. 20008
            
            9,383
                  square feet,
              professional
                  office spaceBangalore,
                  India
            
            71
                  Sona Towers, West Wing
              Millers
                  Rd., Bangalore 560 052
            
            7,800
                  square feet,
              professional
                  office spaceNorcross,
                  Georgia
            
            5555
                  Triangle Parkway
              Norcross,
                  Georgia 30092
            
            7,068
                  square feet,
              professional
                  office spaceReston,
                  Virginia
            
            11440
                  Commerce Park Drive,
              Suite
                  502, Reston, VA 20191
            
            1,413
                  square feet,
              professional
                  office spaceOak
                  Park, Illinois
            
            124
                  South Marion Street
              Oak
                  Park, Illinois, 60302
            
            7,350
                  square fee,
              professional
                  office space





In
        fiscal
        2006, we also assumed a lease in conjunction with an acquisition for
        professional office space located in Cambridge,
        Massachusetts.  Shortly after completing the acquisition, the
        operations were consolidated into our Woburn, Massachusetts location and
        we
        commenced subleasing this facility effective January 15, 2007.


**Item
        3.    Legal Proceedings**
  From
        time
        to time we are subject to ordinary routine litigation and claims incidental
        to
        our business.  As of September 30, 2007, Bridgeline Software is not
        engaged with any material legal proceedings.


**Item
        4.    Submission of Matters to a Vote of Security
        Holders**
 No
        matters were submitted to a vote of the stockholders during the fourth quarter
        of the fiscal year.





-
          7
          -


**Part
      II**








**Item
      5.    Market for Common Equity, Related Stockholder Matters and
      Small Business Issuer Purchase of Equity Securities**





The
      following table sets forth, for the periods indicated, the range of high and
      low
      sale prices for our common stock. Our common stock trades on the NASDAQ Capital
      Market under the symbol BLSW. Trading of our common stock commenced on June
      29,
      2007, following completion of our initial public offering.







**Year
                Ended September 30, 2007**
            
            **High**
            
            
            **Low**Third
                Quarter
            
            $
            5.05
            
            
            $
            4.30Fourth
                Quarter
            
            
            5.09
            
            
            
            2.58








We
      have
      not declared or paid cash dividends on our common stock and do not plan to
      pay
      cash dividends to our shareholders in the near future. As of December 11, 2007,
      our common stock was held by approximately 163 shareholders of
      record.




**Recent
      Sales of Unregistered Securities; Use of Proceeds From Registered
      Securities**





The
      following summarizes all sales of our unregistered securities during the fiscal
      year ended September 30, 2007. The securities in each of the below-referenced
      transactions were (i) issued without registration and (ii) were
      subject to restrictions under the Securities Act and the securities laws of
      certain states, in reliance on the private offering exemptions contained in
      Sections 4(2), 4(6) and/or 3(b) of the Securities Act and on
      Regulation D promulgated thereunder, and in reliance on similar exemptions
      under applicable state laws as a transaction not involving a public offering.
      Unless stated otherwise, no placement or underwriting fees were paid in
      connection with these transactions. Proceeds from the sales of these securities
      were used for general working capital purposes.





*Acquisitions*




*Objectware*
      - The acquisition of Objectware, Inc. closed on July 5, 2007.  At that
      time, we issued 610,716 shares of our common stock to the sole stockholder
      of
      Objectware as partial consideration in our acquisition.





*Purple
      Monkey Studios, Inc.*– The acquisition of Purple Monkey Studios, Inc. closed
      on August 31, 2007.  At that time we issued an aggregate of 476,846
      shares of our common stock to the two stockholders of Purple Monkey Studios
      as
      partial consideration in our acquisition.





The
      securities issued as consideration in our acquisitions were issued to U.S.
      investors in reliance upon exemptions from the registration provisions of the
      Securities Act set forth in Section 4(2) thereof relative to sales by an issuer
      not involving any public offering, to the extent an exemption from such
      registration was required.





*Warrants*





In
      the
      fiscal year ended September 30, 2007, we issued 59,724 shares of our common
      stock pursuant to the exercise of outstanding warrants.





The
      shares of common stock issued upon exercise of such warrants were issued in
      reliance upon exemptions from the registration provisions of the Securities
      Act
      set forth in Section 4(2) thereof relative to sales by an issuer not involving
      any public offering, to the extent an exemption from such registration was
      required.





*Options*





In
      the
      fiscal year ended September 30, 2007, we issued 27,831 shares of our common
      stock pursuant to the exercise of vested stock options.  In the fiscal
      year ended September 30, 2007, we granted options to purchase equity shares
      on
      the following dates and amounts:





**Date**
            
            **Number**
            
            
            **Exercise
                Price**October
                20, 2006
            
            
            31,880
            
            
            $
            3.75December
                9, 2006
            
            
            5,000
            
            
            $
            3.75April
                23, 2007
            
            
            113,998
            
            
            $
            3.75July
                5, 2007
            
            
            42,500
            
            
            $
            1.74July
                9, 2007
            
            
            37,000
            
            
            $
            4.60August
                31, 2007
            
            
            37,400
            
            
            $
            3.92




-
          8
          -


The
      securities were issued exclusively to our directors, executive officers,
      employees and consultants. The issuance of options and the shares of common
      stock issuable upon the exercise of such options as described above were issued
      pursuant to written compensatory plans or arrangements with our employees,
      directors and consultants, in reliance on the exemption provided by
      Rule 701 promulgated under the Securities Act, or, for securities issued
      after our initial public offering, the exemptions from the registration
      provisions of the Securities Act set forth in Section 4(2) thereof relative
      to
      sales by an issuer not involving any public offering, to the extent an exemption
      from such registration was required.




Our
      initial public offering of common stock was completed through our Registration
      Statement on Form SB-2, Commission file number 333-139298, that was declared
      effective by the Securities and Exchange Commission on June 28, 2007. Our
      initial public offering commenced on June 29, 2007 and closed on July 5,
      2007.  Pursuant to our initial public offering we registered a total
      of 3,000,000 shares of common stock, with an aggregate offering price of
      $15,000,000.  In addition, we granted the underwriters an option to
      purchase an additional 450,000 shares of common stock, with an aggregate
      offering price of $2,250,000.  We sold a total of 3,200,000 shares of
      common stock at an initial public offering price of $5.00 per share, including
      200,000 shares of common stock purchased as part of the over-allotment option,
      for an aggregate offering price of $16,000,000.  The managing
      underwriting in our initial public offering was Joseph Gunnar & Co.,
      LLC.




We
      received net proceeds from the offering of approximately $13.5 million,
      after deducting the underwriting discount and other offering costs. Since the
      closing of our initial public offering on July 5, 2007, we have used net
      proceeds from our initial public offering as follows: $2.8 million to repay
      outstanding debt, $4.2 million to complete the acquisitions of Objectware,
      Inc.
      and Purple Monkey Studios, Inc. and the remainder for working capital and other
      general corporate purposes, which may include acquisitions of other
      businesses.




No
      offering expenses were paid directly or indirectly to any of our directors
      or
      officers (or their associates) or to any persons owning ten percent or more
      of
      any class of our equity securities or to any other affiliates






**Item
      6.    Management’s Discussion and Analysis or Plan of
      Operation**





*This
      section contains forward-looking statements that involve risks and
      uncertainties. Our actual results could differ materially from those anticipated
      in the forward-looking statements as a result of a variety of factors and risks
      including  our limited operating history, our history of operating
      losses, our ability to continue to grow sales, the acceptance of our products,
      our ability to deliver services efficiently, growing competition, our ability
      to
      find, make and efficiently integrate acquisitions, our ability to leverage
      our
      existing cost structure as acquisitions are completed and our dependence on
      our
      management team and key personnel.  These and other risks are more
      fully described in our Registration Statement on Form SB-2 dated June 28, 2007
      and our other filings with the Securities and Exchange
      Commission.*





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





Overview:





Founded
        in 2000, Bridgeline Software, Inc. (Bridgeline or the Company) is a developer
        of
        web application management software and award-winning web applications that
        help
        organizations optimize business processes.  Our software and services
        are designed to assist customers in maximizing revenue, improve customer
        service
        and loyalty, enhance employee knowledge, and reduce operational costs by
        leveraging web based technologies.





Our
        internally developed web application management software products (iAPPS®and OrgitectureTM)
        are SaaS (software as a service) solutions that unify Content Management,
        Analytics, eCommerce, and eMarketing capabilities; enabling users to enhance
        and
        optimize the value of their web properties. Combined with award-winning web
        application development services, Bridgeline helps customers cost-effectively
        accommodate the changing needs of today’s websites, intranets, extranets, and
        mission-critical web applications.





We
        have a
        team of Microsoft®-certified
        developers that specialize in end-to-end web application development,
        information architecture, usability engineering, SharePoint development,
        rich
        media development, search engine optimization, and fully-managed application
        hosting.


-
            9
            -


Our
        marketing and selling efforts focus on medium-sized business and large business.
        These businesses are typically in five vertical markets:  Financial
        services, life sciences, high technology, foundations, and government
        agencies.  We have five geographic specific locations in the United
        States that have professional direct sales management in each
        location.  They are in the Atlanta area, Boston area, Chicago area,
        New York area, and Washington DC area.
  In
        2007,
        approximately 66% of our customer base paid Bridgeline Software a monthly
        subscription fee or a monthly managed service fee.  In 2007
        approximately 62% of our total revenue was from existing customers demonstrating
        a deep customer traction model.   The majority of our revenue in
        2007 was driven from our web application development
        services.





Bridgeline
      Software plans to expand its distribution of iAPPS® and its
      web
      application development services throughout North America.  Due to the
      high-touch nature of our sales process and delivery requirements, we believe
      local staff is required in order to maximize market-share results.





We
      believe the Web application development market in North America is growing
      and
      is fragmented. We believe established yet small Web application development
      companies have the ability to market, sell and install our iAPPS®Framework
      and web
      application management software in their local metropolitan
      markets.  In addition, we believe these companies also have a customer
      base and a niche presence in the local markets in which they operate. We believe
      there is an opportunity for us to acquire multiple companies that specialize
      in
      Web application development and are based in other large North American
      cities.  We believe that by acquiring certain of these geographic
      specific companies and applying our business practices and efficiencies, we
      can
      accelerate our time to market in areas other than those in which we currently
      operate.





Our
      expansion strategy led us to the recent acquisitions of Objectware in Atlanta
      and Purple Monkey Studios in Chicago.  We now have a geographical
      presence in five areas in the United States and expect to make additional
      expansion acquisitions over the next twelve months.





The
      fourth quarter of fiscal 2007 marked yet another milestone for
      Bridgeline.  We achieved sales of $4.1 million during the quarter, a
      record quarter in sales volume.  We achieved net income of $23
      thousand for the quarter ended September 30, 2007.  In addition, we
      achieved record earnings before interest, taxes, depreciation and amortization
      (“EBITDA”) and before stock compensation of $294 thousand.  A
      reconciliation of net Income to EBITDA for the fiscal year is included below
      under Results of Operations.  This improved performance came during a
      year in which we completed two acquisitions and started the integration of
      each
      while our existing business experienced growth in sales.  A more
      detailed discussion is contained below.  This fourth quarter
      performance helped contain our operating loss to $1.9 million in fiscal 2007
      when compared to a $1.4 million loss in fiscal 2006.





There
      are
      a number of items that affect the comparison of fiscal 2007 to
      2006.  These items include:




·
            We
                completed the acquisition of Objectware on July 5, 2007.  The
                results for fiscal 2007 include approximately three months of results
                from
                this acquisition.


·
            We
                completed the acquisition of Purple Monkey Studios on August 31,
                2007.  The results for fiscal 2007 include one month of results
                from this acquisition.


·
            We
                completed the acquisition of New Tilt in April 2006.  The fiscal
                2007 results contain a full year of results from this acquisition
                as
                compared to five months in fiscal
                2006.


·
            We
                completed our initial public offering in June
                2007.


·
            During
                fiscal 2006 and 2007, we incurred additional debt to support operations
                that resulted in increased interest expense. We repaid this debt
                with
                proceeds from our public offering.


·
            We
                increased our research and development costs to develop our iAPPS®
                Framework
                product during fiscal 2007.  We launched iAPPS®framework
                in
                August 2007 and we launched the first software module, iAPPS®
                Content
                Manager, in October 2007.








-
          10
          -


We
      regularly monitor a number of key metrics including revenue, gross profit
      margins, and expenses as a percentage of revenue and EBITDA (as defined
      above).   We also monitor and evaluate bookings.





**Results
      of Operations**


2007
            
            
            2006
            
            
            Change
                $
            
            
            Change
                %Total
                revenue
            
            $
            11,151
            
            
            $
            8,235
            
            
            $
            2,916
            
            
            
            35%Gross
                profit margin
            
            
            6,131
            
            
            
            4,426
            
            
            
            1,705
            
            
            
            39%Loss
                from operations
            
            
            (1,006
            )
            
            
            (810
            )
            
            
            (196
            )
            
            
            24%Net
                loss
            
            $
            (1,897
            )
            
            $
            (1,448
            )
            
            $
            (449
            )
            
            
            31%EBITDA
            
            $
            (239
            )
            
            $
            (505
            )
            
            $
            266
            
            
            
            53%





EBITDA
      Reconciliation:


2007
            
            
            2006Net
                loss
            
            $
            (1,897
            )
            
            $
            (1,448
            )Plus:Interest
                expense
            
            
            924
            
            
            
            638Depreciation
            
            
            158
            
            
            
            119Amortization
            
            
            244
            
            
            
            186Stock
                Compensation
            
            
            332
            
            
            
            −EBITDA
            
            $
            (239
            )
            
            $
            (505
            )




Revenue:


Overall,
      revenue increased $2.9 million, or 35%, when compared to the same period one
      year earlier.  Acquisitions accounted for $1.5 million of this
      increase.  Excluding acquisitions, sales increased $1.4 million, or
      17%.   Over 50% of our revenue came from existing customers,
      while the remainder came from new customers.  A detailed discussion of
      revenue is below.





Gross
      Profit Margin:


Gross
      profit margins were largely unchanged at 55% of sales, compared to 54% in the
      fiscal 2006.  Our margins are impacted by several
      factors.  Our largest expense is our cost of direct
      labor.  To supplement full time staff, we utilize outside contractors
      from time to time.  In addition, our revenue is primarily from
      services.  As such, billable hours are an important factor that
      impacts our gross profit margin.  We use measures such as billable
      utilization to monitor this factor.  A discussion of gross margin by
      revenue source follows.





**Sources
      of Revenue:**


Revenue:
            
            2007
            
            
            2006
            
            
            Change
                $
            
            
            Change
                %Web
                development services
            
            $
            8,659
            
            
            $
            6,525
            
            
            $
            2,134
            
            
            
            33%Managed
                services
            
            
            2,050
            
            
            
            1,243
            
            
            
            807
            
            
            
            65%Subscriptions
            
            
            442
            
            
            
            467
            
            
            
            (25
            )
            
            
            (5)%Total
            
            $
            11,151
            
            
            $
            8,235
            
            
            $
            2,916





Web
      Development Services :


Revenue
      from web services increased $2.1 million, a 33% improvement from fiscal
      2006.  Acquisitions of Objectware, Inc. and Purple Monkey Studios,
      Inc. accounted for $1.2 million of the increase.  Excluding these
      acquisitions, revenue increased $900 thousand.  Our growth came in a
      number of industries and customers.  First, revenue from existing
      customers accounted for more than 45% of the fiscal 2007 web development
      services.  We achieved a record year in sales, with sales from new
      customers of approximately $2.6 million in the current year.  Revenue
      from existing customers decreased by approximately $1.8 million when compared
      to
      the same period one year earlier.  This decrease came from primarily
      three customers, whose needs vary by year.  One customer, Nomura
      Securities, had the largest decrease year over year.  This customer
      represented 15% of our total revenues during fiscal 2007.  We believe
      that our business with this customer will decrease in future years, primarily
      due to changes in the needs of the customer and our overall revenue
      growth.  Although this customer has been a significant part of our
      revenue in the past, the combination of new customers and acquired customers
      are
      expected to be more than sufficient to replace the revenue that may be lost
      from
      this customer.   From an industry perspective, we have continued
      to see broad penetration of our services into multiple
      industries.  Our strongest presence is in the life sciences, financial
      services, high technology and non profit industries.  Of the revenue
      growth from new customers, life sciences contributed $625 thousand; financial
      services contributed $842 thousand; high technology contributed $533 thousand
      and non profit customers contributed $214 thousand.  The remaining
      growth came from several other industries.





Managed
      Services:


Revenue
      from managed services increased $807 thousand, or 65% from the prior
      year.  Acquisitions accounted for $367 thousand of this
      increase.  Excluding acquisitions, managed services increased $440
      thousand.  The majority of this growth came from one
      customer.  During the current year, this customer’s need shifted from
      web services to managed services, increasing revenues more than 75% from the
      levels in the prior year.  Excluding this one customer, managed
      services were largely unchanged from the prior year.  Several new
      engagements were won during the year, the benefit of which will be seen in
      fiscal 2008.  The revenue from the one major customer is expected to
      decrease in fiscal 2008 largely due to the customer’s needs
      changing.  With recent acquisitions and new engagements, we do not
      believe that the potential loss of revenue from this customer will be
      significant to our results in fiscal 2008.





-
          11
          -


Subscriptions:


Revenue
      from subscriptions decreased slightly from the prior year level by $25 thousand,
      or 5%.  This decrease is largely due to the loss of five customers
      during fiscal 2007, resulting in a decrease of $23 thousand when compared to
      the
      same period. Otherwise, revenue from subscriptions was largely unchanged from
      the prior year levels.





**Gross
      Profit**


2007
            
            
            2006
            
            
            Change
                $
            
            
            Change
                %Web
                development services
            
            $
            4,101
            
            
            $
            3,136
            
            
            $
            965
            
            
            
            31%Managed
                services
            
            
            1,614
            
            
            
            880
            
            
            
            734
            
            
            
            83%Subscriptions
            
            
            416
            
            
            
            410
            
            
            
            6
            
            
            
            1%Total
            
            $
            6,131
            
            
            $
            4,426
            
            
            $
            1,705





Web
      Development Services :


Gross
      profit from web services increased by $965 thousand, or 31%.  This
      represents a 48% gross profit margin in fiscal 2007, consistent with margins
      achieved in fiscal 2006.  This increase in dollars is attributable
      largely to the increase in sales.  Our Web Development
      Services  are primarily driven by salaries and wages and outside
      contractor costs.  Web Development Services  revenue is
      driven by the number of billable hours on a project.  Thus, the
      increased revenue will generally correspond with a similar increase in costs
      and
      margins.  Margin improvements come from efficiency on engagements
      where the fee is fixed or when billable hours increases without an increase
      in
      headcount.  Margin improvements can also come from increased hourly
      rates at a rate greater than the increase to costs.  To encourage this
      behavior, we use incentive plans that award those performing web services when
      their billable hours exceed stated goals.  Our workforce is largely
      salaried and as such, increases in billable hours do not result in significant
      increases to our cost basis.  We believe that this and other similar
      programs will help to improve margins further in subsequent years.





Managed
      Services:


Gross
      profit increased by $734 thousand, or 83%.  This represents a 79%
      gross profit margin for fiscal 2007, compared to a gross profit margin of 71%
      in
      fiscal 2006.   The improvement in margins is primarily due to the
      increased revenues and cost containment measures taken to reduce
      costs.  Costs for managed services include the cost of operating our
      network operation centers (NOCs).  As of September 30, 2007, we have
      two NOCs operational.  One of those NOCs was part of the acquisition
      of OW during fiscal 2007.  Prior to that acquisition, we operated one
      NOC for the majority of the fiscal year.  Our costs associated with
      the NOC largely include the facility charges for each location.  Our
      current facilities have capacity and can be expanded with our growth in revenue
      without adding substantial costs.  This allows margins to improve as
      we continue to grow this revenue source.  Our other costs for managed
      services include wages for retained professional services.  Margin
      improvements in retained professional services are achieved when the amount
      of
      services is below the estimated levels included in the “use it or lose it”
agreements.





Subscriptions:


Gross
      profits from subscriptions were largely unchanged in dollars, increasing $6
      thousand or 1% from the prior year.  In fiscal 2007, gross profit
      margins were 94%, compared to 88% in fiscal 2006.  Costs for the
      subscription revenue include a shared of the cost of our NOCs and costs to
      maintain the software product.  During fiscal 2007, we shifted much of
      our efforts from maintaining the current on-demand software product sold through
      subscriptions to the development of our new product, iAPPS.  As such,
      costs associated with maintaining the product decreased.  In addition,
      we consolidated two NOCs early in the fiscal year, reducing the cost of hosting
      for the subscription revenues.





**Loss
      from Operations**





Included
      in the loss from operations are costs for sales and marketing, general and
      administrative expenses, technology development expenses and depreciation and
      amortization expense.  Overall, loss from operations increased $196
      thousand, or 24%.  This increased loss from operations is attributable
      to several factors.  In fiscal 2007, we adopted SFAS No. 123R in
      accounting for stock compensation.  The Company recognized $332
      thousand in stock compensation, of which $242 thousand was included in operating
      expenses.  In addition, we increased our spending on technology
      development by $615 thousand.  This represents over three times the
      spending level in fiscal 2006.  These increases in costs were offset
      by our ability to leverage the existing infrastructure, including sales and
      marketing, finance and human resources, while supporting the growth in revenue.
      A brief discussion of each component follows.





Sales
      and
      Marketing Expenses:


Sales
      and
      marketing expenses increased $261 thousand, or 8%, when compared to fiscal
      2006.  We look at sales and marketing as a percentage of
      sales.  For fiscal 2007, sales and marketing represented 31% of sales,
      compared to 39% in fiscal 2006.  The improvement as a percentage of
      sales is largely due to our ability to leverage our existing infrastructure
      as
      sales increase.  We have established a number of incentives and goals
      for each salesperson to encourage this behavior.  We believe that the
      increased sales volume and our current sales run rate will allow this percentage
      to continue to decrease into fiscal 2008. On an absolute dollars basis, the
      increase in sales and marketing expenses is largely due to increased marketing
      expenses and increased sales force headcount in fiscal 2007.  During
      fiscal 2007, we attended and sponsored
      a number of seminars and conferences, adding to the marketing expenses when
      compared to fiscal 2006.  The remaining increase in marketing expenses
      is due to the increase in headcount in marketing. Other sales expenses increased
      as a result of the increased sales, such as commissions.





-
          12
          -


General
      and Administrative Expenses:


General
      and administrative expenses increased $843 thousand, or 51%, when compared
      to
      the same period in fiscal 2006.  This increase is due to several
      factors.  In Fiscal 2007, we adopted SFAS No. 123R in accounting for
      stock compensation.  This resulted in the recognition of $242 thousand
      in additional general and administrative expense when compared to fiscal
      2006.  In addition, our payroll expenses increased due to increased
      headcount at our corporate offices.  We hired additional personnel
      during fiscal 2007 primarily in our accounting function when compared to fiscal
      2006.  As of September 30, 2007, we believe that there are limited
      needs to hire additional personnel in corporate and that the infrastructure
      can
      absorb additional acquisitions without additional personnel.  Total
      payroll increased in fiscal 2007 by $570 thousand.





Technology
      Development:


Expenses
      for technology and development increased $615 thousand in fiscal 2007 or more
      than three times the same level as fiscal 2006.  The increased
      spending during fiscal 2007 was incurred to develop our new on-demand software
      product, iAPPS Framework.  In addition to the development the iAPPS
      Framework, we also spent funds on the development of the various modules,
      including iAPPS Content Manager.  We anticipate spending additional
      amounts in fiscal 2008 as we continue to develop and launch the remaining
      modules during the fiscal year.  The majority of our spending is in
      our India location.  We believe that the quality of the developers
      coupled with the cost factors, has allowed us to spend considerably less than
      if
      this product has been developed solely in the U.S.  We believe that
      the cost would have been more than five times that cost had we not used our
      India personnel.





Depreciation
      and Amortization:


The
      increase in depreciation and amortization of $182 thousand during fiscal 2007,
      a
      97% increase, is largely attributable to the additional depreciation and
      amortization expense associated with acquisitions.  In April 2006, we
      made one acquisition.  The current year includes a full year of
      depreciation and amortization associated with the assets acquired as compared
      to
      five months in fiscal 2006.  During the current year, we made two
      acquisitions and began depreciating and amortizing the acquired
      assets.  This resulted in an increase of $75 thousand to amortization
      and depreciation expense when compared to fiscal 2006.  In addition,
      during fiscal 2007 we invested in equipment for our NOCs.  As a
      result, depreciation associated with our NOCs increased $67 thousand when
      compared to fiscal 2006.  The remaining increase is attributable the
      timing of fixed asset expenditures.





**Liquidity
      and Capital Resources**





We
      have
      historically funded our operations principally through issuances of equity
      and
      short-term debt.  We believe that our operations will generate
      positive cash flows as our revenues increase. During fiscal 2007, our operations
      used $1.0 million in cash, compared to $733 thousand in fiscal
      2006.  The additional cash used is primarily attributable to the
      increased losses in fiscal 2007 when compared to fiscal 2006.  In June
      2007, we completed our initial public offering, raising approximately $13.5
      million in net proceeds. We used these proceeds to repay the outstanding debt,
      including the private placement financing of $2.8 million and to make two
      acquisitions. We also used cash to fund capital expenditures of $457 thousand
      and contingent acquisition payments of $455 thousand.   As of
      September 30 2007, we have $5.2 million in cash available for
      operations.





We
      have
      incurred annual losses since commencement of operations in 2000 and have used
      a
      significant amount of cash to fund our operations over the last several years.
      As a result, we have an accumulated deficit of $6.1 million at September 30,
      2007.





As
      of
      September 30, 2007, as part of acquisitions completed, we have remaining
      contingent acquisition obligations to the prior entities’ shareholders which are
      to be paid in cash up to a maximum of $983 thousand, $775 thousand and $608
      thousand for the fiscal years ending September 30, 2008, 2009, and 2010,
      respectively, provided that the contingent results are
      achieved.   The contingent acquisition obligations are based
      primarily on the achievement of positive EBITDA, as defined in the acquisition
      agreements.





***Cash
      Flows***




*Working
      Capital*




At
      September 30, 2007, we had working capital of $5.9 million.  We
      define working capital as current assets less current liabilities.  We
      had receivables of $2.9 million. This compares to $810 thousand in
      receivables at September 30, 2006. The level of trade receivables at
      September 30, 2007 and September 30, 2006 represented approximately 64 and
      45 days of revenues, respectively. Our receivables can vary dramatically due
      to
      overall sales volumes, the timing of implementation
      of services, receipts from large customers, and other contract payments.
      Unbilled receivables at September 30, 2007 decreased $278 thousand from
      September 30, 2006 principally due to the timing of billing in accordance with
      stated contract terms.




-
          13
          -


*Investing
      Activities*




Net
      cash
      used in investing activities was $5.1 million in fiscal 2007, compared to $842
      thousand in fiscal 2006.  In fiscal 2007, we used $4.2 million in cash
      for the acquisitions of OW and PM, an increase of approximately $3.7 million
      when compared to 2006.  We also spent $457 thousand in capital
      expenditures.  During fiscal 2007, we invested in our network
      operation centers to support the existing software as a service business and
      to
      position the network operation centers for future growth with the introduction
      of iAPPS.  The remaining cash was expended on contingent acquisition
      obligations, totaling $455 thousand.




*Financing
      Activities*





Net
      cash
      provided by financing activities was $10.7 million for fiscal 2007, compared
      to
      $2.0 million in fiscal 2006.  As noted above, the Company completed an
      initial public offering of equity securities that raised $13.5
      million.  We used some of these proceeds to repay existing
      debt.





***Capital
      Resources and Liquidity Outlook***




We
      believe that our operations will generate positive cash flows sufficient to
      cover any requirements for capital expenditures during fiscal
      2008.  We believe that cash requirements for capital expenditures will
      be approximately $500 thousand during fiscal 2008.  We believe
      operating cash flows will be used to fund these expenditures.  Funds
      required for acquisitions, if any, will be funded from the remaining cash flows
      from operations and existing working capital.





***Inflation***





We
      believe that the relatively moderate rates of inflation in recent years have
      not
      had a significant impact on our operations.  Inflationary increases
      can cause pressure on wages and the cost of benefits offered to
      employees.  We believe that these increases to date 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 other than our operating leases and
      contingent acquisition payments disclosed below.





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.





***Contractual
      Obligations***





We
      lease our facilities in the United States and
      India.  Our other contractual 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
      September 30, 2007:





**(in
      thousands)**


**FY
                08**
            
            **FY
                09**
            
            **FY
                10**
            
            **FY
                11**
            
            **FY
                12**
            
            **Totals****Payment
                Obligations by Year**Operating
                leases (A)
            
            
            $ 
                  698
            
            $   
                505
            
            $
                   440
            
            $   340
            
            $     
                —
            
            $ 1,983Capital
                lease obligations
            
            
            102
            
            75
            
            48
            
            35
            
            10
            
            270Contingent
                acquisition payments (B)
            
            
            1,232
            
            1,150
            
            750
            
            —
            
            —
            
            3,132Total
            
            
            $
                2,032
            
            $
                1,730
            
            $ 1,238
            
            $   375
            
            $      10
            
            $
                5,385





(A)
            Net
                of sublease income


(B)
            The
                contingent acquisition payments are maximum potential earn-out
                consideration payable to the former owners of the acquired
                companies.  Amounts actually paid may be
                less.





-
          14
          -


**Critical
      Accounting Policies**





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 include 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.





*A**llowance
      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 allowances are
      adequate, if the financial condition of our clients deteriorates, resulting
      in
      an impairment of their ability tomake 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 three activities: Web Development Services , Managed Services,
      and Subscriptions.  We recognize revenue in accordance with
      Securities and Exchange Commission Staff Accounting Bulletin No.104,*Revenue
      Recognition in Financial Statements* (“SAB 104”), Emerging Issues Task Force
      Issue No. 00-21,*Accounting For Revenue Arrangements with Multiple
      Deliverables* (“EITF 00-21”), and American Institute of Certified
      Public Accountants Statement of Position No. 97-2,*Software Revenue
      Recognition* (“SOP 97-2”) and related interpretations. Revenue is
      recognized when all of the following conditions are satisfied: (1) there is
      persuasive evidence of an arrangement; (2) delivery has occurred or the
      services have been provided to the customer; (3) the amount of fees to
      be paid by the customer is fixed or determinable; and (4) the collection of
      the fees is reasonably assured. Billings made or payments received in
      advance of providing services are deferred until the period these services
      are
      provided.




***Web
      Development Services***




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





For
      Web
      Development Services  engagements sold on a stand alone basis, revenue
      is recognized in accordance with SAB 104.  Web Development Services
      are contracted for on either a fixed price or time and materials
      basis.  For its fixed price engagements, we apply
      the proportional performance model to recognize revenue based on cost
      incurred in relation to total estimated cost at completion. We have
      determined that labor costs are the most appropriate measure to allocate revenue
      among reporting periods, as they are the primary input when providing Web
      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.





-
          15
          -


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





Sales
      of
      perpetual licenses for our software products and related post-contract customer
      support (“PCS”) are included in Web Development
      Services.  Revenues derived from perpetual license sales have been
      insignificant in all periods presented (representing less than 2% of Web
      Development Services revenues).




***Managed
      Services***




Managed
      Services include retained professional services and hosting
      services.





Retained
      professional services are either contracted for on an “on call” basis or for a
      certain amount of hours each month. Such arrangements generally provide for
      a guaranteed availability of a number of professional services hours
      each month on a “use it or lose it” basis.   For retained
      professional services sold on a stand-alone basis, revenue is recognized in
      accordance with SAB 104.  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.





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





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





***Subscriptions***




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





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





***Multiple
      Element Arrangements***




As
      described above, Web Development Services are often sold as part of multiple
      element arrangements.  Such arrangements may include delivery of
      a perpetual license for our software products at the commencement of a Web
      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 EITF 00-21 and, as described
      further below, have concluded that each element can be treated as a
      separate unit of accounting.





-
          16
          -


When
      Web
      Development Services engagements include a perpetual license for our
      software products, we have concluded that the Web Development Services and
      the
      perpetual license are separate units of accounting as each has stand-alone
      value
      to the customer and we have established vendor specific objective evidence
      (VSOE) of fair value for the
      software and objective and reliable third party evidence of fair value for
      the Web Development Services.  In such arrangements, the perpetual
      license is the delivered element and the Web Development Services, and any
      PCS are the undelivered elements.  We recognize revenue from perpetual
      licenses and related PCS in accordance with SOP 97-2 and recognize revenue
      from
      Web Development Services following the proportional performance model as
      described above.  The amount of revenue to be recognized upon delivery
      of the software is determined using the residual method whereby the value
      ascribed to the delivered element (i.e., the product license) is equal to the
      total consideration of the multiple element arrangement less the third
      party evidence of fair value of the undelivered elements (i.e., Web Development
      Services and, if applicable, PCS).





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





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





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





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





***Customer
      Payment Terms***





Our
      payment terms with customers typically are “net 30 days from invoice”.
 Payments terms may vary by customer but in generally do not exceed 45 days
      from invoice date. For Web Development Services, we typically invoice
      project deposits of between 20% and 33% of the total contract value which we
      record as deferred revenue until such time the related services are
      completed. Subsequent invoicing for Web Development Services is either monthly
      or upon achievement of milestones and payment terms for such billings are
      within the standard terms described above. Invoicing for subscriptions
      and hosting are typically issued monthly and are generally due upon invoice
      receipt. Our 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, we have 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 generally between 30 to 90 days from
      the
      completion of work. In hosting arrangements, we may provide warranties of
      up-time reliability. 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 related cost to satisfy the
      warranty obligation is estimated and accrued. Warranty claims to date have
      been
      immaterial.





***Reimbursable
      Expenses***




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




-
          17
          -


*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 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*




At
      September 30, 2007, we maintained two stock-based compensation plans which
      are
      more fully described in Note 9.





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





Through
      September 30, 2006, we accounted for stock compensation awards under the
      provisions of SFAS 123, as amended by SFAS No. 148,*Accounting
      for* *Stock-Based Compensation--Transition and Disclosure*
      (“SFAS 148”). As permitted by SFAS 123, for all periods through
      September 30, 2006, we measured compensation cost in accordance
      with Accounting Principles Board Opinion No. 25,*Accounting for
      Stock Issued to Employees* (“APB 25”) and related interpretations using
      the intrinsic value method and following the disclosure-only provisions of
      SFAS
      123.





Under
      the
      intrinsic value method, compensation expense is determined at the measurement
      date, generally the date of grant, as the excess, if any, of the estimated
      fair value of our common stock (the “Stock Price”) and the exercise
      price, multiplied by the number of options granted. Generally, we grant
      stock options with exercise prices equal to or greater than the Stock
      Price; however, to the extent that the Stock Price exceeds the exercise price
      of
      stock options on the date of grant, we record stock-based compensation
      expense using the graded vested attribution method over the vesting schedule
      of
      the options, which is generally three years.




-
          18
          -


Prior
      to
      June 28, 2007, there had been no public market for our common stock to observe
      its Stock Price on award grant dates. Therefore, for purposes of applying
      the intrinsic value method, management estimated the stock price based on the
      American Institute of Certified Public Accountants Practice Alert No.
      00-1,*Accounting for Certain Equity Transactions*. The estimated
      fair value of the common stock on the date of grant was based on weighing a
      variety of different quantitative and qualitative factors including, but
      not limited to, our financial position, an evaluation of our competition, the
      economic climate in the marketplace, the illiquid nature of the common
      stock, contemporaneous and anticipated private sales of the common stock, and
      our analysis of the trading prices of a peer group of comparable public
      companies.




Prior
      to
      our initial public offering, we had a policy whereby, when issuing stock options
      or warrants, the fair value of the underlying common stock would be based
      on valuations prepared by management.  Management performed internal
      valuations (“Level C”, as defined in the AICPA Audit and Accounting Aid
      Series, “*Valuation of Privately-Held-Company
      Equity****Securities Issued as Compensation*”) to
      determine the fair value of the
      stock.  Management utilized market data from a
      third party in developing our valuation methodology and
      models.





Determining
      the fair value of our stock required making complex and subjective
      judgments.  Our approach to valuation was based on several
      factors.  Since August 1, 2005 and up to our initial public offering,
      we did not complete any private placement sales of our common stock, and
      accordingly, we used an approach to valuation based on a weighted average of
      enterprise value as determined using three customary valuation techniques:
      the
      discounted cash flow method, the market approach, and the guideline public
      company method.  We believe that due to our size, continued operating
      losses, a business plan highly dependent on future acquisitions, and our limited
      ability to raise the capital for such acquisitions, that a weighted average
      of
      these three techniques was the most reasonable approach to the valuation of
      our
      stock.  Management's weighting of the three techniques is
      subjective. We believe, however, that the enterprise value derived using
      the public company guideline approach was most representative of our business
      and, therefore, we have applied the highest weighting to this factor in all
      periods.  We applied a lower weighting to the results derived
      from the discounted cash flow method because the cash flows used in this method
      were based on future events with varying degrees of uncertainty. We increased
      the weighting on this factor slightly during the nine-month period ended
      June 30, 2007 as we deemed current estimates of cash flow to be more
      predictable and achievable.  We applied the lowest rating to the
      results of the market approach because this technique depends on analyses of
      mergers and acquisitions of comparable entities and there have been a relatively
      small number of such transactions to analyze.





The
      changes in the fair value of our common stock at the date of stock option grants
      is principally attributable to the changes in our estimates of earnings and
      revenues during the applicable periods, and the accretive effect of such changes
      when applying the weighted values of the three valuation techniques
      utilized.  The slight increase in the weighting applied to the
      discounted cash flow method described above did not have significant effect
      on
      the per share enterprise value determined for that period.




Under
      the
      discounted cash flow method, since we are an emerging growth company with a
      business plan highly dependent on acquisitions, estimates of revenue, market
      growth rates and costs are used when applying the appropriate discount
      rates.  Discount rates utilized in our analyses ranged from 35% to 21%
      based on a capital asset pricing model (“CAPM”) which considered factors such as
      risk-free rate of return, an equity risk adjustment, the beta for companies
      in
      our SIC code (7372), and a size discount due to our limited revenues. The
      difference in the discount rates applied is attributable to changes in the
      above
      factors that comprise the rate, which factors are updated annually. A higher
      discount rate is used for periods from August 2005 to September 2006 based
      on
      management's forecast of rapid growth in revenues and earnings based on
      future events with varying degrees of uncertainty.  Management
      determined that a 13% forecasting uncertainty factor should be added to the
      discount rate computed using the CAPM.  The financial estimates we
      used are consistent with the plans and estimates that we use to manage our
      business. We complete a five-year business plan each fiscal year, which plans
      are updated semi-annually.  We believe a five-year outlook is
      consistent with the long-term business cycle of the Web Development Services
      industry.  However, there is inherent uncertainty in making these
      estimates and based on historical significant differences between prior
      forecasts and prior actual results, we applied a lower weighting to the
      enterprise value determined using the discounted cash flow method.





Under
      the
      market approach and guideline public company method, we evaluated a variety
      of
      financial ratio metrics to determine the value multiples to be utilized in
      our
      valuation models, including price-to-cash flow, price-to-earnings, market value
      of invested capital (“MVIC”)-to-earnings before interest and taxes
      (“EBIT”),MVIC-to-EBITDA, price-to-assets and MVIC-to-revenue.  After
      evaluating these metrics, we believe, since we have incurred losses
      historically, and since a number of comparable companies in our analyses have
      also reported losses, that the most appropriate multiple to apply is
      MVIC-to-revenues.  This is the ratio used in our valuation model under
      the market approach and guideline public company method.





-
          19
          -


Under
      the
      market approach, we evaluated merger and acquisition transactions involving
      comparable public and private companies to determine our enterprise value using
      estimated revenues and applying the comparable multiple derived from such
      transactions. We used data provided by a third party database to evaluate recent
      merger and acquisition transactions.  We qualified our selection to
      only include those transactions within SIC code 7372, then we limited those
      transactions to Internet related companies and then further refined our
      selection to those entities within the Web Development Services industry that
      had revenues and total asset size most comparable to ours. Since our revenues
      are considerably lower and we have incurred losses since inception in relation
      to the comparable group, we apply the lowest weighting to the enterprise value
      derived using the market approach.





The
      final
      technique utilized in our analysis is the guideline public company method.
      We
      used data provided by a third party for ten comparable publicly traded
      companies. We qualified our selection of comparable public companies to only
      include those companies within SIC code 7372, then we limited the selection
      to
      only internet related companies and then further refined our selection to those
      companies within the Web Development Services industry.  Due to our
      relatively small size, continued operating losses and the high risks associated
      with our forecasted revenue growth through acquisitions, we determined our
      enterprise value by multiplying our rolling twelve months sales by the
      MVIC-to-revenues ratio applicable to those companies in the statistical 10thpercentile
      (on a
      scale of 100%).  Since revenue growth is dependent on raising large
      amounts of capital, we believe it results in a higher risk and therefore
      conclude that a 10th percentile
      MVIC-to-revenues ratio is reasonable to apply in our model.  We
      believe that a value market multiple of comparable public companies based on
      MVIC-to-revenues provides an objective basis for measuring our fair market
      value. Accordingly, we placed the highest weighting on this factor in our
      analysis.





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





We
      used
      the per share enterprise value determined above as an input to the
      Black-Scholes-Merton option valuation model in determining stock-based
      compensation, or if applicable, pro forma stock-based
      compensation.  For fiscal 2007, had the Company used different
      assumptions, the results of the stock compensation would not be materially
      different.  The most sensitive of theses assumptions is
      volatility.  Had the Company used a volatility 500 basis higher or
      lower than the current estimates, the related stock compensation could increase
      or decrease by as much as $55 thousand over the life of options granted in
      the
      current year.





***Recent
      Accounting Pronouncements***




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




-
          20
          -


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





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




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





In
      December 2007, the FASB issued SFAS 141R, *Business Combinations* (“SFAS
      141R”), which replaces FASB SFAS 141, *Business Combinations.*This
      Statement retains the fundamental requirements in SFAS 141 that the acquisition
      method of accounting be used for all business combinations and for an acquirer
      to be identified for each business combination. SFAS 141R defines the acquirer
      as the entity that obtains control of one or more businesses in the business
      combination and establishes the acquisition date as the date that the acquirer
      achieves control.  SFAS 141R will require an entity to record
      separately from the business combination the direct costs, where previously
      these costs were included in the total allocated cost of the
      acquisition.  SFAS 141R will require an entity to recognize the assets
      acquired, liabilities assumed, and any non-controlling interest in the acquired
      entity at the acquisition date, at their fair values as of that
      date.  This compares to the cost allocation method previously required
      by SFAS No. 141.  SFAS 141R will require an entity to recognize as an
      asset or liability at fair value for certain contingencies, either contractual
      or non-contractual, if certain criteria are met.  Finally, SFAS 141R
      will require an entity to recognize contingent consideration at the date of
      acquisition, based on the fair value at that date.  This Statement
      will be effective for business combinations completed in or after the first
      annual reporting period beginning on or after December 15,
      2008.  Early adoption of this standard is not permitted and the
      standards are to be applied prospectively only.  Upon adoption of this
      standard, there will be no impact to the Company’s results of operations and
      financial condition for acquisitions previously completed.  The
      adoption of this standard will impact any acquisitions completed by the Company
      in our fiscal 2010.

























-
          21
          -


**Item
      7.    Financial Statements**






***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, 2007 and 2006, 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. An audit also includes
      assessing the accounting principles used and significant estimates made by
      management, as well as evaluating the overall financial statement presentation.
      We believe that our audits provide a reasonable basis for our
      opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Bridgeline Software, Inc.
      as
      of September 30, 2007 and 2006, 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
      19, 2007


Boston,
      Massachusetts








-
          22
          -


**BRIDGELINE
      SOFTWARE, INC.**


**CONSOLIDATED
      BALANCE SHEETS**


(Dollars
      in thousands, except per share data)









**ASSETS**
            
            **September
                30,****2007**
            
            
            **2006**Current
                assets:Cash
                and cash equivalents
            
            $
            5,219
            
            
            $
            591Accounts
                receivable (less allowance for doubtful accounts of $101 and $52,
                respectively)
            
            
            2,892
            
            
            
            810Unbilled
                receivables
            
            
            355
            
            
            
            633Prepaid
                expenses and other current assets
            
            
            192
            
            
            
            39Total
                current assets
            
            
            8,658
            
            
            
            2,073Equipment
                and improvements, net
            
            
            961
            
            
            
            429Definite-lived
                intangible assets, net
            
            
            1,441
            
            
            
            303Goodwill
            
            
            14,426
            
            
            
            6,346Deferred
                financing fees, net
            
            
            —
            
            
            
            273Other
                assets
            
            
            273
            
            
            
            400Total
                assets
            
            $
            25,759
            
            
            $
            9,824**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Current
                liabilities:Senior
                notes payable
            
            $
            —
            
            
            $
            2,497Capital
                lease obligations – current
            
            
            76
            
            
            
            45Accounts
                payable
            
            
            652
            
            
            
            581Deferred
                revenue
            
            
            725
            
            
            
            264Accrued
                liabilities
            
            
            1,266
            
            
            
            706Total
                current liabilities
            
            
            2,719
            
            
            
            4,093Capital
                lease obligations, less current portion
            
            
            146
            
            
            
            99Other
                long term liabilities
            
            
            19
            
            
            
            —Total
                liabilities
            
            
            2,884
            
            
            
            4,192Commitments
                and contingenciesShareholders’
                equity:Preferred
                stock — $0.001 par value; 1,000,000 sharesauthorized; none issued
                and outstanding
            
            
            —
            
            
            
            —Common
                stock — $0.001 par value; 20,000,000 sharesauthorized: 8,648,950
                and 4,273,833 shares issued andoutstanding, respectively
            
            
            9
            
            
            
            4Additional
                paid-in capital
            
            
            28,908
            
            
            
            9,791Accumulated
                deficit
            
            
            (6,060
            )
            
            
            (4,163
            )Accumulated
                other comprehensive income
            
            
            18
            
            
            
            —Total
                shareholders’ equity
            
            
            22,875
            
            
            
            5,632Total
                liabilities and shareholders’ equity
            
            $
            25,759
            
            
            $
            9,824








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




-
          23
          -


**BRIDGELINE
      SOFTWARE, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


(Dollars
      in thousands, except per share data)








**Year
                Ended September 30,****2007**
            
            
            **2006**Revenue:Web
                development services
            
            $
            8,659
            
            
            $
            6,525Managed
                services
            
            
            2,050
            
            
            
            1,243Subscription
            
            
            442
            
            
            
            467Total
                revenue
            
            
            11,151
            
            
            
            8,235Cost
                of revenue:Web
                development services
            
            
            4,558
            
            
            
            3,389Managed
                services
            
            
            436
            
            
            
            363Subscription
            
            
            26
            
            
            
            57Total
                cost of revenue
            
            
            5,020
            
            
            
            3,809Gross
                profit
            
            
            6,131
            
            
            
            4,426Operating
                expenses:Sales
                and marketing
            
            
            3,488
            
            
            
            3,227General
                and administrative
            
            
            2,489
            
            
            
            1,646Technology
                development
            
            
            791
            
            
            
            176Depreciation
                and amortization
            
            
            369
            
            
            
            187Total
                operating expenses
            
            
            7,137
            
            
            
            5,236Loss
                from operations
            
            
            (1,006
            )
            
            
            (810
            )Interest
                and other expense
            
            
            (924
            )
            
            
            (638
            )Other
                income
            
            
            33
            
            
            
            —Loss
                before income taxes
            
            
            (1,897
            )
            
            
            (1,448
            )Income
                taxes
            
            
            —
            
            
            
            —Net
                loss
            
            $
            (1,897
            )
            
            $
            (1,448
            )Net
                loss per share:Basic
                and diluted
            
            $
            (0.36)
            
            
            $
            (0.36
            )Number
                of weighted average shares:Basic
                and diluted
            
            
            5,285,787
            
            
            
            4,046,278








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




-
          24
          -


**BRIDGELINE
      SOFTWARE, INC.**


**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS’ EQUITY**


(Dollars
      in thousands)






**Accumulated****Common
                  Stock**
              
              **Additional**
              
              
              
              
              **Other**
              
              **Total****Par**
              
              **Paid
                  in**
              
              **Accumulated**
              
              **Comprehensive**
              
              **Shareholders’****Shares**
              
              **Value**
              
              **Capital**
              
              **Deficit**
              
              **Income**
              
              **Equity**Balance,
                  October 1, 2005
              
              
              3,903,833
              
              
              4
              
              
              8,303
              
              
              (2,715)
              
              
              —
              
              
              5,592Issuance
                  of stock for acquisition
              
              
              320,000
              
              
              —
              
              
              838
              
              
              —
              
              
              —
              
              
              838Exercise
                  of warrants
              
              
              50,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Issuance
                  of common stock warrants in private placement
                  of debt
              
              
              —
              
              
              —
              
              
              646
              
              
              —
              
              
              —
              
              
              646Stock
                  based compensation
              
              
              —
              
              
              —
              
              
              4
              
              
              —
              
              
              —
              
              
              4Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,448)
              
              
              —
              
              
              (1,448)Balance,
                  October 1, 2006
              
              
              4,273,833
              
              
              4
              
              
              9,791
              
              
              (4,163)
              
              
              —
              
              
              5,632Stock
                  based
                compensation
              
              
              —
              
              
              —
              
              
              332
              
              
              —
              
              
              —
              
              
              332Exercise
                  of stock options
              
              
              27,831
              
              
              —
              
              
              26
              
              
              —
              
              
              —
              
              
              26Exercise
                  of stock warrants and options
              
              
              59,724
              
              
              —
              
              
              33
              
              
              —
              
              
              —
              
              
              33Issuance
                  of common stock and options in connection with
                  acquisitions
              
              
              1,087,562
              
              
              1
              
              
              5,195
              
              
              —
              
              
              —
              
              
              5,196Issuance
                  of common stock in initial public offering
              
              
              3,200,000
              
              
              4
              
              
              13,531
              
              
              —
              
              
              —
              
              
              13,535Comprehensive
                  lossNet
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,897)
              
              
              —
              
              
              (1,897)Foreign currencytranslationadjustment
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              18
              
              
              18Total
                  comprehensive loss
              
              
              —
              
              
              —
              
              
              —
              
              
              
              
              
              
              
              
              (1,879)Balance,
                  September 30, 2007
              
              
              8,648,950
              
              $
              9
              
              $
              28,908
              
              $
              (6,060)
              
              $
              18
              
              
              22,875



















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





-
          25
          -


**BRIDGELINE
      SOFTWARE, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(Dollars
      in thousands)






**Year
                Ended**
              **September
                30,**Cash
                flows from operating activities:
            
            **2007**
            
            
            **2006**Net
                loss
            
            $
            (1,897
            )
            
            $
            (1,448
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
            
            
            244
            
            
            
            186Amortization
                of intangible assets
            
            
            158
            
            
            
            119Amortization
                of debt discount and deferred financing fees
            
            
            576
            
            
            
            436Stock
                based compensation
            
            
            332
            
            
            
            4Gain
                on sale of assets
            
            
            (1
            )
            
            
            —Changes
                in operating assets and liabilities, net of acquired assets and
                liabilities:Accounts
                receivable and unbilled receivables
            
            
            (539
            )
            
            
            (498
            )Other
                assets
            
            
            30
            
            
            
            (287
            )Accounts
                payable and accrued liabilities
            
            
            422
            
            
            
            721Deferred
                revenue
            
            
            (309
            )
            
            
            34Total
                adjustments
            
            
            913
            
            
            
            715Net
                cash used in operating activities
            
            
            (984
            )
            
            
            (733
            )Cash
                flows from investing activities:Acquisitions,
                net of cash acquired
            
            
            (4,230
            )
            
            
            (553
            )Proceeds
                from sale of assets
            
            
            15
            
            
            
            —Contingent
                acquisition payments
            
            
            (455
            )
            
            
            (126
            )Equipment
                and improvements expenditures
            
            
            (457
            )
            
            
            (163
            )Net
                cash used in investing activities
            
            
            (5,127
            )
            
            
            (842
            )Cash
                flows from financing activities:(Payments
                on)/proceeds from issuance of senior notes payable, net of deferred
                costs
            
            
            (2,800
            )
            
            
            2,434Proceeds
                from issuance of common stock, net of $2,434 in fees
            
            
            13,535
            
            
            
            —Proceeds
                from / payments on financing agreement, net
            
            
            
            
            
            
            (292
            )Proceeds
                from exercise of stock options and warrants
            
            
            59
            
            
            
            —Principal
                payments on capital leases
            
            
            (54
            )
            
            
            (29
            )Principal
                payments on notes payable to shareholders
            
            
            —
            
            
            
            (85
            )Net
                cash provided by financing activities
            
            
            10,740
            
            
            
            2,028Effect
                of exchange rate changes on cash
            
            
            (1
            )Net
                increase in cash
            
            
            4,628
            
            
            
            453Cash
                and cash equivalents at beginning of period
            
            
            591
            
            
            
            138Cash
                and cash equivalents at end of period
            
            $
            5,219
            
            
            $
            591Supplemental
                disclosures of cash flow information:Cash
                paid for interest
            
            $
            318
            
            
            $
            133Non
                cash activities:Issuance
                of common stock for acquisitions
            
            $
            5,196
            
            
            $
            838Warrants
                issued in connection with equity and debt
                transactions
            
            $
            531
            
            
            $
            646Purchase
                of capital equipment through capital leases
            
            $
            63
            
            
            $
            129







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






-
          26
          -


**BRIDGELINE
      SOFTWARE, INC.**


****


**NOTES
      TO CONSOLIDATED FINANCIAL
      STATEMENTS**


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






**1.    
      Description of Business and Basis of Presentation**




***Description
      of Business***




Bridgeline
      Software, Inc. (“Bridgeline” or the “Company”), was incorporated in Delaware on
      August 28, 2000. Bridgeline, operating as a single segment, is a developer
      of
      Web application management software and web
      applications.  Bridgeline’s web application management software
      products, iAPPS®and OrgitectureTM, are SaaS
      (software as a service) solutions that
      unify Content Management, Analytics, eCommerce, and eMarketing
      capabilities.  The Company’s in-house team of Microsoft®-certified
      developers specialize in web application development, information architecture,
      usability engineering, SharePoint development, rich media development, search
      engine optimization, and fully-managed application hosting.





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





On
      April
      7, 2006, the Company affected a 3 to 1 reverse stock split. The reduction in
      the
      number of shares as a result of the reverse stock split has been reflected
      retroactively for all periods presented.  On June 28, 2007, the
      Company completed an equity offering of 3.2 million shares raising approximately
      $13.5 million in capital, net of fees.  The Company’s stock is traded
      under the ticker symbol BLSW on NASDAQ.  During fiscal 2007, the
      Company completed two acquisitions.  A further description of these
      transactions is contained in Note 3 below.




***Principles
      of Consolidation***




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





**2.    
      Summary of Significant Accounting Policies**




***Revenue
      Recognition***




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





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





***Web
      Development Services***




Web
      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,
      Web
      application development, rich media, e-Commerce, e-Learning and e-Training,
      search engine optimization, and content management. Web Development Services
      engagements often include a hosting arrangement that provides for the use of
      certain hardware and infrastructure, generally at the Company’s network
      operating center. As described further below, revenue for these hosting
      arrangements is included in Managed Services. Web development services
      engagements that include hosting arrangements are accounted for as multiple
      element arrangements as described below under “Multiple-Element
      Arrangements.”





-
          27
          -


For
      Web
      Development Services engagements sold on a stand alone basis, revenue is
      recognized in accordance with SAB 104.  Web 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 Web 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
      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 Web 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.”





Sales
      of
      perpetual licenses for the Company’s software products and related post-contract
      customer support (“PCS”) are included in Web Development
      Services.  Revenues derived from perpetual license sales have been
      insignificant in all periods presented (representing less than 2% of Web
      Development Services revenues).




***Managed
      Services***




Managed
      Services include retained professional services and hosting
      services.





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





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





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




***Subscriptions***




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





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





-
          28
          -


***Multiple
      Element Arrangements***




As
      described above, Web 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
      a


Web
      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, the Company follows EITF 00-21 and, as described further
      below, has concluded that each element can be treated as a separate unit of
      accounting.





When
      Web
      Development Services engagements include a perpetual license for the Company’s
      software products, the Company has concluded that the Web Development Services
      and the perpetual software license are separate units of accounting as each
      has
      stand-alone value to the customer and the Company has established vendor
      specific objective evidence (VSOE) of fair value for the software and objective
      and reliable third party evidence of fair value for the Web Development
      Services.  In such arrangements, the perpetual license is the
      delivered element and the Web Development Services, and any PCS are the
      undelivered elements.  The Company recognizes revenue from perpetual
      licenses and related PCS in accordance with SOP 97-2 and recognizes revenue
      from
      Web Development Services following the proportional performance model as
      described above.  The amount of revenue to be recognized upon delivery
      of the software is determined using the residual method whereby the value
      ascribed to the delivered element (i.e., the NetEDITOR license or iAPPS license)
      is equal to the total consideration of the multiple element arrangement less
      the
      third party evidence of fair value of the undelivered elements (i.e., Web
      Development Services and, if applicable, PCS).





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





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





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





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





***Customer
      Payment Terms***





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





-
          29
          -


***Warranty***




Certain
      arrangements include a warranty period generally between 30 to 90 days from
      the
      completion of work. In hosting arrangements, the Company may provide warranties
      of up-time reliability. The Company continues to monitor the conditions that
      are
      subject to the warranties to identify if a warranty claim may arise. If the
      Company determines that a warranty
      claim is probable, then any related cost to satisfy the warranty obligation
      is
      estimated and accrued. Warranty claims to date have been
      immaterial.





***Reimbursable
      Expenses***




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





***Use
      of Estimates***




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




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





***Segment
      Information***




The
      Company is structured and operates internally as one reportable operating
      segment as defined in Statement of Financial Accounting Standard (“SFAS”)
      No. 131, *Disclosures about Segments of an Enterprise and Related
      Information* (“SFAS 131”). SFAS 131 establishes standards for the way public
      business enterprises report information about operating segments in annual
      consolidated financial statements and requires that those enterprises report
      selected information about operating segments in interim financial reports.
      SFAS
      131 also establishes standards for related disclosures about products and
      services, geographic areas and major customers. Although the Company had five
      U.S. operating locations and an Indian subsidiary at September 30, 2007,
      under the aggregation criteria set forth in SFAS 131, the Company operates
      in
      only one reportable operating segment since each location has similar economic
      characteristics.




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




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





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




Year
                Ended September 30,2007
            
            
            2006Customer
                #1
            
            
            15%
            
            
            
            22%




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





September
                30,2007
            
            
            2006Customer
                #1
            
            
            *%
            
            
            
            17%Customer
                #2
            
            
            10%
            
            
            
            *%Customer
                #3
            
            
            10%
            
            
            
            *%*
                Represents less than 10%





-
          30
          -


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




***Cash
      and Cash Equivalents***




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




***Fair
      Value of Financial Instruments***




The
      carrying amounts of financial instruments, including cash and cash equivalents,
      receivables, accounts payable and senior notes payable approximate their fair
      value because of the short-term maturity of these instruments. Based on rates
      available to the Company at September 30, 2007 and 2006 for loans with similar
      terms, the carrying values of capital lease obligations approximate their fair
      value.





***Impairment
      of Long-Lived and Intangible Assets***




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




***Allowance
      for Doubtful Accounts***




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





***Technology
      Development Costs***




Research
      and development expenditures for technology development are charged to
      operations as incurred.  Pursuant to SFAS No. 86 *“Accounting for Cost
      of Computer Systems to be Sold, Leased or Otherwise
      Marketed,”* Software development costs subsequent to the establishment
      of technological feasibility are capitalized and amortized to cost of software
      and included in cost of sales. Based on the Company’s product development
      process, technological feasibility is established upon completion of a working
      model. Costs incurred between completion of a working model and the point at
      which the product is ready for general release are capitalized if significant.
      No software development costs have been capitalized to date as a result of
      the
      Company’s development process.





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




***Equipment
      and Improvements***




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





-
          31
          -


***Internal
      Use Software***





In
      accordance with EITF No. 00-2, *Accounting for Web Site Development
      Costs*, and EITF No. 00-3, *Application of AICPA Statement of
      Position, or SOP, No. 97-2 to Arrangements That Include the Right to Use
      Software Stored on Another Entity’s Hardware*, we apply AICPA SOP
      No. 98-1, *Accounting for the Costs of Computer Software Developed or
      Obtained for Internal Use*. The costs 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.
      We also capitalize 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 property and equipment. Training
      costs are expensed as incurred. Internal use software is amortized
      on a straight-line basis over its estimated useful life, generally three
      years.





***Definite
      Lived Intangible Assets***




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




***Deferred
      Financing Fees***





In
      April
      2006, the Company incurred $472 thousand of direct costs in connection with
      the
      issuance of $2.8 million in Senior Notes Payable, which includes the fair value
      of underwriter debt warrants of $106 thousand (See Note 7). These costs were
      being amortized using the straight-line method, over the one year term of
      the notes.  As of September 30, 2007, these costs have been fully
      amortized.




***Deferred
      Offering Costs***




As
      September 30, 2006, the Company incurred $116 thousand of direct costs in
      connection with the initial public offering of its common
      stock.  These costs were included in other assets and have been
      charged to additional paid in capital in fiscal 2007.  In total, the
      Company incurred costs of $2.5 million in connection with the initial public
      offering.  This amount has been charged to additional paid in
      capital.





***Contingent
      Consideration***




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





***Goodwill***




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




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




-
          32
          -


In
      evaluating the impairment of goodwill, the Company considers a number of factors
      such as discounted cash flow projections, market capitalization value and
      acquisition transactions of comparable third party companies. The process of
      evaluating the potential impairment of goodwill is highly subjective and
      requires significant judgment at many points during the
      analysis, especially with regard to the future cash flows of the Company. In
      estimating fair value of such, management makes estimates and judgments about
      the future cash flows of the Company. As a result of management’s
      evaluation, the Company concluded there was no impairment of goodwill based
      upon
      its annual assessments.




***Advertising
      Costs***




All
      advertising costs are expensed when incurred. Advertising costs were $65
      thousand and $124 thousand for the years ended September 30, 2007 and 2006,
      respectively.




***Stock-Based
      Compensation***




The
      Company maintains two stock-based compensation plans which are more fully
      described in Note 9.





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





Through
      September 30, 2006, the Company accounted for stock compensation awards under
      the provisions of SFAS No. 123, as amended by SFAS No. 148,
*Accounting for* *Stock-Based Compensation—Transition and
      Disclosure*(“SFAS 148”). As permitted by SFAS 123, for all periods
      through September 30, 2006, the Company measured compensation cost in accordance
      with Accounting Principles Board Opinion No. 25, *Accounting for Stock
      Issued to Employees* (“APB 25”) and related interpretations using the
      intrinsic value method and following the disclosure-only provisions of SFAS
      123.





Under
      the
      intrinsic value method, compensation expense is determined at the measurement
      date, generally the date of grant, as the excess, if any, of the estimated
      fair
      value of the Company’s common stock (the “Stock Price”) and the exercise price,
      multiplied by the number of options granted. Generally, the Company grants
      stock
      options with exercise prices equal to or greater than the Stock Price; however,
      to the extent that the Stock Price exceeds the exercise price of stock options
      on the date of grant, the Company records stock-based compensation expense
      using
      the graded vested attribution method over the vesting schedule of the options,
      which is generally three years. The Company recognized stock-based
      compensation expense of $332 thousand and $4 thousand in stock-based
      compensation expense for the years ended September 30, 2007 and 2006,
      respectively.




Prior
      to
      the Company’s initial public offering, the fair value of the Company’s common
      stock was generally determined using the weighted average of three customary
      valuation techniques: the discounted cash flow method, the market approach,
      and
      the guideline public company method.  The Company believes that a
      weighted average of these three techniques is the most reasonable approach
      to
      the valuation of our stock for this period.





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





The
      weighted average enterprise value, as described above, is reduced by a lack
      of
      marketability discount of 20% which reflected the Company’s small size, its
      losses since inception, and its inability to provide a distribution of earnings
      to shareholders.  This per share enterprise value was used as an input
      to the Black-Scholes-Merton option valuation model (the “Model”) in determining
      stock-based compensation.





-
          33
          -


Certain
      assumptions were used by the Company in the application of the Model to estimate
      the fair value of all stock options issued to employees on the grant date.
      The
      risk-free interest rate for all stock option grants is based on U.S. Treasury
      zero-coupon issues with equivalent remaining terms. The expected life of such
      options has been estimated to equal the average of the contractual term and
      the
      vesting term. The Company anticipates paying no cash dividends for its common
      stock; therefore, the expected dividend yield is assumed to be zero. As there
      was no public market for its common stock prior to June 28, 2007, the Company
      estimated the volatility for options granted based on an analysis of reported
      data for a peer group of publicly traded companies that issued options with
      substantially similar terms consistent with SFAS 123R and Securities and
      Exchange Commission Staff Accounting Bulletin No. 107, *Share Based
      Payment*. For purposes of calculating the pro forma compensation expense
      illustrated below, the Company used its cumulative actual forfeiture rates
      of
      between 11% and 13% for all awards which management believes is a reasonable
      approximation of anticipated future forfeitures. The fair value is amortized
      ratably over the vesting period of the awards, which is typically three
      years.  At September 30, 2007, there was approximately $345 thousand
      of total unrecognized compensation cost related to non-vested share-based
      compensation arrangements granted under all equity compensation
      plans.





The
      following disclosure illustrates the pro forma effect on net loss and net loss
      per share that would have been recognized in the 2006 statement of operations
      if
      the fair-value-based method had been applied to all awards in accordance with
      SFAS 123R. Under the fair value-based-method, the Company must measure the
      estimated fair value of equity instruments awarded to employees at the grant
      date for which the Company is obligated to issue when employees have rendered
      the requisite service and satisfied any other conditions necessary to earn
      the
      right to benefit from the instruments (for example, to exercise the share
      options). That estimate is not re-measured in subsequent periods. The Company
      estimated the fair value of stock options issued to employees using the Model,
      which requires assumptions be made by management including the economic life
      of
      the option, expected volatility, expected dividends and risk-free interest
      rates. The Company believes that the Model provides a fair value estimate that
      is consistent with the measurement objective and the fair-value-based method
      of
      SFAS 123R.





The
      following table illustrates the pro forma effect on 2006 net loss per share
      as
      if the Company had applied the fair value recognition provisions of SFAS
      123R:





Net
                loss
            
            
            $
            (1,448
            )Deduct:
                Stock based employeecompensation
                determined underthe
                fair value based methodfor
                all awards, net of tax effect
            
            
            
            (507
            )Pro
                forma net loss
            
            
            $
            (1,955
            )Pro
                forma net loss per share:Basic
                and diluted
            
            
            $
            (0.48
            )As
                reported net loss per share:Basic
                and diluted
            
            
            $
            (0.36
            )Weighted
                average shares outstanding:Basic
                and diluted
            
            
            
            4,046,278






As
      stock
      options vest over several years, additional stock option grants are made and
      employees terminate each year, the above pro forma disclosures and related
      assumptions used in the Model are not necessarily representative of pro forma
      effects on operations for future periods.




-
          34
          -


***Valuation
      of Options and Warrants Issued to Non-Employees***




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





Year
                Ended September 30,2007
            
            
            2006Options
                granted to non-employees
            
            
            −
            
            
            
            9,227Warrants
                granted to non-employees
            
            
            150,000
            
            
            
            392,000Contractual
                lives in years
            
            
            5
            
            
            
            5
–
                10Estimated
                fair value of common stock
            
            $
            2.73
            
            
            $
            2.07
                – 2.46Exercise
                prices
            
            $
            7.50
            
            
            $
            0.001
                – 4.68Estimated
                stock volatility
            
            
            72%
            
            
            
            70%Risk
                free rate of return
            
            5.22%
            
            
            3.70%
                to 4.93%Dividend
                Rate
            
            
            0%
            
            
            
            0%







The
      intrinsic value of the options outstanding at September 30, 2007 was
      approximately $725 thousand of which $638 thousand related to vested options
      and
      $86 thousand related to unvested options.





***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
      2007 or 2006.




***Income
      Taxes***




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




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





***Net
      Loss Per Share of Common Stock***





Basic
      loss per common share is computed by dividing net loss available to common
      shareholders by the weighted average number of common shares outstanding.
      Diluted loss per common share is computed similarly to basic loss per common
      share, except that the denominator is increased to include the number of
      additional common shares that would have been outstanding if the potential
      common shares had been issued and if the additional common shares were not
      anti-dilutive. The Company has excluded all outstanding options, warrants and
      convertible debt from the calculation of diluted weighted average shares
      outstanding because these securities were anti-dilutive for all periods
      presented. The number of potential shares represented by these excluded equity
      instruments were 1,544,831 and 1,507,856 at September 30, 2007 and 2006,
      respectively.





***Recent
      Accounting Pronouncements***




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




-
          35
          -


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





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




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





In
      December 2007, the FASB issued SFAS 141R, *Business Combinations* (“SFAS
      141R”), which replaces FASB SFAS 141, *Business Combinations.*This
      Statement retains the fundamental requirements in SFAS 141 that the acquisition
      method of accounting be used for all business combinations and for an acquirer
      to be identified for each business combination. SFAS 141R defines the acquirer
      as the entity that obtains control of one or more businesses in the business
      combination and establishes the acquisition date as the date that the acquirer
      achieves control.  SFAS 141R will require an entity to record
      separately from the business combination the direct costs, where previously
      these costs were included in the total allocated cost of the
      acquisition.  SFAS 141R will require an entity to recognize the assets
      acquired, liabilities assumed, and any non-controlling interest in the acquired
      at the acquisition date, at their fair values as of that date.  This
      compares to the cost allocation method previously required by SFAS No.
      141.  SFAS 141R will require an entity to recognize as an asset or
      liability at fair value for certain contingencies, either contractual or
      non-contractual, if certain criteria are met.  Finally, SFAS 141R will
      require an entity to recognize contingent consideration at the date of
      acquisition, based on the fair value at that date.  This Statement
      will be effective for business combinations completed on or after the first
      annual reporting period beginning on or after December 15,
      2008.  Early adoption of this standard is not permitted and the
      standards are to be applied prospectively only.  Upon adoption of this
      standard, there will be no impact to the Company’s results of operations and
      financial condition for acquisitions previously completed.  The
      adoption of this standard will impact any acquisitions completed by the Company
      in our fiscal 2010.




**3.   
      Acquisitions**




***New
      Tilt, Inc.***





On
      April
      24, 2006, the Company acquired New Tilt, a privately held provider of Web
      Development Services. New Tilt's results of operations have been included
      in the consolidated financial statements since the date of acquisition. As
      a
      result of the acquisition, the Company expanded its services in the health
      care and insurance industries. The aggregate purchase price
      of approximately $1.6 million consisted of $550 thousand in cash, 320,000
      shares of common stock valued at $717 thousand, 37,830 options for
      common stock valued at $121 thousand and closing costs of $162 thousand.
 Additional consideration of up to approximately $750 thousand may be
      paid over a three-year period in cash as additional consideration. The
      additional consideration described above is based upon the attainment by the
      acquired entity of defined operating objectives. At September 30, 2007, the
      maximum remaining future consideration pursuant to this arrangement is
      approximately $500 thousand.  To date $250 thousand was recorded as an
      increase to goodwill under this arrangement.





-
          36
          -


***Objectware,
      Inc.***




On
      July
      5, 2007, the Company acquired Objectware, Inc. (OW), a privately held provider
      of Web Development Services. OW’s results of operations have been included in
      the consolidated financial statements since the date of acquisition. OW is
      an
      Atlanta, Georgia-based company that specializes in Web application development,
      Web design, wireless application development, search engine optimization and
      providing managed Web Development Services to customers. The initial
      consideration of $6.7 million for the acquisition of OW consisted of $3.7
      million in cash and 610,716 shares of Bridgeline common
      stock.   The former owner of OW also has the opportunity to
      receive up to $1.8 million as additional consideration payable in cash and
      stock
      quarterly over the three years after the acquisition, contingent upon OW
      attaining certain operational performance benchmarks.





The
      additional consideration described above is based upon the attainment by the
      acquired entity of defined operating objectives.  At September 30, 2007,
      the maximum remaining future consideration pursuant to this arrangement is
      approximately $1.6 million.  To date $150 thousand was recorded as an
      increase to goodwill under this arrangement.





In
      connection with the acquisition of OW, we acquired a note receivable from a
      customer of OW.  We evaluated the note and the customer’s ability to
      pay the note and provided a reserve for 100% of the balance as of the
      acquisition date.  If the customer ends up paying the entire balance,
      the Company will record an adjustment to goodwill associated with the OW
      acquisition.  The acquisition has been treated as a non-taxable
      transaction; therefore, the intangible assets, including goodwill, are not
      tax
      deductible for the Company.





***Purple
      Monkey Studios, Inc.***





On
      August
      31, 2007, the Company acquired Purple Monkey Studios, Inc. (PM), a
      privately-held provider of Web Development Services.  PM’s results of
      operations have been included in the consolidated financial statements since
      the
      date of acquisition. PM specializes in web content management solutions,
      interface design, and eTraining applications. Purple Monkey operates in the
      Chicago region, serving over 50 customers including Motorola, Marriott
      International, American Medical Association, McGraw Hill, Discovery
      Communications, and the American Academy of Pediatrics.  The initial
      consideration of $2.9 million consisted of $723 thousand in cash, $210 thousand
      of repayment of a bank line of credit and 476,846 shares of Bridgeline Software
      common stock.  The former owners of PM also have the opportunity to
      receive an additional $900 thousand in cash over a three year period as
      additional consideration based on certain minimum operating income goals being
      achieved.





The
      additional consideration described above is based upon the attainment by the
      acquired entity of defined operating objectives. At September 30, 2007, the
      maximum remaining future consideration pursuant to this arrangement is
      approximately $900 thousand.





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





The
      following table summarizes the estimated fair values of the net assets acquired
      through the acquisitions of OW and PM:





Net
                assets acquired:Cash
            
            $
            322Other
                current assets
            
            
            1,261Equipment
            
            
            251Other
                assets
            
            
            27Intangible
                assets
            
            
            1,296Goodwill
            
            
            7,656


Total
                assets
            
            
            10,813Current
                liabilities
            
            
            996Capital
                lease obligations
            
            
            69Total
                liabilities assumed
            
            
            1,065Net
                assets acquired
            
            $
            9,748Purchase
                price:Cash
                paid
            
            $
            3,881Equity
                exchanged
            
            
            4,983Options
                issued and exchanged
            
            
            213Closing
                costs and fees
            
            
            671Total
                purchase price
            
            $
            9,748







-
          37
          -


Of
      the
      $1.3 million in intangible assets, $1.1 million was assigned to customer
      relationships with an average useful life of five years and $142 thousand was
      assigned to noncompetition agreements with an average estimated life of five
      years.  The total amount of goodwill recognized will not be deductible
      for tax purposes.  The following unaudited pro forma information
      reflects the results of operations of the Company as though the acquisitions
      of
      OW and PM were completed as of October 1, 2005:




Pro
                Forma (Unaudited)Years
                Ended September 30,2007
            
            
            2006Revenue
            
            $
            18,094
            
            
            $
            15,326Net
                loss
            
            $
            (2,083
            )
            
            $
            (987
            )Net
                loss per share:Basic
                and diluted
            
            $
            (0.33
            )
            
            $
            (0.19
            )Number
                of weighted average shares:Basic
                and diluted
            
            
            6,227,211
            
            
            
            5,311,395







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





**4.   
       Equipment and Improvements**





Equipment
      and improvements, net consisted of the following:




As
                of September 302007
            
            
            2006Furniture
                and fixtures
            
            $
            342
            
            
            $
            136Purchased
                software
            
            
            362
            
            
            
            124Computers
                and peripherals
            
            
            951
            
            
            
            629Leasehold
                improvements
            
            
            44
            
            
            
            381,699
            
            
            
            927Less
                accumulated depreciation
            
            
            738
            
            
            
            498$
            961
            
            
            $
            429







Included
      above are assets acquired under capitalized leases of $338 thousand and $207
      thousand as of September 30, 2007 and 2006, respectively, with accumulated
      depreciation thereon of $155 thousand and $92 thousand,
      respectively.





The
      Company has $329 thousand and $233 thousand of net property and equipment at
      September 30, 2007 and 2006, respectively, for use in its hosting
      arrangements.




**5.   
      Definite Lived Intangible Assets and Goodwill**





Definite
      lived intangible assets and goodwill consisted of the following:




As
                of September 30, 2007
            
            
            As
                of September 30, 2006Gross
            
            
            Accumulated
            
            
            Net
            
            
            Gross
            
            
            Accumulated
            
            
            NetAsset
            
            
            Amortization
            
            
            Amount
            
            
            Asset
            
            
            Amortization
            
            
            AmountIntangible
                assets;Domain
                and trade names
            
            
            
            
            
            $
            39
            
            
            $
            (15
            )
            
            $
            24
            
            
            $
            29
            
            
            $
            (13
            )
            
            $
            16Customer
                related
            
            
            
            
            
            
            1,764
            
            
            
            (352
            )
            
            
            1,412
            
            
            
            478
            
            
            
            (229
            )
            
            
            249Acquired
                software
            
            
            
            
            
            
            95
            
            
            
            (90
            )
            
            
            5
            
            
            
            95
            
            
            
            (57
            )
            
            
            38Total
                intangible assets
            
            
            
            
            
            $
            1,898
            
            
            $
            (457
            )
            
            $
            1,441
            
            
            $
            602
            
            
            $
            (299
            )
            
            $
            303Goodwill
            
            
            
            
            
            $
            14,426
            
            
            $
            —
            
            
            $
            14,426
            
            
            $
            6,346
            
            
            $
            —
            
            
            $
            6,346




-
          38
          -


The
      aggregate amortization expense related to intangible assets for the years ended
      September 30, 2007 and 2006 is as follows:





Total
            
            
            Expense
                Charge ToAmortization
            
            
            Cost
                ofExpense
            
            
            Revenue
            
            
            OperationsYear
                Ended September 30, 2007
            
            $
            159
            
            
            $
            33
            
            
            $
            126Year
                Ended September 30, 2006
            
            $
            119
            
            
            $
            117
            
            
            $
            2





The
      estimated amortization expense for fiscal years 2008, 2009, 2010, 2011, 2012
      and
      thereafter is $325 thousand, $320 thousand, $297 thousand, $275 thousand, $214
      thousand and $10 thousand, respectively.





Goodwill
      increased $8 million and $1.3 million in the years ended September 30, 2007
      and
      2006. The increase in the year ended September 30, 2007 included $7.6 million
      as
      a result of the acquisitions of OW and PM and $455 thousand due to contingent
      consideration earned under acquisition agreements. The increase in the year
      ended September 30, 2006 included $1.1 million as a result of acquisitions
      and
      $126 thousand due to contingent consideration earned under prior acquisition
      agreements.






**6.    
      Accrued Liabilities**





Accrued
      liabilities consisted of the following:





As
                of September 30,2007
            
            
            2006Compensation
                and benefits
            
            $
            509
            
            
            $
            259Subcontractors
            
            
            90
            
            
            
            58Deferred
                rent
            
            
            65
            
            
            
            59Interest
            
            
            —
            
            
            
            70Professional
                fees
            
            
            134
            
            
            
            178Other
            
            
            468
            
            
            
            82$
            1,266
            
            
            $
            706






**7.    
      Indebtedness**




The
      Company’s indebtedness consisted of the following:





***Senior
      Notes Payable***





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




In
      2006,
      the Company entered into an agreement, as amended, with an underwriter to
      execute a private placement of $2.8 million of senior secured notes payable
      and
      related security agreement (the “Senior Notes”) and to underwrite an initial
      public offering of the Company’s common stock.  The Senior Notes were
      collateralized by all assets of the Company. The Senior Notes were
      subordinated to other creditors at issuance; however, those debts were fully
      paid by the Company as of July 1, 2006. The principal amount of the Senior
      Notes
      was payable in full at the closing date of an initial public offering of the
      Company’s securities (the “Maturity Date”).  In July 2007, the Company
      repaid the Senior Notes in their entirety after the initial public offering
      was
      completed.




-
          39
          -


In
      connection with the issuance of the Senior Notes, the Company issued 280,000
      warrants to the note holders (the “Debt Warrants”) and 112,000 warrants to the
      underwriter for services rendered in connection with the private placement
      (the
“Underwriter’s Debt Warrants”). These warrants are exercisable into shares of
      the Company’s common stock. The Debt Warrants are exercisable at $0.001 per
      share at any time within five years from the date of grant. The Underwriter’s
      Debt Warrants are exercisable at any time within five years from the grant
      date
      provided, however, that no such exercise shall take place prior to the earlier
      of the date of an initial public offering or April 21, 2008. The Underwriter’s
      Debt Warrants are exercisable at $5.00 per share. As part of the Senior Notes,
      the Company's investment banker received $280 thousand in fees which are
      recorded as deferred financing fees and were amortized over the one-year term
      of
      the Senior Notes.




Interest
      expense related to this debt, including amortization of the deferred financing
      fees, was $858 thousand and $558 thousand for the years ended September 30,
      2007
      and 2006, respectively.





***Capital
      Lease Obligations***


As
                of September 30,2007
            
            
            2006Capital
                lease obligations
            
            $
            222
            
            
            $
            144Less:  Current
                portion
            
            
            (76
            )
            
            
            (45
            )Capital
                lease obligations
            
            $
            146
            
            
            $
            99






As
      of
      September 30, 2007, the Company had remaining the following minimum lease
      payments under capitalized lease obligations:





Year
                Ending September 30,2008
            
            $
            1022009
            
            
            752010
            
            
            482011
            
            
            352012
            
            
            10Totals
            
            
            270Less
                interest at a weighted average of 14.15%
            
            
            48Total
                capital lease obligations
            
            $
            222







**8.    Commitments
      and Contingencies**





***Guarantees
      and Indemnifications***




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





***Litigation***




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




-
          40
          -


***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, 2007
      were
      as follows:





Year
                Ending September 30,2008
            
            $
            6982009
            
            
            5052010
            
            
            4402011
            
            
            340Total
            
            $
            1,983





Rent
      expense for the years ended September 30, 2007 and 2006 was approximately
      $730 thousand and $615 thousand, respectively, exclusive of sublease income
      of
      $71 thousand and $100 thousand for the years ended September 30, 2007 and 2006,
      respectively.  In January 2007, the Company entered into an
      arrangement to sub lease certain excess office space.  The terms of
      the sublease are substantially consistent with the terms of the original
      lease.  Prior subleases ceased when the related leases
      expired.




***Other
      Commitments***




On
      October 1, 2005, the Company entered into a Business Combination Services
      Agreement with Joseph Gunnar & Co., LLC (“Gunnar”), pursuant to which Gunnar
      provides Bridgeline with certain advisory services concerning potential
      acquisitions and transactions. The term of the agreement is for one year with
      automatic one-year renewals until either party elects not to renew and provides
      90 days’ written notice prior to the commencement of the next renewal period or
      after the consummation of two business combinations during any term. During
      the
      term and any renewal periods, the Company is required to pay cash advances
      against success fees in the initial amount of $7 thousand per month, which
      amount increased to $10 per month in May 2006, and will increase to $15 thousand
      per month upon a public stock offering. As compensation for its services, the
      Company is obligated to pay Gunnar, at the closing of a business combination
      (*i.e*., a merger, acquisition, sale or joint venture), a success fee
      equal to six percent of the total value of all cash, securities or other
      property paid in connection with the transaction. The success fee for each
      business combination consummated during the initial term or a renewal period
      is
      a minimum of $125 thousand and a maximum of $375 thousand, net of the cash
      advances paid to Gunnar during the applicable period. Success fees, less amounts
      paid in advance, are included in the total purchase price of the related
      acquisition. Amounts paid in advance are expensed as paid.  Effective
      August 31, 2007, the Company renegotiated the agreement with Gunnar and as
      a
      result no longer pays a monthly amount and all fees relating to the success
      of
      any business combination is payable only upon the consummation of the
      deal.





The
      Company frequently warrants that the technology solutions it develops for its
      clients will operate in accordance with the project specifications without
      defects for a specified warranty period, subject to certain limitations that
      the
      Company believes are standard in the industry. In the event that defects are
      discovered during the warranty period, and none of the limitations apply, the
      Company is obligated to remedy the defects until the solution that the Company
      provided operates within the project specifications. The Company is not
      typically obligated by contract to provide its clients with any refunds of
      the
      fees they have paid, although a small number of its contracts provide for the
      payment of liquidated damages upon default. The Company has purchased insurance
      policies covering professional errors and omissions, property damage and general
      liability that reduce its monetary exposure for warranty-related claims and
      enable it to recover a portion of any future amounts paid. The Company typically
      provides in its contracts for testing and client acceptance procedures that
      are
      designed to mitigate the likelihood of warranty-related claims, although there
      can be no assurance that such procedures will be effective for each project.
      The
      Company has never paid any material amounts with respect to the warranties
      for
      its solutions. The Company sometimes commits unanticipated levels of effort
      to
      projects to remedy defects covered by its warranties. The Company’s estimate of
      its exposure related to warranties on contracts is immaterial as of
      September 30, 2007 and 2006.







**9.    
      Shareholder’s Equity**




The
      Company completed an initial public offering in June 2007.  In
      addition to the shares in the market, the Company has granted common stock,
      common stock warrants, and common stock option awards (the “Equity Awards”) to
      employees, consultants, advisors and debt holders of the Company and to former
      owners and employees of acquired companies that become employees of the Company.
      The following is a summary of the common stock reserved for issuance for stock
      option and warrant activity.





-
          41
          -


***Common
      Stock Warrants***





During
      2001 through 2004, the Company issued to certain investment advisors warrants
      to
      purchase 160,542 shares of common stock for services rendered in connection
      with
      private placement sales of common stock with aggregate proceeds of approximately
      $4.7 million. The warrants are exercisable at $3.75 and $4.68 per share at
      any
      time within five years from the grant date.  In connection with a
      December 2004 acquisition, the Company issued 72,527 warrants to its investment
      advisor for services rendered in connection with the acquisition. The warrants
      are exercisable at $4.68 per share at any time within five years from the
      grant date. The Company valued the warrants at $269 thousand using the Model
      and
      assumptions as described in Note 2, which the Company recorded as a direct
      cost
      of the acquisition.





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





In
      accordance with the terms of the warrant agreements, any liquidity event,
      including an initial public offering, would result in the conversion of the
      warrants per a prescribed formula to Bridgeline common stock.  In
      connection with the Company’s successful initial public offering, the above
      referenced warrants were converted to common stock.





The
      Debt
      Warrants issued in connection with the Senior Notes described in Note 7 are
      exercisable at $0.001 per share at any time within five years from the date
      of
      grant. As of September 30, 2007, 75,000 Debt Warrants have been exercised by
      Senior Note holders. The Underwriter’s Debt Warrants issued in connection with
      the Senior Notes described in Note 7 are exercisable at any time within five
      years from the grant date provided, however, that no such exercise shall take
      place prior to the earlier of the date of an initial public offering or April
      21, 2008. The Underwriter’s Debt Warrants are exercisable at $5.00. The Company
      valued the Debt Warrants at $531 thousand and the Underwriter’s Debt Warrants at
      $115 thousand using the Model and assumptions as described in Note 2. The value
      of the Debt Warrants was recorded as a discount on the Senior Notes and was
      amortized over the one year term of the Senior Notes. The value of the
      Underwriter’s Debt Warrants was charged to deferred financing costs and was
      amortized over the one year term of the Senior Notes.





In
      July
      2007, the Company issued 150,000 warrants in connection with the successful
      initial public offering (the IPO Warrants).  The Company had agreed
      with the underwriters that such IPO Warrants would be issued in connection
      with
      the fees due to the underwriters for the successful transaction.  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 of $400 thousand, using the Model and
      assumptions as described in Note 2, directly to additional paid in capital
      as
      part of the direct incremental fees associated with the initial public
      offering.  At September 30, 2007, the Company has 467,000 warrants
      outstanding.





Subsequent
      to the initial issuance, the Company amended the terms of the Debt Warrants,
      the
      Underwriter’s Debt Warrants and IPO Warrants described above to eliminate a
      provision included in error during the drafting of the
      documents.  This provision would have permitted the holders of the
      warrants to redeem the warrants in the event that the Company’s registration
      during the terms of each warrant became ineffective.  The inclusion of
      this provision would have required the Company to reflect the outstanding
      warrants as liabilities rather than as equity, as this provision could be
      interpreted as a put option with a cash settlement.  The Company and
      the holders of the warrants intended for the instruments to only be settled
      in
      equity and thus the terms were amended accordingly.





***2000
      Stock Incentive Plan***





During
      2000, the Company adopted the 2000 Stock Incentive Plan (the “Plan”) and
      reserved 1.0 million shares of common stock for issuance thereunder. On
      June 24, 2005 the Board of Directors increased the reserve for common stock
      issued under the Plan to 1.2 million shares. The Plan authorized the award
      of
      incentive stock options, non-statutory stock options, restricted stock,
      unrestricted stock, performance shares, stock appreciation rights and any
      combination thereof to employees, officers, directors, consultants, independent
      contractors and advisors of the Company. During 2006, the Company amended and
      restated the Plan to conform to current tax laws and to increase the number
      of
      common shares reserved for issuance under the plan to 1.4 million. Options
      granted under the Plan may be granted with contractual lives of up to ten years.
      There were 294,338 options reserved for issuance under the Plan as of September
      30, 2007.





***2001
      Lead Dog Stock Option Plan***





In
      connection with the Company’s merger with Lead Dog in February 2002, the Company
      assumed Lead Dog’s 2001 Stock Option Plan (the “Lead Dog Plan”). Options under
      the Lead Dog Plan may be granted for periods of up to ten years and at prices
      no
      less than the fair market value of the shares on the date of grant. Under the
      terms of the Agreement and Plan of Merger with Lead Dog, 98,731 options of
      the
      Lead Dog Plan were reserved for issuance to former Lead Dog employees that
      remained with the Company for one year subsequent to the
      merger.





-
          42
          -


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





Stock
                Options
            
            
            Stock
                WarrantsWeighted
            
            
            
            
            
            WeightedAverage
            
            
            
            
            
            AverageExercise
            
            
            
            
            
            ExerciseOptions
            
            
            Price
            
            
            Warrants
            
            
            PriceOutstanding,
                September 30, 2005
            
            
            797,907
            
            
            $
            2.953
            
            
            
            236,269
            
            
            $
            4.273Granted
                (2)
            
            
            204,920
            
            
            $
            3.750
            
            
            
            392,000
            
            
            $
            1.533Exercised
                (3)
            
            
            —
            
            
            
            —
            
            
            
            (50,000
            )
            
            $
            0.001Cancelled
                or expired
            
            
            (73,240
            )
            
            $
            3.492
            
            
            
            —
            
            
            
            —Outstanding,
                September 30, 2006
            
            
            929,587
            
            
            
            3.086
            
            
            
            578,269
            
            
            $
            2.653Granted
                (4)
            
            
            267,778
            
            
            $
            4.120
            
            
            
            150,000
            
            
            
            7.500Exercised
                (3)
            
            
            (27,831
            )
            
            
            0.940
            
            
            
            (59,724
            )
            
            $
            0.554Cancelled
                or expired
            
            
            (91,703
            )
            
            $
            3.710
            
            
            
            (201,545
            )
            
            
            4.504Outstanding,
                September 30, 2007
            
            
            1,077,831
            
            
            $
            3.430
            
            
            
            467,000
            
            
            $
            3.610




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




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




(3)
      The
      intrinsic value of options and warrants exercised during the year ended
      September 30, 2007 was $93 thousand and $122 thousand, respectively. Warrants
      exercised during the year ended September 30, 2007 had an intrinsic value of
      $3.61 per share.  Warrants exercised during the year ended September
      30, 2006 had an intrinsic value of $2.23 per share.




(4)
      The
      weighted average grant-date fair value of options granted during the fiscal
      year
      ended 2007 was $1.50.




A
      summary
      of options outstanding and options exercisable at September 30,
      2007:





Options
                Outstanding
            
            
            Options
                ExercisableWeightedAverageRemaining
            
            
            Aggregate
            
            
            Number
                of
            
            
            AggregateExercise
            
            
            Number
                of
            
            
            Contractual
            
            
            Intrinsic
            
            
            Options
            
            
            IntrinsicPrice
            
            
            Options
            
            
            Life
                in Years
            
            
            Value
            
            
            Exercisable
            
            
            Value$
                0.003
            
            
            
            13,334
            
            
            
            5.00
            
            
            $
            58,829
            
            
            
            13,334
            
            
            $
            53,829$
                0.357
            
            
            
            3,220
            
            
            
            4.41
            
            
            $
            11,858
            
            
            
            3,220
            
            
            $
            11,858$
                1.072
            
            
            
            29,675
            
            
            
            4.41
            
            
            $
            88,087
            
            
            
            29,675
            
            
            $
            88,087$
                1.200
            
            
            
            43,111
            
            
            
            7.21
            
            
            $
            122,435
            
            
            
            43,111
            
            
            $
            122,435$ 1.740
            
            
            
            42,500
            
            
            
            9.77
            
            
            $
            97,750
            
            
            
            42,500
            
            
            $
            97,750$
                3.000
            
            
            
            254,971
            
            
            
            5.55
            
            
            $
            265,170
            
            
            
            253,303
            
            
            $
            263,436$
                3.750
            
            
            
            616,620
            
            
            
            8.19
            
            
            $
            178,820
            
            
            
            325,407
            
            
            $
            94,368$
                3.920
            
            
            
            37,400
            
            
            
            9.92
            
            
            $
            4,488
            
            
            
            37,400
            
            
            $
            4,488$
                4.900
            
            
            
            37,000
            
            
            
            9.77
            
            
            $
            —
            
            
            
            —
            
            
            $
            —1,077,831
            
            
            
            
            
            
            
            
            
            
            
            747,950







-
          43
          -


A
      summary
      of the status of Bridgeline’s nonvested shares is presented below.




Nonvested
                Shares
            
            Shares
            
            Weighted-Average
              Grant-Date
              Fair
                ValueNonvested
                at September 30, 2006
            
            379,131
            
            $
                2.11Granted
            
            267,778
            
            1.50Vested
            
            (295,048)
            
            1.61Forfeited
            
            (21,981)
            
            1.46Nonvested
                at September 30, 2007
            
            329,880
            
            $
                2.26




As
      of
      September 30, 2007 there was $345 thousand of total unrecognized compensation
      cost related to nonvested share-based compensation arrangements granted under
      the Plan. That cost is expected to be recognized over a weighted average of
      2.3
      years. The total fair value of shares vested during the years ended September
      30, 2007 and 2006 were $475 thousand and $936 thousand, respectively of which
      options with a value $309 thousand and $339 thousand have been subsequently
      cancelled after vesting in years ended September 30, 2007 and 2006,
      respectively.





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





Fair
                Value
            
            
            
            
            
            
            
            Expected
            
            Optionof
                Stock
            
            Stock
            
            Risk
                Free
            
            Dividend
            
            Option
                Life
            
            ExercisePrices
            
            Volatility
            
            Rate
                of Return
            
            Rate
            
            in
                Years
            
            PricesYear
                Ended September 30,2007
            
            $
                0.61 - $2.92
            
            72%
            
            4.70%
                - 5.22%
            
            0%
            
            3.0
                - 10
            
            $
                3.75 - $4.902006
            
            $
                2.07 - $2.46
            
            70%
            
            4.31%
                - 4.70%
            
            0%
            
            6.5
                - 10
            
            $ 3.75







**10.  
      Income Taxes**





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




Year
                Ended September 30,2007
            
            
            2006Income
                tax benefit at the federal statutory rate of 34%
            
            $
            (645
            )
            
            $
            (538
            )Permanent
                differences, net
            
            
            335
            
            
            
            151State
                income benefit, net of federal benefit
            
            
            (106
            )
            
            
            (70
            )Change
                in valuation allowance attributable to operations
            
            
            355
            
            
            
            464Other
            
            
            61
            
            
            
            (7
            )$
            —
            
            
            $
            —





As
      of September 30, 2007, the Company has net operating loss carryforwards (“NOLs”)
      of approximately $4.8 million for federal purposes and $4.1 million for state
      purposes, which will be available to offset future taxable income. 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 2008 and 2027.




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.





-
          44
          -


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




As
                of September 30,Deferred
                tax assets:
            
            2007
            
            
            2006Short-term:Contract
                loss reserve
            
            $
            1
            
            
            $
            59Long-termNet
                operating loss carry forwards
            
            
            1,892
            
            
            
            1,551Deferred
                tax liabilities:Current:Other
            
            
            6
            
            
            
            23Long-term:Intangibles
            
            
            (567
            )
            
            
            (122
            )Depreciation
            
            
            (140
            )
            
            
            (38
            )1,192
            
            
            
            1,473Valuation
                allowance
            
            
            1,192
            
            
            
            1,473$
            —
            
            
            $
            —




For
      the
      year ended September 30, 2007 the valuation allowance for deferred tax assets
      decreased $337 thousand which was mainly due to the acquisitions of Objectware,
      Inc. and Purple Monkey, Inc. offset by the operating loss
      incurred.  For the year ended September 30, 2006 the valuation
      allowance for deferred tax assets increased $479 thousand which was mainly
      due
      to the operating loss incurred and $15 thousand due to the acquisition of New
      Tilt. The Company has NOLs and other deferred tax benefits that are available
      to
      offset future taxable income. A valuation allowance is established if it is
      more
      likely than not that all or a portion of the deferred tax asset will not be
      realized. Accordingly, the Company has established a full valuation allowance
      against its net deferred tax asset at September 30, 2007 and 2006,
      respectively.




In
      January 2005, 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 $280
      thousand and $186 thousand at September 30, 2007 and 2006, 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, 2007, there would be minimal withholding taxes upon remittance
      of all previously unremitted earnings.







**11.  
      Related Party Transactions**





In
      connection with the acquisition of Purple Monkey Studios, Inc., the Company
      entered into a lease for six months with Purple Monkey Realty
      LLC.  The owners of Purple Monkey Realty LLC are also employees of the
      Company.  The Company intends on relocating to a new space after the
      terms of the initial lease expire.  For the year ended September 30,
      2007, the Company paid $11 thousand under this agreement.





In
      April
      2007, we issued secured promissory notes to our Chief Executive Officer and
      a
      member of the Board of Directors aggregating $200 thousand.  The notes
      bore interest at a rate of 15% per annum payable, along with the outstanding
      principal on the notes, on the closing of the initial public offering of
      securities.  The Company paid $6 thousand in interest expense and
      repaid the notes in their entirety in July 2007 upon the completion of the
      initial public offering.





-
          45
          -


**Item
      8.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE**





None







**Item
      8A. CONTROLS AND PROCEDURES**





We
      maintain disclosure controls and procedures that are designed to ensure that
      information required to be disclosed in our Securities Exchange Act of 1934
      reports is recorded, processed, summarized and reported within the time periods
      specified in the SEC’s rules and forms, and that such information is accumulated
      and communicated to our management, including our President and Chief Executive
      Officer (Principal Executive Officer) and our Executive Vice President and
      Chief
      Financial Officer (Principal Financial Officer), as appropriate, to allow timely
      decisions regarding required disclosure. In designing and evaluating the
      disclosure controls and procedures, management recognized that any controls
      and
      procedures, no matter how well designed and operated, can provide only
      reasonable assurance of achieving the desired control objectives, as ours are
      designed to do, and management necessarily was required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible controls and
      procedures.





In
      connection with its audit of our financial statements, our external auditors,
      UHY LLP, advised us that they were concerned that during the years ended
      September 30, 2007 and 2006, our accounting resources did not include enough
      people with the detailed knowledge, experience and training in the selection
      and
      application of certain accounting principles generally accepted in the United
      States of America (GAAP) to meet our financial reporting needs. This control
      deficiency contributed to material weaknesses in internal control with respect
      to accounting for revenue recognition and equity. A “material weakness” is a
      control deficiency or combination of control deficiencies that results in more
      than a remote likelihood that a material misstatement in the financial
      statements or related disclosures will not be prevented or
      detected.





During
      fiscal 2007, we created several new positions in our Company, including one
      at
      the vice-president level, with specific responsibilities for external financial
      reporting, internal control, revenue recognition and purchase
      accounting.  We filled all of these positions during fiscal 2007,
      including the vice-president level position in the fourth quarter of fiscal
      2007.   We believe that the addition of these accounting
      resources will address the material weakness noted above.  We estimate
      that the annual cost of the new positions referred to above will be between
      $300
      thousand and $350 thousand.  In addition, we expect to incur
      significant additional costs in the future. While we expect to complete the
      process of bringing our internal control documentation into compliance with
      the
      Sarbanes-Oxley Act (SOX) Section 404 as quickly as possible, we cannot at this
      time estimate how long it will take to complete the process or its ultimate
      cost.  We expect such costs to be
      significant.  During the fourth quarter of fiscal 2007, we commenced
      the implementation of a new financial reporting system that is expected to
      improve the reporting process by eliminating redundant
      spreadsheets.







**Item
      8B. OTHER INFORMATION**





None





**PART
      III**





**Item
      9.    DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS
      AND CORPORATE GOVERANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
      ACT**





The
        following table sets forth information regarding our directors and executive
        officers:


**Name**
            
            **Age**
            
            **Position**Thomas
                Massie
            
            46
            
            Chairman,
                Chief Executive Officer and PresidentJohn
                Cavalier
            
            68
            
            Director(1)(2)(3)(4)William
                Coldrick
            
            65
            
            Director
                (1)(2)(3)(4)Kenneth
                Galaznik
            
            56
            
            Director
                (1)(4)Robert
                Hegarty
            
            44
            
            Director(2)(3)(4)Gary
                Cebula
            
            48
            
            Executive
                Vice President, Treasurer, Corporate Secretary and Chief Financial
                OfficerBrett
                Zucker
            
            36
            
            Executive
                Vice President and Chief Technical OfficerTimothy
                O’Neil
            
            36
            
            Vice
                President of Finance and Chief Accounting
                Officer




-
          46
          -


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





The
      additional information required by this Item 9 of Form 10-KSB is hereby
      incorporated by reference to the information in our definitive proxy statement
      to be filed within 120 days after the close of our fiscal year.







**Item
      10.  EXECUTIVE COMPENSATION**





The
      information required by this Item 10 of Form 10-KSB is hereby incorporated
      by
      reference to the information in our definitive proxy statement to be filed
      within 120 days after the close of our fiscal year.







**Item
      11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
      RELATED STOCKHOLDERS MATTERS.**





We
      maintain a number of equity compensation plans for employees, officers,
      directors and other entities and individuals whose efforts contribute to our
      success. The table below sets forth certain information as of our fiscal year
      ended September 30, 2007 regarding the shares of our common stock available
      for
      grant or granted under our equity compensation plans.





**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
            
            
            1,077,831
            
            
            $         
                3.43
            
            
            294,338Equity
                compensation plans not approved by security holders (1)
            
            
            262,000
            
            
            6.43
            
            
            −Total
            
            
            1,339,831
            
            
            $         
                4.02
            
            
            294,338




(1)  
      In April 2006, the Company issued 112,000 warrants to the underwriter for
      services rendered in connection with the private placement (the “Underwriter’s
      Debt Warrants”). These warrants are exercisable into shares of the Company’s
      common stock.  The Underwriter’s Debt Warrants are exercisable at any
      time within five years from the grant date provided, however, that no such
      exercise shall take place prior to the July 5, 2007. The Underwriter’s Debt
      Warrants are exercisable at $5.00 per share.  In July 2007, the
      Company issued 150,000 warrants in connection with the successful initial public
      offering (the “IPO Warrants”).  The Company had agreed with the
      underwriters that such IPO Warrants would be issued in connection with the
      fees
      due to the underwriters for the successful transaction.  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 of $400 thousand, using the Model and
      assumptions as described in Note 2, directly to additional paid in capital
      as
      part of the direct incremental fees associated with the initial public
      offering.  At September 30, 2007, the Company has 467,000 warrants
      outstanding.





The
      additional information required by this Item 11 of Form 10-KSB is hereby
      incorporated by reference to the information in our definitive proxy statement
      to be filed within 120 days after the close of our fiscal year.





-
          47
          -


**Item
      12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS; AND DIRECTORS
      INDEPENDENCE.**





The
      information required by this Item 12 of Form 10-KSB is hereby incorporated
      by
      reference to the information in our definitive proxy statement to be filed
      within 120 days after the close of our fiscal year.







**Item
      13.  EXHIBITS**





**(a)**
            **Exhibits**





**Item**
            
            
            **Title**





2.1*
            
            
            New
                Tilt, Inc. Acquisition Agreement2.2*
            
            
            Interactive
                Applications, Inc. Acquisition Agreement2.3*
            
            
            Objectware,
                Inc. Acquisition Agreement2.4*
            
            
            Lead
                Dog Digital, Inc. Acquisition Agreement2.5*
            
            
            Streamline
                Communications, Inc. Acquisition Agreement2.6
            
            
            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)3.1(ii)*
            
            
            Amended
                and Restated Certificate of Incorporation3.1(iii)
            
            
            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 Certificate10.1*
            
            
            Office
                Building Lease between Sixth Road Woburn, LLC and Bridgeline Software,
                Inc., dated May 5, 200510.2*
            
            
            Office
                Building Lease between 104 West 40th
                Street
                Partners LLC and Bridgeline Software, Inc., dated November 26,
                200310.3*
            
            
            Office
                Building Lease between Starwood Urban Retail I, LLC and Interactive
                Applications Group, Inc., dated August 20, 199910.4*
            
            
            First
                Amendment to Office Building Lease between Starwood Urban Retail
                I, LLC
                and Interactive Applications Group, Inc., dated January 16,
                200110.5*
            
            
            Office
                Building Lease between Valliappa Software Technological Park Pvt.
                Ltd. and
                Bridgeline Software Enterprises Pvt. Ltd. dated December 5,
                200510.6*
            
            
            Lease
                between Cameron-Elmwood Realty, LLC and New Tilt, Inc. dated December
                6,
                200410.7*
            
            
            Employment
                Agreement with Thomas Massie, dated October 1, 2001**10.8*
            
            
            Employment
                Agreement with Gary Cebula, dated January 1, 2006**10.9*
            
            
            Employment
                Agreement with Brett Zucker, dated January 1, 2006**10.10*
            
            
            Employment
                Agreement with Robert Seeger, dated January 1, 2006**10.11
            
            
            Employment
                Agreement with Erez M. Katz (incorporated by reference to Exhibit
                2.4 to
                our Current Report on Form 8-K filed on July 11, 2007)**10.12*
            
            
            Business
                Combination Services Agreement dated as of October 1, 2005 between
                Bridgeline Software, Inc. and Joseph Gunnar & Co., LLC10.13*
            
            
            Memorandum
                of Understanding between Fin Net, LLC and Bridgeline Software, Inc.
                dated
                January 5, 200410.14*
            
            
            Financing
                Agreement between Sand Hill Finance, LLC and Bridgeline Software,
                Inc.
                dated March 29, 200510.15*
            
            
            First
                Amendment to Financing Agreement between Sand Hill Finance, LLC and
                Bridgeline Software, Inc. dated September 12, 200510.16*
            
            
            Convertible
                Term Note issued by Bridgeline Software, Inc. to Thomas Massie for
                the
                principal sum of $200,000, dated September 3, 200210.17*
            
            
            Convertible
                Term Note issued by Bridgeline Software, Inc. to Thomas Massie for
                the
                principal sum of $112,000, dated September 3, 200210.18*
            
            
            Security
                Agreement between Bridgeline Software, Inc. and Thomas Massie dated
                as of
                September 3, 2002


10.19*
            
            
            Placement
                Agent Agreement by and between Bridgeline Software, Inc. and Joseph
                Gunnar
                & Co., LLC, dated as of April 10, 200610.20*
            
            
            General
                Security Agreement by and between Bridgeline Software, Inc. and the
                investors named therein, dated as of April 21, 200610.21*
            
            
            Form
                of Subscription Agreement by and between Bridgeline Software, Inc.
                and the
                investors listed on Schedule A attached thereto10.22*
            
            
            Form
                of Secured Promissory Note issued to the investors listed on Schedule
                A
                attached thereto10.23*
            
            
            Form
                of Warrant to Purchase Common Stock of Bridgeline Software, Inc.
                issued to
                the investors listed on Schedule A attached thereto, as
                amended10.24*
            
            
            Form
                of Warrant to Purchase Common Stock of Bridgeline Software, Inc.
                issued to
                Placement Agent in April 2006 offering, as amended





-
          48
          -


10.25*
            
            
            Form
                of Warrant to Purchase Common Stock of Bridgeline Software, Inc.
                issued to
                Winslow, Evans & Crocker, Inc., and associates of Winslow, Evans &
                Crocker, Inc., as compensation for services as placement gent in
                2003 and
                2004 equity offerings10.26*
            
            
            Form
                of Warrant to Purchase Common Stock of Bridgeline Software, Inc.
                issued to
                Fin Net, LLC as compensation for investment banking
                services10.27*
            
            
            Common
                Stock Purchase Warrant of Bridgeline Software issued to Sand Hill
                Finance,
                LLC10.28*
            
            
            Data
                Processing and Technical Services Agreement between The Bank of New
                York
                and Bridgeline Software, Inc. dated as of October 25, 200210.29*
            
            
            Professional
                Services Agreement between The Depository Trust & Clearing Corporation
                and Bridgeline Software, Inc. dated as of January 2, 200610.30*
            
            
            Statement
                of Work for Web Maintenance Services between Nomura Securities, Inc.
                and
                Bridgeline Software, Inc. dated as of June 12, 200210.31*
            
            
            Agreement
                between Pfizer, Inc. and Bridgeline Software, Inc. dated as of December
                16, 200510.32*
            
            
            Master
                Services Agreement between John Hancock Life Insurance Co. and Bridgeline
                Software, Inc. dated as of July 1, 200410.33*
            
            
            Amended
                and Restated Stock Incentive Plan****10.34*
            
            
            Lead
                Dog Digital, Inc. 2001 Stock Option Plan**10.35*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Brett Zucker, dated
                February
                27, 2002**10.36*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Brett Zucker, dated
                February
                27, 2002**10.37*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Brett Zucker, dated
                February
                27, 2002**10.38*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Brett Zucker, dated
                June 1,
                2003**10.39*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Brett Zucker, dated
                June 1,
                2005**10.40*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Robert Seeger, dated
                February
                27, 2002**10.41*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Robert Seeger, dated
                February
                27, 2002**10.42*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Robert Seeger, dated
                September 30, 2002**10.43*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Robert Seeger, dated
                June 1,
                2003**10.44*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Robert Seeger, dated
                June 1,
                2005**10.45*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Gary Cebula, dated August
                31,
                2000**10.46*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Gary Cebula, dated September
                30, 2002**10.47*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Gary Cebula, dated June
                1,
                2003**10.48*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Gary Cebula, dated June
                1,
                2005**10.49*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to William Coldrick, dated
                June
                1, 2005**10.50*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Thomas Massie, dated
                September 3, 2002**10.51*
            
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Thomas Massie, dated
                September 30, 2002**


10.52*
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Robert Hegarty, dated
                September 20, 2006**10.53*
            
            Stock
                Option Grant by Bridgeline Software, Inc. to Kenneth Galaznik, dated
                September 20, 2006**10.54*
            
            Amendment
                No. 1 to Secured Promissory Note filed as Exhibit 10.22, dated as
                of March
                29, 200710.55*
            
            First
                Amendment to Agreement and Plan of Merger filed as Exhibit 2.3, dated
                as
                of March 29, 200710.56*
            
            Form
                of Escrow Agreement by and among Bridgeline Software, Inc., Erez
                M. Katz,
                and Arnall Golden Gregory10.57*
            
            Secured
                Promissory Note issued by Bridgeline Software, Inc. to Thomas Massie
                for
                the principal sum of $100,000 dated April 3, 2007.10.58*
            
            Secured
                Promissory Note issued by Bridgeline Software, Inc. to William Coldrick
                for the principal sum of $100,000 dated April 3, 2007.10.59*
            
            Amended
                and Restated General Security Agreement by and between Bridgeline
                Software, Inc. and the investors named therein, dated April 3,
                2007.10.60*
            
            Second
                Amendment to Financing Agreement between Sand Hill Finance, LLC and
                Bridgeline Software, Inc. dated April 26, 2007.10.61*
            
            Agreement
                between Joseph Gunnar & Co., LLC, as agent for certain Noteholders and
                Bridgeline Software, Inc. dated May 15, 2007.10.62*
            
            Subordination
                Agreement between Joseph Gunnar & Co., LLC, as agent for certain
                Noteholders and Bridgeline Software, Inc. dated May 15,
                2007.10.63*
            
            
            Second
                Amendment to Agreement and Plan of Merger filed as Exhibit 2.3, dated
                June
                14, 2007.10.64*
            
            
            Amendment
                No. 2 to Secured Promissory Note filed as Exhibit 10.22, dated as
                of June
                20, 2007.


10.65*
            
            
            Form
                of Warrant to Purchase Common Stock of Bridgeline Software, Inc.,
                to be
                issued to the underwriters.10.66
            
            
            Employment
                Agreement with Russell Klitchman (incorporated by reference to Exhibit
                2.2
                to our Current Report on Form 8-K filed on September 5,
                2007)**




-
          49
          -




10.67
            
            
            Employment
                Agreement with Steven Saraceno (incorporated by reference to Exhibit
                2.3
                to our Current Report on Form 8-K filed on September 5,
                2007)**21.1
            
            
            Subsidiaries
                of the Registrant31.1
            
            
            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.








*
            Incorporated
                by reference to the similarly numbered exhibit to our Registration
                Statement on Form S-B2, File
                  No. 333-139298.**
            Management
                contract or compensatory plan












**Item
      14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES**





Information
      required by this Item 14 of Form 10-KSB is hereby incorporated by reference
      to
      the information in our definitive proxy statement to be filed within 120 days
      after the close of our fiscal year.














































-
          50
          -


**SIGNATURES**






Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.








**BRIDGELINE
                SOFTWARE, INC.**
              a
                  Delaware corporationBy:
            /s/ Thomas
              MassieName:
                Thomas MassieTitle:  
                Chief Executive Officer and Director





In
      accordance with the requirements of the Securities Act of 1933, as amended,
      this
      annual report on Form 10-KSB has been signed by the following persons in the
      capacities with Bridgeline Software, Inc., and on the dates
      indicated.




Signature
            
            Title
            
            Date/s/
              Thomas Massie
            
            Chief
                Executive Officer and Director
            
            December
                21, 2007Thomas
                Massie
            
            (Principal
                Executive
                Officer)/s/
              Gary Cebula
            
            Chief
                Financial Officer (Principal
            
            December
                21, 2007Gary
                Cebula
            
            Financial
                Officer)/s/
              Timothy S. O’Neil
            
            Chief
                Accounting Officer (Principal
            
            December
                21, 2007Timothy
                S. O’Neil
            
            Accounting
                Officer)/s/
              John Cavalier
            
            Director
            
            December
                21, 2007John
                Cavalier/s/
              William Coldrick
            
            Director
            
            December
                21, 2007William
                Coldrick


/s/
              Kenneth Galaznik
            
            Director
            
            December
                21, 2007Kenneth
                Galaznik/s/
              Robert Hegarty
            
            Director
            
            December
                21, 2007Robert
                Hegarty








-
          51
          -




**Exhibit
      Index**





21.1
            
            
            Subsidiaries
                of the Registrant31.1
            
            
            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.

















































-
          52
          -