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 the impact of the weakness in the U.S. and international economies on our business, our inability to manage our future growth effectively or profitably, fluctuations in our revenue and quarterly results, our license renewal rate, the impact of competition and our ability to maintain margins or market share, the limited market for our common stock, the volatility of the market price of our common stock, the performance of our products, our ability to respond to rapidly evolving technology and customer requirements, our ability to protect our proprietary technology, the security of our software, our dependence on our management team and key personnel, our ability to hire and retain future key personnel, or our ability to maintain an effective system of internal controls. These and other risks are more fully described herein and in 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
Bridgeline Digitalenables its customers to maximize the performance of their mission critical websites, intranets, and online stores. Bridgelineis the developer of the award-winning iAPPS® Web Engagement Management (WEM) product platform and related digital solutions. The iAPPS platform deeply integrates web content management, eCommerce, eMarketing, social media management and web analytics capabilities within the heart of websites or online stores to help marketers deliver web experiences that attract, engage, and convert their customers across all digital channels. Bridgeline'siAPPS platform combined with its digital services assists customers in maximizing on-line revenue, improving customer service and loyalty, enhancing employee knowledge, and reducing operational costs. In fiscal 2012 Bridgeline Digitalannounced the release of iAPPSds ("distributed subscription"), a platform that empowers franchise and large dealer networks with state-of-the-art web engagement management platform that provides superior oversight of corporate branding while allowing franchises to modify local content and execute local digital marketing initiatives. iAPPSds deeply integrates content management, eCommerce, eMarketing, social media management and web analytics and is a self-service web platform that is offered to each authorized franchise or dealer for a monthly subscription fee. On August 1, 2013, we acquired franchise web platform developer ElementsLocal, expanding Bridgeline Digital'spresence in the franchise market place. Please see Acquisitions section for more detail on the ElementsLocal acquisition. The iAPPS platform is delivered either through a cloud-based SaaS("Software as a Service") multi-tenant business model, whose flexible architecture provides customers with state of the art deployment providing maintenance, daily technical operation and support, or via a traditional perpetual licensing business model, in which the iAPPS software resides on a dedicated server in either the customer's facility or Bridgeline'sco-managed hosting facility. In 2013, KMWorld Magazine Editors selected Bridgeline Digitalas one of the 100 Companies That Matter in Knowledge Management and also selected iAPPS as a Trend Setting Product in 2012. iAPPS Content Manager and iAPPS Commerce were selected as finalists for the 2013 CODiE Awards for Best Content Management Solution and Best Electronic Commerce Solution, globally. In 2013 the Internet Advertising Competitionhonored Bridgeline Digitalwith three awards for iAPPS customer websites. In addition, in 2013 Bridgeline Digitalwon fifteen Horizon Interactive Awards for outstanding development of web applications and websites and B2B Magazinehas selected Bridgeline Digitalas one of the Top Interactive Technology companies in the United States.
Locations The Company's corporate office is located in
Burlington, Massachusetts. The Company maintains regional field offices serving the following geographical locations: Atlanta, Baltimore, Boston, Chicago, Dallas, Denver, New York, San Diego, San Luis Obispoand Tampa. The Company has one wholly-owned subsidiary, Bridgeline Digital Pvt. Ltd.located in Bangalore, India. Sales and Marketing Bridgelineemploys a direct sales force and each sale takes on average 180 days to complete. Each franchise/large dealer network sale takes on average 365 days to complete. Our direct sales force focuses its efforts selling to medium-sized and large companies. These companies are generally categorized in the following vertical markets: (i) financial services; (ii) franchises/large dealer networks; (iii) retail brand names; (iv) health services and life sciences; (v) technology (software and hardware); and (vi) associations and foundations. We have ten geographic locations in the United Stateswith full-time professional direct sales personnel. We have business development professionals dedicated to identifying and establishing strategic alliances for iAPPS and iAPPSds. In June 2012, Bridgelineannounced a strategic alliance with UPS Logistics. Bridgelineand UPS Logistics signed a multi-year agreement to offer B2B and B2C eCommerce web stores with an end-to-end eCommerce offering comprised of Bridgeline'seCommerce Fulfilled™ solution and UPS Logistics and fulfillment services. The combined Bridgelineand UPS Logistics offering provides customers with the ability to manage the eCommerce and supply chain fulfillment needs and was designed to benefit mid-market and larger online web stores who seek end to end solutions. In July of fiscal 2012 Bridgelinesigned a multi-year agreement with The UPS Stores, a national franchise network of over 4,300 locations who license the iAPPSds platform. In July of 2013 we signed a multi-year agreement with a national provider of outsourced sales services with over 300 locations. In August of 2013 we added national brand names such as Sport Clips®, Glass Doctor® and Maaco® to our list of franchise customers via the ElementsLocal acquisition.
We continue to pursue significant strategic alliances that will enhance the sales and distribution opportunities of iAPPS related intellectual property.
During the fiscal year ended
September 30, 2013we completed one acquisition. On August 1, 2013, we completed the acquisition of ElementsLocal, a Californiabased developer of an online SaaSplatform for the franchise marketplace. ElementsLocal had over 3,200 franchises on its platform. We acquired all of the outstanding capital stock of ElementsLocal for consideration consisting of (i) $463 thousandin cash; (ii) $604 thousandin shares of Bridgeline Digitalcommon stock (valued at $1.15per share);(iii) assumption of $188 thousandof indebtedness; and (iv) contingent consideration of up to $904 thousandin cash and $396 thousandin shares of Bridgeline Digitalcommon stock. The contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving a certain quarterly revenue target during the period. The contingent common stock payable each earnout period is determined by dividing $33 thousandby the greater of: (i) the average closing price for Bridgline Digitial common stock for the 30 day trading period preceding the end of the earnout period, or (ii) $1.17. To the extent that a quarterly revenue target is not met in a particular quarter, the earn-out period will be extended for up to four additional quarters. During the fiscal year ended September 30, 2012we completed two acquisitions. On October 3, 2011, we completed the acquisition of Magnetic Corporation("Magnetic"), an interactive technology company based in Tampa, Florida. We acquired all of the outstanding capital stock of Magnetic for consideration consisting of (i) $150 thousandin cash (ii) assumption of $130 thousandof indebtedness; and (iii) contingent consideration of up to $600 thousandin cash and 166,666 shares of Bridgeline Digitalcommon stock. The contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving certain quarterly revenue and quarterly operating income targets during the period. The contingent common stock has been issued and is being held in escrow pending satisfaction of the applicable targets. To the extent that either the quarterly revenue targets or the quarterly operating income targets are not met in a particular quarter, the earn-out period will be extended for up to four additional quarters. 20
May 31, 2012, we completed the acquisition of MarketNet, Inc.("MarketNet"), an interactive technology company based in Dallas, Texas. Bridgelineacquired all of the outstanding capital stock of MarketNet for consideration consisting of (i) $20 thousandin cash; (ii) assumption of debt of $244 thousand; and (ii) contingent consideration of up to $650 thousandin cash and 204,331 shares of Bridgeline Digitalcommon stock. This contingent consideration is payable quarterly over the 12 consecutive calendar quarters following the acquisition, contingent upon the acquired business achieving certain quarterly revenue and quarterly operating income targets during the period. To the extent that either the quarterly revenue target or the quarterly operating income target is not met in a particular quarter, the earn-out period will be extended for up to four additional quarters. MarketNet is also eligible to earn additional bonus equity consideration of 200,000 shares, if annual net revenues of the acquired business exceed a certain threshold in any fiscal year through September 30, 2015. The contingent common stock has been issued and is being held in escrow pending satisfaction of the applicable targets.
Each of ElementsLocal, Magnetic and MarketNet's operating results are reflected in the condensed consolidated financial statements as of the acquisition date.
We may make additional acquisitions in the foreseeable future. These potential acquisitions are consistent with our iAPPS platform distribution strategy and growth strategy by providing
Bridgelinewith new geographical distribution opportunities, an expanded customer base, an expanded sales force and an expanded developer force. In addition, integrating acquired companies into our existing operations allows us to consolidate the finance, human resources, legal, marketing, research and development of the acquired businesses with our own internal resources, hence reducing the aggregate of these expenses for the combined businesses and resulting in improved operating results. Customer Information We currently have over 2,500 active customers. For the years ended September 30, 2013and 2012 no one customer represented 10% or more of the Company's total revenue.
Summary of Results of Operations
Total revenue for the fiscal year ended
September 30, 2013("fiscal 2013") decreased to $24.5 millionfrom $26.3 millionfor the fiscal year ended September 30, 2012("fiscal 2012"). Loss from operations for fiscal 2013 was ($3.2) millioncompared with loss from operations of ($602) thousandfor fiscal 2012. We had a net loss for fiscal 2013 of ($3.6) millioncompared with a net loss of ($946) thousandfor fiscal 2012. Loss per share for fiscal 2013 was ( $0.23) compared with loss per share of ( $0.07) for fiscal 2012. Highlights of Fiscal 2013 Financial ? Total iAPPS related revenue increased 13% to $18.8 millionin fiscal 2013 from $16.6 millionin fiscal 2012
? Total subscription and perpetual license revenue increased
or 59%, compared to fiscal 2012 ? Recurring revenue, which reflects amounts that are contractually due to
in fiscal 2012 ? Non-iAPPS related revenue decreased 44%, or
$4.3 million, in fiscal 2013 compared to fiscal 2012 Acquisitions, and Product Enhancements ? In the fourth quarter of fiscal 2013, we acquired ElementsLocal, a
franchise web platform developer, expanding our presence in the franchise
? In the third quarter of fiscal 2012
which offered cross-channel interface, personalized to the user and their
tasks, mobile & tablet friendly editing for publishing content, video publishing, built-in translation services and other enhancements that allow users to add or change content without needing a developer RESULTS OF OPERATIONS Year Ended September 30, $ % (dollars in thousands) 2013 2012 Change Change Revenue
Digital engagement services iAPPS digital engagement services
9 % % of total revenue 60 % 51 % Other digital engagement services 3,853 7,775 (3,922 ) (50 %) % of total revenue 16 % 30 % Subtotal digital engagement services 18,586 21,268 (2,682 ) (13 %) % of total revenue 76 % 81 % Managed service hosting 1,921 2,517 (596 ) (24 %) % of total revenue 8 % 10 % Subscription and perpetual licenses 4,000 2,511 1,489 59 % % of total revenue 16 % 9 % Total revenue 24,507 26,296 (1,789 ) (7 %) Cost of revenue Digital engagement services iAPPS digital engagement cost 7,808 6,342 1,467 23 % % of iAPPS digital engagement revenue 53 % 47 % Other digital engagement cost 2,306 4,607 (2,301 ) (50 %) % of other digital engagement revenue 60 % 59 % Subtotal digital engagement services 10,114 10,949 (834 ) (8 %) % of digital engagement revenue 54 % 51 % Managed service hosting 317 372 (55 ) (15 %) % of managed service hosting 17 % 15 % Subscription and perpetual licenses 1,108 450 658 146 % % of subscription and perpetual licenses revenue 28 % 18 % Total cost of revenue 11,539 11,771 (231 ) (2 %) Gross profit 12,968 14,525 (1,558 ) (11 %) Gross profit margin 52.9 % 55.2 % Operating expenses Sales and marketing 8,593 7,730 863 11 % % of total revenue 35 % 29 % General and administrative 4,474 3,931 543 14 % % of total revenue 18 % 15 % Research and development 1,365 1,456 (91 ) (6 %) % of total revenue 6 % 6 % Depreciation and amortization 1,690 1,729 (39 ) (2 %) % of total revenue 7 % 7 % Impairment of intangible asset - 281 (281 ) NA % of total revenue 0 % 1 % Total operating expenses 16,122 15,127 995 7 % % of total revenue 66 % 58 % Loss from operations (3,154 ) (602 ) (2,553 ) 424 % Interest expense, net (273 ) (276 ) 3 (1 %) Loss before income taxes (3,427 ) (878 ) (2,550 ) 291 % Provision for income taxes 171 68 103 151 % Net loss
$ (3,598 ) $ (946 ) $ (2,653 )281 % Adjusted EBITDA $ (712 ) $ 1,964 $ (2,677 )(136 %) 22
Our revenue is derived from three sources: (i) digital engagement services (ii) managed service hosting and (iii) subscription and perpetual licenses.
Digital Engagement Services Digital engagement services revenue is comprised of iAPPS digital engagement services and other services generated from non iAPPS related engagements. Total revenue from digital engagement services decreased
$2.7 million, or 13% to $18.6 millionfor the year ended September 30, 2013("fiscal 2013). The decrease in digital engagement services revenue compared to the prior period is due to a decrease in non-iAPPS digital engagement services revenues of $3.9 million, or 50%, when compared to the year ended September 30, 2012("fiscal 2012). However, revenue from iAPPS related digital engagement services increased $1.2 million, or 9% to $14.7 millioncompared to fiscal 2012 as we continue to concentrate on selling higher-margin iAPPS engagements to both new and existing customers. Digital engagement services revenue as a percentage of total revenue decreased to 76% from 81% in the prior period. The decrease is attributable to a larger mix of iAPPS license related revenue compared to sales of digital engagement services. Managed Service Hosting Revenue from managed service hosting decreased $596 thousandfrom $2.5 millionin fiscal 2012. The decrease is due to our efforts to engage with customers that are aligned with our core competencies and proactively end engagements with a number of smaller hosting customers obtained through previous acquisitions.
Managed services revenue as a percentage of total revenue decreased to 8% from 10% in fiscal 2013 due to the ending of engagements with smaller hosting customers obtained through previous acquisitions.
Subscription and Perpetual Licenses
Revenue from subscription and perpetual licenses increased
$1.5 million, or 59%, to $4.0 millionfrom $2.5 millionin fiscal 2012. The increase is due primarily to a higher amount of subscription license revenues from our new product, iAPPSds, and annual maintenance renewals.
Subscription and perpetual license revenue as a percentage of total revenue increased to 16% from 10% in fiscal 2012 due to the increase in subscription license revenues from our new product, iAPPSds, and annual maintenance renewals.
Costs of Revenue
Total cost of revenue for the fiscal year ended
Cost of Digital Engagement Services
Cost of digital engagement services decreased
$0.8 million, or 8%, compared to fiscal 2012. The cost of total digital engagement services as a percentage of total digital engagement services revenue increased to 54% from 51% in fiscal 2012. This increase is a result of the decrease in non-iAPPS related revenue compared to fiscal 2012. Cost of iAPPS digital engagement services increased $1.5 millionto $7.8 million, an increase of 23% when compared to fiscal 2012. The increase is a result of iAPPS digital engagement service revenue increasing 9% when compared to fiscal 2012. Cost of iAPPS digital engagement services as a percentage of iAPPS digital engagement revenue increased to 53% from 47% due to unused capacity of digital engagement personnel in the third quarter of fiscal 2013 compared to the prior year. 23
-------------------------------------------------------------------------------- Cost of other digital engagement services for fiscal 2013 decreased
$2.3 millionto $2.3 million, a decrease of 50% when compared to fiscal 2012. The decrease is due to reducing personnel costs in line with non-iAPPS revenue decrease. The cost of other digital engagement services as a percentage of other digital engagement service revenue increased to 60% in fiscal 2013 from 59% in fiscal 2012.
Cost of Managed Service Hosting
Cost of managed service hosting decreased
$55 thousandor 15% when compared to fiscal 2012. The decrease in the amount of managed service hosting costs is due to efforts to streamline costs by ending engagements with non-iAPPS related customers, and our continued investments in our co-managed network operation center to support our core iAPPS customer base. The cost of managed services as a percentage of managed services revenue increased to 17% from 15% in fiscal 2012. This increase was due to managed service hosting revenue from low margin hosting customers decreasing faster than the addition of new, iAPPS related managed service hosting agreements for perpetual licenses.
Cost of Subscription and Perpetual License
Cost of subscription and perpetual licenses increased
$658 thousandwhen compared to fiscal 2012. This is primarily due to the increase in subscription and perpetual license revenue as more of the direct costs associated with our co-managed network operations center are being used to support subscription license revenue, software amortization costs of $270 thousandrelated to significant enhancements to our iAPPS platform that began in April 2013, investments made in our co-managed network operations center during the period and, to a lesser extent, incremental costs on lower margin, non-iAPPS SaaSlicenses from the MarketNet and ElementsLocal acquisitions. The cost of subscription and perpetual licenses as a percentage of subscription and perpetual license revenue increased to 28% from 18% in fiscal 2012. This is primarily due to a decrease in perpetual license sales when compared to the prior period as perpetual licenses sales can be lumpy and have a significantly lower direct cost than subscription licenses and an increase in software amortization. We expect the increase in costs of subscription and perpetual licenses as a percentage of license revenue to be temporary and should begin to decrease in fiscal 2014 due to the acquisition of ElementsLocal and the expansion of our iAPPS customer base by selling more iAPPS licenses, including iAPPSds. Gross Profit
Gross profit decreased
Operating Expenses Sales and Marketing Expenses Sales and marketing expenses increased
$0.9 million, or 11%, compared to fiscal 2012. This increase is primarily attributable to increases associated with personnel and marketing costs related to our acquisitions of MarketNet and ElementsLocal, including personnel costs and marketing costs to promote our iAPPS products. Sales and marketing expense as a percentage of total revenue increased to 35% compared to 29% in fiscal 2012. This increase was due to the decrease in non-iAPPS related digital engagement revenue.
General and Administrative Expenses
General and administrative expenses increased
$0.5 million, or 14%, compared to fiscal 2012. The increase was primarily due to costs associated with the settlement of Bridgeline Digital, Inc.vs. e.Magination network, LLC and its principal owner, Daniel Roche, which is described in further detail in Legal Proceedings and fiscal 2012 reflecting a larger reduction of expense for changes in estimate of settlement of contingent earnout payments from prior acquisitions that, in our estimation, will not be achieved. 24 -------------------------------------------------------------------------------- General and administrative expense as a percentage of revenue increased to 18% compared to 15% in fiscal 2012. General and administrative expenses as a percentage of revenue increased due to the decrease in non-iAPPS related digital engagement revenue. Research and Development Research and development expense decreased by $91 thousand, or 6%, compared with fiscal 2012, after capitalization of software development costs. Capitalized software development costs were $640 thousandand $480 thousandfor fiscal 2013 and 2012, respectively. The decrease is due to the aforementioned increase in capitalized software and development costs related to enhancements to our existing iAPPS platform.
Depreciation and Amortization
Depreciation and amortization expense decreased by
$39 thousand, or 2%, compared to fiscal 2012. This decrease is primarily attributable to a decrease in amortization for intangibles acquired before fiscal 2010 that reached the end of their useful life, offset by additional depreciation expense related to investments made in our co-managed network operation center. Depreciation and amortization was 7% of total revenue for both fiscal 2013 and fiscal 2012.
Impairment of Intangible Asset
We incurred a charge to operations of
$281 thousandfor impairment charges related to an intangible asset assumed from our fiscal 2010 acquisition of e.Magination and its wholly-owned subsidiary e. Magination IG, LLC. In the first quarter of fiscal 2012, the Company stopped servicing low margin non-iAPPS opportunities acquired from e. Magination IG, LLC. It was therefore determined that a portion of the customer list was impaired. Loss from Operations The loss from operations was ($3.2) millionfor fiscal 2013 compared to a loss from operations of ($602) thousandfor fiscal 2012. This increase in loss from operations is a result of the foregoing. Provision for Income Taxes The provision for income tax expense was $171 thousandfor fiscal 2013 compared to $68 thousandfor fiscal 2012. Income tax expense represents the estimated liability for Federal, state and foreign income taxes owed by the Company, including the alternative minimum tax. This increase is due to deferred tax liabilities related to indefinite lived, tax deductible assets from two previous acquisitions. The Company has net operating loss carryforwards and other deferred tax benefits that are available to offset future taxable income. A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Accordingly, the Company has established a full valuation allowance against its net deferred tax asset at September 30, 2013and 2012. The Federal net operating loss (NOL) carryforward of approximately $8.0 millionas of September 30, 2013expires on various dates through 2028. Internal Revenue Code Section 382 places a limitation on the amount of taxable income which can be offset by NOL carryforwards after a change in control of a loss corporation. Generally, after a change in control, a loss corporation cannot deduct NOL carryforwards in excess of the Section 382 Limitation. Due to these "change of ownership" provisions, utilization of NOL carryforwards may be subject to an annual limitation regarding their utilization against taxable income in future periods. The Company has not performed a Section 382 analysis. However, if performed, Section 382 may be found to limit potential future utilization of our NOL carryforwards. Adjusted EBITDA
We also measure our performance based on a non-GAAP ("Generally Accepted Accounting Principles") measurement of earnings before interest, taxes, depreciation, and amortization and before stock-based compensation expense and impairment of goodwill and intangible assets ("Adjusted EBITDA").
25 -------------------------------------------------------------------------------- We believe this non-GAAP financial measure of Adjusted EBITDA is useful to management and investors in evaluating our operating performance for the periods presented and provides a tool for evaluating our ongoing operations. Adjusted EBITDA, however, is not a measure of operating performance under GAAP and should not be considered as an alternative or substitute for GAAP profitability measures such as (i) income from operations and net income, or (ii) cash flows from operating, investing and financing activities, both as determined in accordance with GAAP. Adjusted EBITDA as an operating performance measure has material limitations since it excludes the financial statement impact of income taxes, net interest expense, amortization of intangibles, depreciation, other amortization and stock-based compensation, and therefore does not represent an accurate measure of profitability. As a result, Adjusted EBITDA should be evaluated in conjunction with net income for a complete analysis of our profitability, as net income includes the financial statement impact of these items and is the most directly comparable GAAP operating performance measure to Adjusted EBITDA. Our definition of Adjusted EBITDA may also differ from and therefore may not be comparable with similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. Because of the limitations that Adjusted EBITDA has as an analytical tool, investors should not consider it in isolation, or as a substitute for analysis of our operating results as reported under GAAP. The following table reconciles net loss (which is the most directly comparable GAAP operating performance measure) to EBITDA, and EBITDA to Adjusted EBITDA: Year Ended September 30, 2013 2012 Net loss
$ (3,598 ) $ (946 )Provision for income taxes 171 68 Interest expense, net 273 276 Amortization of intangible assets 511 750 Impairment of intangible assets - 281 Depreciation 1,179 979 EBITDA (1,464 ) 1,408 Other amortization 314 170 Stock-based compensation 438 386 Adjusted EBITDA $ (712 ) $ 1,964Adjusted EBITDA was ($0.7) millionfor fiscal 2013 compared with $2.0 millionfor fiscal 2012. This was due to the decrease in non-iAPPS related application development revenue compared to fiscal 2012.
Liquidity and Capital Resources
Cash Flows Operating Activities Cash used in operating activities was
$77 thousandfor fiscal 2013, compared to cash provided by operating activities of $279 thousandfor fiscal 2012. This decrease in cash from operating activities is primarily attributable to lower net income for fiscal 2013, offset by adjustments to reconcile net loss to net cash used in operating activities and an increase in deferred revenue as the majority of our iAPPSds customers elect annual subscriptions. Investing Activities Cash used in investing activities was $2.3 millionfor fiscal 2013 compared to $2.0 millionfor fiscal 2012. The increase was primarily due to the cash consideration for the acquisition of ElementsLocal in fiscal 2013 compared to MarketNet and Magnetic. The decrease in cash used for equipment and improvements was offset by increases in amounts capitalized for software development and contingent acquisition payments. Financing Activities Cash provided by financing activities was $3.0 millionfor fiscal 2013 compared with $1.3 millionfor fiscal 2012. The increase was due to the net proceeds from the sale of subordinated convertible debt. At September 30, 2013, the Company had an outstanding balance under the credit line of $3.5 millionat 9.25% (Silicon Valley Bank's prime rate was 4.00%) and $272 thousandon its term loam at 9.75%. 26
Capital Resources and Liquidity Outlook
December 2013, we entered into a Loan and Security Agreement with BridgeBank (the "BridgeBank Loan Agreement"). The Loan Agreement has a 27 month which expires on March 31, 2016. The Loan Agreement provides for up to $5 millionof revolving credit advances which may be used for acquisitions and working capital purposes. Borrowings are limited to the lesser of (i) $5 millionand (ii) 80% of eligible receivables as defined. We can borrow up to $1.0 millionin out of formula borrowings for specified periods of time. Borrowings bear interest at BridgeBank's prime plus 1.00%. We pay an annual commitment fee of 0.25%. Borrowings are secured by all of our assets and all intellectual property. We are also required to comply with certain financial covenants. The BridgeBank Loan Agreement replaced our prior credit facility with Silicon Valley Bank ("SVB"), which expires on December 31, 2013. At September 30, 2013, the Company had an outstanding balance under the SVB credit line of $3.5 millionand $272 thousandoutstanding on the term loan, of which $1.0 millionand $272 thousandwas repaid after September 30, 2013, respectively. As of the date of the BridgeBank Loan Agreement the Company had an outstanding balance under the SVB credit line of $2.5 million. In November 2013, we amended our loan agreement ("the November 2013Amendment") with SVB. The November 2013Amendment accelerated the maturity date of the line of credit to December 31, 2013. On September 30, 2013, Bridgeline Digitalentered into a Note Purchase Agreement (the "Purchase Agreement") with accredited investors pursuant to which Bridgeline Digitalsold an aggregate of $2,000,000of 10% secured subordinated convertible notes (the "Notes"). Taglich Brothers, Inc.served as placement agent for the transaction. The gross proceeds to Bridgeline Digitalat the closing of this private placement were $2,000,000. The Notes accrue interest at a rate of ten percent (10%) per annum and mature on September 30, 2016. Interest on the Notes is payable quarterly in cash. The Notes are convertible at the election of the holder into shares of common stock of Bridgeline Digitalat a conversion price equal to $1.30per share at any time prior to the maturity date, provided that no holder may convert the Notes if such conversion would result in the holder beneficially owning more than 4.99% of the number of shares of Bridgeline Digitalcommon stock outstanding at the time of conversion. We amended the Purchase Agreement in November 2013and sold another $1,000,000of 10% secured subordinated convertible notes with the same terms. The Notes are secured by all of Bridgeline Digital'sassets. The security interest granted to the holders of the Notes is subordinate to the security interest held by Bridgeline Digital'ssenior lender, BridgeBank. Bridgeline Digitalmay prepay any portion of the principal amount of the outstanding Notes at any time, provided that if Bridgeline Digitalprepays any principal on or before September 30, 2014, Bridgeline Digitalwill pay a penalty equal to 10% of the principal amount being prepaid. Under certain circumstances Bridgeline Digitalhas the right to force conversion of the Notes into shares of Bridgeline Digitalcommon stock in the event the Bridgeline Digitalcommon stock trades in excess of $2.60per share for 20 trading days out of any 30 trading day period. In May 2012, we assumed two promissory notes in connection with the acquisition of MarketNet, Inc.The first promissory note in the amount of $63 thousandis payable in eight equal installments of $8 thousand, including interest accrued at 5%, and matures in May 2014. The first installment was paid in July 2012. The second promissory note in the amount of $80 thousandis due in twelve equal installments of $7 thousand, including interest accrued at 5%, and matures in May 2015. The first installment was paid in July 2012. On May 31, 2012, the Company sold 2,173,913 shares of common stock at $1.15per share for gross proceeds of $2.5 millionin a private placement. Net proceeds after offering expenses were approximately $2.2 million. On June 19, 2013, the Company sold 2,300,000 shares of common stock at $1.00per share for gross proceeds of $2.3 millionin a private placement. Net proceeds after offering expenses were approximately $2.0 million. We believe that cash generated from operations and proceeds from the bank line of credit, the sale of common stock and sale of subordinated convertible debt will be sufficient to fund the company's working capital and capital expenditure needs in the foreseeable future. Inflation
Inflationary increases can cause pressure on wages and the cost of benefits offered to employees. We believe that the relatively moderate rates of inflation in recent years have not had a significant impact on our operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, financings or other relationships with unconsolidated entities or other persons, other than our operating leases and contingent acquisition payments.
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. Therefore, we are 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 Statesand India. Other contractual obligations include (i) certain equipment acquired under capitalized lease agreements; (ii) a subordinated promissory notes in the amount of $500 thousandand $143 thousandpayable quarterly over three years beginning January 2011and July 2013, respectively, with interest at 1% and 5%, respectively, per annum; (iii) contingent earnouts in the amount of $600 thousandpayable in cash beginning with the quarter ended December 31, 2012based on the achievement of revenue and earnings targets and 166,666 shares of Bridgelinecommon stock in connection with the Magnetic acquisition; (iv) contingent earnouts in the amount of $650 thousandpayable in cash beginning with the quarter ended September 30, 2012based on the achievement of revenue and earnings targets and 404,331 shares of Bridgelinecommon stock in connection with the MarketNet acquisition; and (v) contingent earnouts in the amount of $904 thousandpayable in cash beginning with the quarter ended September 30, 2012based on the achievement of revenue targets and 338,461 shares of Bridgelinecommon stock in connection with the ElementsLocal acquisition. Our contractual obligations extend through FY 2019 and pertain to two leased facilities located in the United States.
The following summarizes our contractual obligations:
For the Year Ending September 30, (in thousands) 2014 2015 2016 2017 2018 and Total thereafter Payment obligations by year Line of credit
$ 800$ - $ 2,704$ - $ - $ 3,504Term loan (a) 272 - - - - 272 Subordinated convertible debt - - 2,000 - - 2,000 Subordinated promissory notes 93 21 - - - 114 Capital leases 397 339 205 - - 941 Operating leases (b) 1,310 1,197 1,100 912 1,230 5,749 Contingent acquisition payments (c) 561 507 443
- - 1,511 Total
$ 3,433 $ 2,064 $ 6,452 $ 912 $ 1,230 $ 14,091(a) Paid in full in October 2013 (b) Net of sublease income (c) The contingent acquisition payments are maximum potential earn-out consideration payable to former owners of acquired companies. Amounts actually paid may be less. Contingent acquisition payments do not include $0.8 millionof potential common stock issuable upon achievement of certain revenue and earnings targets. Critical Accounting Policies These critical accounting policies and estimates by our management should be read in conjunction with Note 2 Summary of Significant Accounting Policies to the Consolidated Financial Statements that were prepared in accordance with accounting principles generally accepted in the United States of America("US GAAP"). 28
-------------------------------------------------------------------------------- The preparation of financial statements in accordance US GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses in the reporting period. We regularly make estimates and assumptions that affect the reported amounts of assets and liabilities. The most significant estimates included in our 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. 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:
? Revenue recognition ? Allowance for doubtful accounts;
? Accounting for cost of computer software to be sold, leased or otherwise
marketed; ? Accounting for goodwill and other intangible assets; and ? Accounting for stock-based compensation. Revenue Recognition Overview We enter into arrangements to sell digital engagement services (professional services), software licenses or combinations thereof. Revenue is categorized into (i) digital engagement services; (ii) managed service hosting; and (iii) subscriptions and perpetual licenses. We recognize revenue as required by the Revenue Recognition Topic of the Codification. Revenue is generally 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. During fiscal 2010, we began to develop a reseller channel to supplement our direct sales force for our iAPPS platform. We continue to develop this reseller channel. Resellers are generally located in territories where we do not have a direct sales force. Customers generally sign a license agreement directly with us. Revenue from perpetual licenses sold through resellers is recognized upon delivery to the end user as long as evidence of an arrangement exists, collectability is probable, and the fee is fixed and determinable. Revenue for subscription licenses is recognized monthly as the services are delivered. Digital Engagement Services Digital engagement services include professional services primarily related to the Company's web development solutions that address specific customer needs such as site audits, digital strategy, design, information architecture, search engine optimization, search engine marketing, directory services, project management, .NET development, and third party system integration. 29 -------------------------------------------------------------------------------- Digital engagement services are contracted for on either a fixed price or time and materials basis. For its fixed price engagements, after assigning the relative selling price to the elements of the arrangement, the Company applies the proportional performance model (if not subject to contract accounting) to recognize revenue based on cost incurred in relation to total estimated cost at completion. The Company has determined that labor costs are the most appropriate measure to allocate revenue among reporting periods, as they are the primary input when providing application development services. Customers are invoiced monthly or upon the completion of milestones. For milestone based projects, since milestone pricing is based on expected hourly costs and the duration of such engagements is relatively short, this input approach principally mirrors an output approach under the proportional performance model for revenue recognition on such fixed priced engagements. For time and materials contracts, revenues are recognized as the services are provided. Digital engagement services also include retained professional services contracted for on an "on call" basis or for a certain amount of hours each month. Such arrangements generally provide for a guaranteed availability of a number of professional services hours each month on a "use it or lose it" basis. For retained professional services sold on a stand-alone basis 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. Managed Service Hosting Managed service hosting includes hosting arrangements that provide for the use of certain hardware and infrastructure for those customers who do not wish to host our applications independently. Hosting agreements are either annual or month-to-month arrangements that provide for termination for convenience by either party generally upon 30-days notice. Revenue is recognized monthly as the hosting services are delivered. Set up fees paid by customers in connection with managed hosting services are deferred and recognized ratably over the longer of the life of the hosting period or the expected lives of customer relationships. We continue to evaluate the length of the amortization period of the set up fees as we gain more experience with customer contract renewals.
Subscriptions and Perpetual Licenses
The Company licenses its software on either a perpetual or subscription basis. Customers who license the software on a perpetual basis receive rights to use the software for an indefinite time period and an option to purchase Post-Customer Support ("PCS"). For arrangements that consist of a perpetual license and PCS, as long as Vendor Specific Objective Evidence ("VSOE") exists for the PCS, then PCS revenue is recognized ratably on a straight-line basis over the period of performance and the perpetual license is recognized on a residual basis. Under the residual method, the fair value of the undelivered elements are deferred and the remaining portion of the arrangement fee is allocated to the delivered elements and recognized as revenue, assuming all other revenue recognition criteria have been met. Customers may also license the software on a subscription basis, which can be described as "Software as a Service" or "SaaS".
SaaSis a model of software deployment where an application is hosted as a service provided to customers across the Internet. Subscription agreements include access to the Company's software application via an internet connection, the related hosting of the application, and PCS. Customers receive automatic updates and upgrades, and new releases of the products as soon as they become available. Customers cannot take possession of the software. Subscription agreements are either annual or month-to-month arrangements that provide for termination for convenience by either party upon 90 days notice. Revenue is recognized monthly as the services are delivered. Set up fees paid by customers in connection with subscription services are deferred and recognized ratably over the longer of the life of subscription period or the expected lives of customer relationships. We continue to evaluate the length of the amortization period of the set up fees as we gain more experience with customer contract renewals.
Multiple Element Arrangements
In accounting for multiple element arrangements, we follow either ASC Topic 605-985
In accordance with this standard, each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting if both of the following criteria are met (1) the delivered item has value to the customer on a standalone basis and (2) for an arrangement that includes a right of return relative to the delivered item, delivery or performance of the delivered item is considered probable and within our control. If the deliverables do not meet the criteria for being a separate unit of accounting then they are combined with a deliverable that does meet that criterion. The accounting guidance also requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The accounting guidance also establishes a selling price hierarchy for determining the selling price of a deliverable. We determine selling price using VSOE, if it exists; otherwise, we use Third-party Evidence ("TPE"). If neither VSOE nor TPE of selling price exists for a unit of accounting, we use Estimated Selling Price ("ESP"). 30
-------------------------------------------------------------------------------- VSOE is generally limited to the price at which we sell the element in a separate stand-alone transaction. TPE is determined based on the prices charged by our competitors for a similar deliverable when sold separately. It is difficult for us to obtain sufficient information on competitor pricing, so we may not be able to substantiate TPE. If we cannot establish selling price based on VSOE or TPE then we will use ESP. ESP is derived by considering the selling price for similar services and our ongoing pricing strategies. The selling prices used in our allocations of arrangement consideration are analyzed at minimum on an annual basis and more frequently if our business necessitates a more timely review. We have determined that we have VSOE on our
SaaSofferings, certain application development services, managed hosting services, and PCS because we have evidence of these elements sold on a stand-alone basis. When the Company licenses its software on a perpetual basis in a multiple element arrangement that arrangement typically includes PCS and application development services, we follow the guidance of ASC Topic 605-985. In assessing the hierarchy of relative selling price for PCS, we have determined that VSOE is established for PCS. VSOE for PCS is based on the price of PCS when sold separately, which has been established via annual renewal rates. Similarly, when the Company licenses its software on a perpetual basis in a multiple element arrangement that also includes managed service hosting ("hosting"), we have determined that VSOE is established for hosting based on the price of the hosting when sold separately, which has been established based on renewal rates of the hosting contract. Revenue recognition for perpetual licenses sold with application development services are considered on a case by case basis. The Company has not established VSOE for perpetual licenses or fixed price development services and therefore in accordance with ASC Topic 605-985, when perpetual licenses are sold in multiple element arrangements including application development services where VSOE for the services has not been established, the license revenue is deferred and recognized over the largest measured deliverable. The Company has determined that services are not essential to the functionality of the software and it has the ability to make estimates necessary to apply proportional performance model. In those cases where perpetual licenses are sold in a multiple element arrangement that includes application development services where VSOE for the services has been established, the license revenue is recognized under the residual method and the application services are recognized upon delivery. In determining VSOE for the application development services element, the ability to separate the application development services from the software license and the value of the services when sold on a standalone basis are considered. The Company also considers the categorization of the services, the timing of when the services contract was signed in relation to the signing of the perpetual license contract and delivery of the software, and whether the services can be performed by others. The Company has concluded that its application development services are not required for the customer to use the product but, rather enhance the benefits that the software can bring to the customer. In addition, the services provided do not result in significant customization or modification of the software and are not essential to its functionality, and can also be performed by the customer or a third party. If an application development services arrangement does qualify for separate accounting, the Company recognizes the perpetual license on a residual basis. If an application development services arrangement does not qualify for separate accounting, the Company recognizes the perpetual license under the proportional performance model as described above. When subscription arrangements are sold with application development services, the Company uses its judgment as to whether the application development services qualify as a separate unit of accounting. When subscription service arrangements involve multiple elements that qualify as separate units of accounting, the Company allocates arrangement consideration in multiple-deliverable arrangements at the inception of an arrangement to all deliverables based on the relative selling price model in accordance with the selling price hierarchy, which includes: (i) VSOE when available; (ii) TPE if VSOE is not available; and (iii) ESP if neither VSOE or TPE is available. For those subscription arrangements sold with multiple elements whereby the application development services do not qualify as a separate unit of accounting, the application services revenue is recognized ratably over the subscription period. Subscriptions also include a PCS component, and the Company has determined that the two elements cannot be separated and must be recognized as one unit over the applicable service period. Set up fees paid by customers in connection with subscription arrangements are deferred and recognized ratably over the longer of the life of the hosting period or the expected lives of customer relationships, which generally range from two to three years. We continue to evaluate the length of the amortization period of the set up fees as we gain more experience with customer contract renewals and our newer product offerings. 31 --------------------------------------------------------------------------------
Customer Payment Terms Payment terms with customers typically require payment 30 days from invoice date. Payment terms may vary by customer but generally do not exceed 45 days from invoice date. Invoicing for digital engagement services are 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 in the month of service. 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 a concern 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, which is generally 30 days from the completion of work. In hosting arrangements, we 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.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts which represents estimated losses resulting from the inability, failure or refusal of our clients to make required payments. We analyze historical percentages of uncollectible accounts and changes in payment history when evaluating the adequacy of the allowance for doubtful accounts. We use an internal collection effort, which may include our sales and services groups as we deem appropriate. Although we believe that our allowances are adequate, if the financial condition of our clients deteriorates, resulting in an impairment of their ability to make payments, or if we underestimate the allowances required, additional allowances may be necessary, resulting in increased expense in the period in which such determination is made.
Accounting for Cost of
We charge research and development expenditures for technology development to operations as incurred. However, in accordance with Codification 985-20 Costs of Software to be Sold Leased or Otherwise Marketed , we capitalize certain software development costs subsequent to the establishment of technological feasibility. Based on our product development process, technological feasibility is established upon completion of a working model. Certain costs incurred between completion of a working model and the point at which the product is ready for general release is capitalized if significant. Once the product is available for general release, the capitalized costs are amortized in cost of sales. 32
Accounting for Goodwill and Intangible Assets
Goodwill is tested for impairment annually during the fourth quarter of every year and more frequently if events and circumstances indicate that the asset might be impaired. In assessing goodwill for impairment, an entity has the option to assess qualitative factors to determine whether events or circumstances indicate that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount. We assess goodwill at the consolidated level as one reporting unit. If this is the case, then performing the quantitative two-step goodwill impairment test is unnecessary. An entity can choose not to perform a qualitative assessment for any or all of its reporting units, and proceed directly to the use of the two-step impairment test. In assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we assess relevant events and circumstances that may impact the fair value and the carrying amount of a reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit's fair value or carrying amount involve significant judgments by management. These judgments include the consideration of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, events which are specific to
Bridgeline, and trends in the market price of our common stock. Each factor is assessed to determine whether it impacts the impairment test positively or negatively, and the magnitude of any such impact. For fiscal 2013 we performed the annual assessment of our goodwill during the fourth quarter of 2013, using the qualitative approach described above. Based on our qualitative assessment, we concluded that it was not more likely than not that the fair values of any of our reporting units were less than their carrying amounts, and therefore it was not necessary to perform the quantitative two-step impairment test. The key qualitative factors that led to our conclusion included the following: (i) our stock price of $1.10as of September 30, 2013did not materially change from the stock price of $1.20of September 30, 2012; (ii) the successful launch of iAPPSds in 2012 with our first iAPPSds customer, a franchisor with over 4,000 locations, and our strategic acquisition of ElementsLocal in 2013, has improved predictability of our forecasts by increasing contractually recurring revenue; and (iii) inputs from recent transactions within the technology sector, such as revenue multiples used to value transactions, have either remained steady since the fiscal 2012 assessment For fiscal 2012 we performed the annual assessment of our goodwill during the fourth quarter of fiscal 2012, using the qualitative approach described above. Based on our qualitative assessment, we concluded that it was not more likely than not that the fair values of any of our reporting units were less than their carrying amounts, and therefore it was not necessary to perform the quantitative two-step impairment test. The key qualitative factors that led to our conclusion included the following: (i) our stock price more than doubled to $1.20as of September 30, 2012; (ii) our strategic alliance with UPS Logistics and the successful launch of iAPPSds with our first iAPPSds customer, a franchisor with over 4,000 locations, has improved the predictability of our forecasts; and (iii) inputs from recent transactions within the technology sector, such a revenue multiples used to value transactions, have either remained steady or improved since the fiscal 2011 assessment.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation awards in accordance with the Compensation-Stock Topic of the Codification. Share-based payments (to the extent they are compensatory) are recognized in our consolidated statements of operations based on their fair values. We recognize stock-based compensation expense for share-based payments issued or assumed after
October 1, 2006that are expected to vest on a straight-line basis over the service period of the award, which is generally three years. We recognize the fair value of the unvested portion of share-based payments granted prior to October 1, 2006over the remaining service period, net of estimated forfeitures. In determining whether an award is expected to vest, we use an estimated, forward-looking forfeiture rate based upon our historical forfeiture rate and reduce the expense over the recognition period. Estimated forfeiture rates are updated for actual forfeitures quarterly. We also consider, each quarter, whether there have been any significant changes in facts and circumstances that would affect our forfeiture rate. Although we estimate forfeitures based on historical experience, actual forfeitures in the future may differ. In addition, to the extent our actual forfeitures are different than our estimates, we record a true-up for the difference in the period that the awards vest, and such true-ups could materially affect our operating results. We estimate the fair value of employee stock options using the Black-Scholes-Merton option valuation model. The fair value of an award is affected by our stock price on the date of grant as well as other assumptions including the estimated volatility of our stock price over the term of the awards and the estimated period of time that we expect employees to hold their stock options. The risk-free interest rate assumption we use is based upon United Statestreasury interest rates appropriate for the expected life of the awards. We use the historical volatility of our publicly traded options in order to estimate future stock price trends. In order to determine the estimated period of time that we expect employees to hold their stock options, we use historical trends of employee turnovers. Our expected dividend rate is zero since we do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future. The aforementioned inputs entered into the option valuation model we use to fair value our stock awards are subjective estimates and changes to these estimates will cause the fair value of our stock awards and related stock-based compensation expense we record to vary. 33
We record deferred tax assets for stock-based awards that result in deductions on our income tax returns, based on the amount of stock-based compensation recognized and the statutory tax rate in the jurisdiction in which we will receive a tax deduction.
Stock Options Activity (Repricing Plan)
October 28, 2011, the Company offered its employees the opportunity to have certain outstanding options modified by (i) reducing the grant exercise price to $0.67, the fair market value of the common stock as of the modification date and (ii) starting a new three year vesting schedule. The aggregate fair value of the modified options of approximately $90 thousandwas calculated using the difference in value between the original terms and the new terms as of the modification date. The incremental cost of the modified option over the original option will be recognized as additional compensation expense over the new three year vesting period beginning on the date of modification. This opportunity was generally limited to options issued subsequent to October 2008.