**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C.  20549**

----

**FORM 10–Q**

**(MarkOne)**
| ý | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|--------|---------------------------------------------------------------------------------------------------|

**For The Quarterly Period EndedSeptember 30, 2001****OR**
| o | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|----------------------------------------------------------------------------------------------------|

**FOR THETRANSITION PERIOD FROM _________TO ________**

**Commission file number 0–27794**

**SEGUE SOFTWARE, INC.******(Exact name of registrant as specified inits charter)

 

| **Delaware**                                                    |   | **95–4188982**                   |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |   | (I.R.S.  Employer Identification No.) |
|                                                            |   |                                  |
| **201 Spring Street Lexington,  MA 02421**                      |
| (Address  of principal executive offices)                       |

****Registrant's telephone number, including area code: **(781) 402-1000**

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such a shorter period that theregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days.  Yes ý  No o

Thenumber of shares of Registrant's Common Stock outstanding as of November 5,2001 was 9,454,446

 

**SEGUE SOFTWARE, INC.**

**FORM10-Q**

**FOR THEQUARTERLY PERIOD ENDED SEPTEMBER 30, 2001INDEX**
|       |                                                                                                                              |   |
|------------|-----------------------------------------------------------------------------------------------------------------------------------|--------|
| PART I.    | FINANCIAL INFORMATION                                                                                                             |   |
|       |                                                                                                                              |   |
| Item 1.    | Condensed  Consolidated Financial Statements:                                                                                     |   |
|       |                                                                                                                              |   |
|       | Condensed  Consolidated Balance Sheets September 30, 2001 (unaudited) and December 31,  2000 (audited)                       |   |
|       |                                                                                                                              |   |
|       | Condensed  Consolidated Statements of Operations (unaudited) three months and nine  months ended September 30, 2001 and 2000 |   |
|       |                                                                                                                              |   |
|       | Condensed  Consolidated Statements of Cash Flows (unaudited) nine months ended September  30, 2001 and 2000                       |   |
|       |                                                                                                                              |   |
|       | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                 |   |
|       |                                                                                                                              |   |
| Item  2.   | Management's  Discussion and Analysis of Financial Condition and Results of Operations                                            |   |
|       |                                                                                                                              |   |
| Item  3.   | Quantitative  and Qualitative Disclosures about Market Risk                                                                       |   |
|       |                                                                                                                              |   |
| PART II.   | OTHER INFORMATION                                                                                                                 |   |
|       |                                                                                                                              |   |
| Item 1.    | Legal Proceedings                                                                                                                 |   |
|       |                                                                                                                              |   |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                                                              |   |
|       |                                                                                                                              |   |
| Item 6.    | Exhibits and Reports  on Form 8-K                                                                                            |   |
|       |                                                                                                                              |   |
|       |                                                                                                                              |   |
| Signatures |                                                                                                                              |   |

**PART I. FINANCIAL INFORMATION**

**ITEM 1. CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**SEGUESOFTWARE, INC.CONDENSED CONSOLIDATED BALANCESHEETS(IN THOUSANDS EXCEPT PER SHARE DATA)**
|                                                                                                             |   | **September 30, 2001**

**(Unaudited)** |   | **December 31, 2000**

**(Audited)** |   |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                             |   |                                         |   |                                      |   |
| ASSETS                                                                                                           |   |                                         |   |                                      |   |
| Current  assets:                                                                                                 |   |                                         |   |                                      |   |
| Cash  and cash equivalents                                                                                       |   | $                                            | 3,378  |                                      | $      | 9,379 |   |
| Short-term  investments                                                                                          |   | 4,976                                        |   | 7,839                                     |   |
| Accounts  receivable, net of allowances of $851 and $665                                                         |   | 5,519                                        |   | 12,176                                    |   |
| Other  current assets                                                                                            |   | 1,597                                        |   | 1,710                                     |   |
| Total  current assets                                                                                            |   | 15,470                                       |   | 31,104                                    |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Property  and equipment, net                                                                                     |   | 4,278                                        |   | 5,774                                     |   |
| Goodwill,  net                                                                                                   |   | 1,882                                        |   | 3,011                                     |   |
| Other  assets                                                                                                    |   | 422                                          |   | 12                                        |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Total  assets                                                                                                    |   | $                                            | 22,052 |                                      | $      | 39,901 |   |
|                                                                                                             |   |                                         |   |                                      |   |
| **LIABILITIES  AND STOCKHOLDERS' EQUITY**                                                                        |   |                                         |   |                                      |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Current  liabilities:                                                                                            |   |                                         |   |                                      |   |
| Accounts  payable                                                                                                |   | $                                            | 1,959  |                                      | $      | 1,525 |   |
| Accrued  compensation and benefits                                                                               |   | 2,114                                        |   | 2,834                                     |   |
| Accrued  expenses                                                                                                |   | 4,082                                        |   | 3,012                                     |   |
| Deferred  revenue                                                                                                |   | 8,131                                        |   | 11,480                                    |   |
| Total  current liabilities                                                                                       |   | 16,286                                       |   | 18,851                                    |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Stockholders'  equity:                                                                                           |   |                                         |   |                                      |   |
| Preferred  stock, par value $.01 per share;   9,000 shares authorized; no shares issued and outstanding          |   | -                                            |   | -                                         |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Common  stock, par value $.01 per share;   30,000 shares authorized; 9,599 and 9,472 shares issued, respectively |   | 96                                           |   | 95                                        |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Additional  paid-in capital                                                                                      |   | 58,150                                       |   | 57,684                                    |   |
| Cumulative  translation adjustment                                                                               |   | (429                                         | )      | (391                                      | )      |
| Accumulated  deficit                                                                                             |   | (51,451                                      | )      | (35,738                                   | )      |
|                                                                                                             |   | 6,366                                        |   | 21,650                                    |   |
| Less  treasury stock, at cost, 145 and 145 shares, respectively                                                  |   | (600                                         | )      | (600                                      | )      |
| Total  stockholders' equity                                                                                      |   | 5,766                                        |   | 21,050                                    |   |
|                                                                                                             |   |                                         |   |                                      |   |
| Total  liabilities and stockholders' equity                                                                      |   | $                                            | 22,052 |                                      | $      | 39,901 |   |

Theaccompanying notes are an integral part of the consolidated financialstatements.****

**SEGUESOFTWARE, INC.CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS(IN THOUSANDS EXCEPT PER SHARE DATA)(UNAUDITED)**
|                                                     |   | **Three Months Ended September 30,** |   | **Nine Months Ended September 30,** |   |
|----------------------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
|                                                     |   | **2001**                                  |   | **2000**                                 |   | **2001** |   | **2000** |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Revenue:                                                 |   |                                      |   |                                     |   |   |   |   |   |
| Software                                                 |   | $                                         | 3,655  |                                     | $      | 8,620 |   | $ | 12,834 |   | $ | 27,680 |   |
| Services                                                 |   | 5,048                                     |   | 5,516                                    |   | 17,149 |   | 15,621 |   |
| Total  revenue                                           |   | 8,703                                     |   | 14,136                                   |   | 29,983 |   | 43,301 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Cost  of revenue:                                        |   |                                      |   |                                     |   |   |   |   |   |
| Cost  of software                                        |   | 95                                        |   | 590                                      |   | 492 |   | 1,853 |   |
| Cost  of services                                        |   | 1,600                                     |   | 2,215                                    |   | 6,000 |   | 6,776 |   |
| Total  cost of revenue                                   |   | 1,695                                     |   | 2,805                                    |   | 6,492 |   | 8,629 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Gross  margin                                            |   | 7,008                                     |   | 11,331                                   |   | 23,491 |   | 34,672 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Operating  expenses:                                     |   |                                      |   |                                     |   |   |   |   |   |
| Sales  and marketing                                     |   | 5,491                                     |   | 8,505                                    |   | 21,423 |   | 26,194 |   |
| Research  and development                                |   | 1,925                                     |   | 2,258                                    |   | 6,455 |   | 7,327 |   |
| General  and administrative                              |   | 1,649                                     |   | 1,848                                    |   | 6,235 |   | 6,660 |   |
| Amortization  of goodwill                                |   | 376                                       |   | 376                                      |   | 1,129 |   | 1,129 |   |
| Restructuring  and other charges                         |   | 1,964                                     |   | -                                        |   | 4,221 |   | - |   |
| Total  operating expenses                                |   | 11,405                                    |   | 12,987                                   |   | 39,463 |   | 41,310 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Loss  from operations                                    |   | (4,397                                    | )      | (1,656                                   | )      | (15,972 | ) | (6,638 | ) |
| Other  income, net                                       |   | 78                                        |   | 256                                      |   | 425 |   | 804 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Loss  before provision for income taxes                  |   | (4,319                                    | )      | (1,400                                   | )      | (15,547 | ) | (5,834 | ) |
| Provision  for income taxes                              |   | 50                                        |   | 49                                       |   | 166 |   | 151 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Net  loss                                                |   | $                                         | (4,369 | )                                        | $      | (1,449 | ) | $ | (15,713 | ) | $ | (5,985 | ) |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Net  loss per share - basic and diluted                  |   | $                                         | (0.46  | )                                        | $      | (0.15 | ) | $ | (1.67 | ) | $ | (0.64 | ) |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Weighted  average shares outstanding - basic and diluted |   | 9,421                                     |   | 9,428                                    |   | 9,388 |   | 9,376 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |

Theaccompanying notes are an integral part of the consolidated financialstatements.****

**SEGUE SOFTWARE, INCCONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(IN THOUSANDS)**

**(UNAUDITED)**
|                                                             |   | **Nine Months Ended  September 30,** |    |
|------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                             |   | **2001**                             |    | **2000** |   |
|                                                             |   |                                 |    |   |   |
| Cash  flows from operating activities:                           |   |                                 |    |   |   |
| Net  loss                                                        |   | $                                    | (15,713 | ) | $ | (5,985 | ) |
| Adjustments  to reconcile net loss to net cash                   |   |                                 |    |   |   |
| Provided  by (used in) operating activities:                     |   |                                 |    |   |   |
| Depreciation  and amortization                                   |   | 3,031                                |    | 3,784 |   |
| Changes  in operating assets and liabilities:                    |   |                                 |    |   |   |
| Accounts  receivable                                             |   | 6,639                                |    | (1,515 | ) |
| Other  current assets                                            |   | (120                                 | )       | (850 | ) |
| Accounts  payable                                                |   | 439                                  |    | (262 | ) |
| Accrued  expenses, royalties, compensation and benefits          |   | 340                                  |    | (76 | ) |
| Deferred  revenue                                                |   | (3,332                               | )       | 3,258 |   |
|                                                             |   |                                 |    |   |   |
| Net  cash used in operating activities                           |   | (8,716                               | )       | (1,646 | ) |
|                                                             |   |                                 |    |   |   |
| Cash  flows from investing activities:                           |   |                                 |    |   |   |
| Additions  to property and equipment                             |   | (425                                 | )       | (2,267 | ) |
| Maturities  of short-term investments                            |   | 12,944                               |    | 42,839 |   |
| Purchases  of short-term investments                             |   | (10,081                              | )       | (33,789 | ) |
| Other  investing activities                                      |   | (177                                 | )       | 214 |   |
|                                                             |   |                                 |    |   |   |
| Net  cash provided by investing activities                       |   | 2,261                                |    | 6,997 |   |
|                                                             |   |                                 |    |   |   |
| Cash  flows from financing activities:                           |   |                                 |    |   |   |
| Proceeds  from exercise of stock options and stock purchase plan |   | 467                                  |    | 1,148 |   |
|                                                             |   |                                 |    |   |   |
| Net  cash provided by financing activities                       |   | 467                                  |    | 1,148 |   |
|                                                             |   |                                 |    |   |   |
| Effect  of exchange rate changes on cash                         |   | (13                                  | )       | (34 | ) |
|                                                             |   |                                 |    |   |   |
| Net  increase (decrease) in cash and cash equivalents            |   | (6,001                               | )       | 6,465 |   |
| Cash  and cash equivalents, beginning of period                  |   | 9,379                                |    | 7,429 |   |
|                                                             |   |                                 |    |   |   |
| Cash  and cash equivalents, end of period                        |   | $                                    | 3,378   |   | $ | 13,894 |   |
|                                                             |   |                                 |    |   |   |

The accompanying notes are an integral part ofthe consolidated financial statements.

**SEGUESOFTWARE, INC.NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS(UNAUDITED)**

**1.**          **BASIS OF PRESENTATION**

             The financial statements includedherein have been prepared by Segue, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations. We believe that the disclosuresare adequate to make the information presented not misleading. However, it issuggested that these financial statements be read in conjunction with Segue'saudited financial statements for the year ended December 31, 2000,included in its 2000 Annual Report on Form 10-K.

             This financial information reflects, in the opinion ofmanagement, all adjustments of a normal recurring nature necessary to present fairlythe results for the interim periods. Results of interim periods may not beindicative of results for the full year.

**2.          OTHER ASSETS**

**            **Included in other assets at September 30, 2001 is aninterest bearing promissory note receivable of approximately $300,000 fromSegue's chief executive officer.

**3.**          **NET LOSS PER COMMON SHARE**

             The following table sets forth the computation of basicand diluted loss per share (in thousands, except per share data):
|                                                                       |   | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** |   |
|----------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
|                                                                       |   |                                  |       |                                 |   |   |   |   |   |
|                                                                       |   | **2001**                              | ** ** | **2000**                             |   | **2001** |   | **2000** |   |
|                                                                       |   |                                  |       |                                 |   |   |   |   |   |
| Net loss                                                                   |   | $                                     | (4,369     | )                                    | $      | (1,449 | ) | $ | (15,713 | ) | $ | (5,985 | ) |
|                                                                       |   |                                  |       |                                 |   |   |   |   |   |
| Weighted average shares used in net  loss per share—basic and diluted |   | 9,421                                 |       | 9,428                                |   | 9,388 |   | 9,376 |   |
|                                                                       |   |                                  |       |                                 |   |   |   |   |   |
| Net loss per common share—basic and  diluted                          |   | $                                     | (0.46      | )                                    | $      | (0.15 | ) | $ | (1.67 | ) | $ | (0.64 | ) |

             Options to purchase 3,201,736 and 2,902,000 shares ofcommon stock, respectively, were excluded from the calculation of dilutedearnings per share for the three and nine months ended September 30, 2001 and2000, respectively, because their inclusion would be anti-dilutive.

** 4.**         **RESTRUCTURING AND OTHER CHARGES**

Duringthe second quarter of 2001, in reaction to the revenue shortfall due to aneconomic downturn, Segue executed a restructuring plan. The restructuringincluded a 20% reduction in workforce, the closing of the research anddevelopment laboratory in the Los Gatos, California office with a shifting ofsome resources to Segue’s Austrian facility, consolidation of space in Segue’sLexington and Los Gatos facilities and the elimination of Segue’s inside salesorganization in favor of a new enterprise-oriented sales model andprocess.  As a result, Segue recognizedrestructuring and other charges of $2.3 million. The restructuring and othercharges included approximately $1.4 million for facility-related costs, whichincludes the accrual of estimated lease obligations associated with the closureof excess office facilities net of anticipated subleasing income, and approximately$859,000 for severance, and other employee-related costs for the termination of73 employees.

Nearthe end of the third quarter of 2001, Segue executed an additionalrestructuring plan in light of the deteriorating economic conditions. Therestructuring included a 14% reduction in workforce and further consolidationof space in Segue’s Lexington facility. As a result, Segue recognized restructuring and other charges of $2.0million in the third quarter. The restructuring and other charges includedapproximately $485,000 for severance and other employee-related costs for thetermination of 42 employees and approximately $1.5 million for facility-relatedcosts, including the accrual of estimated lease obligations associated withexcess office facilities, net of anticipated subleasing income.

Duringthe third quarter of 2001, we paid approximately $169,000 for the severance andtermination benefits associated with the restructuring actions from the secondquarter.  No amounts were paid forseverance and benefits associated with the third quarter terminations.  At September 30, 2001, we had approximately$505,000 accrued for severance and benefits associated with both quarters’restructuring actions.

Forthe nine months ended September 30, 2001, Segue has recorded approximately $2.9million of restructuring expense associated with the excess facilities in ourLexington and Los Gatos offices.  Anactive marketing effort to sublease space in Lexington is under way.  During the third quarter, we entered into asublease with a private company for the excess space in the Los Gatosfacility.  The term of the sublease isfrom October 1, 2001 until December 31, 2004, which is approximately the end ofSegue’s lease in Los Gatos.  AtSeptember 30, 2001, the accrual balance related to the obligations associatedwith excess office space in both the Lexington and Los Gatos facilities isapproximately $2.6 million.  This iscomprised of an estimated $5.7 million for future rents payable by Segue onunoccupied space, plus $275,000 in miscellaneous costs related to subleasingthe space, less $3.3 million of estimated sublease income.

**5.**          **PROVISION FOR INCOME TAXES**

             Seguerecorded provisions for foreign and state income taxes of $50,000 and $166,000for the three and nine months ended September 30, 2001, respectively, and$49,000 and $151,000 for the same periods last year. There was no tax benefitrecorded for losses generated in the U.S. in either period due to theuncertainty of realizing such benefits.

**6.**          **COMPREHENSIVE LOSS**

             EffectiveJanuary 1, 1998, Segue adopted Statement of Financial Accounting StandardsNo. 130, "Reporting Comprehensive Income"("SFAS 130"). SFAS 130 requires the reporting ofcomprehensive income in addition to net income from operations. Comprehensiveincome is a more inclusive reporting methodology that includes disclosure ofcertain financial information that historically has not been recognized in thecalculation of net income. To date, Segue's comprehensive income items haveconsisted exclusively of foreign translation adjustments. The following tablesets forth the computation of comprehensive loss (in thousands):
|                            |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|---------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                            |   |                                  |   |                                 |   |   |   |   |   |
|                            |   | **2001**                              |   | **2000**                             |   | **2001** |   | **2000** |   |
|                            |   |                                  |   |                                 |   |   |   |   |   |
| Net loss                        |   | $                                     | (4,369 | )                                    | $      | (1,449 | ) | $ | (15,713 | ) | $ | (5,985 | ) |
|                            |   |                                  |   |                                 |   |   |   |   |   |
| Foreign translation adjustments |   | (42                                   | )      | (163                                 | )      | (38 | ) | (293 | ) |
|                            |   |                                  |   |                                 |   |   |   |   |   |
| Comprehensive loss              |   | $                                     | (4,411 | )                                    | $      | (1,612 | ) | $ | (15,751 | ) | $ | (6,278 | ) |
|                            |   |                                  |   |                                 |   |   |   |   |   |

**7.          COMMITMENTS AND CONTINGENCIES**

             Underthe provision of Segue’s lease obligation at its Lexington facility, Segue hasan obligation to provide a security deposit if Segue’s current assets, asdefined in the lease, become less than $20.0 million, as evidenced by Segue’sannual audited financial statements as of each of December 31st.  Segue is required to provide annual auditedfinancial statements for each fiscal year ending December 31st byMarch 31st of the following year. As of September 30, 2001, current assets, as defined in the lease, wereapproximately $13.9 million.  The amountof the security deposit declines by $350,000 for each year that passes from thecommencement of the lease.  At September30, 2001, the amount of the security deposit, if required, would beapproximately $1.5 million.

             On or about April 27, 1999, a putative class actioncomplaint was filed in the United States District Court for the District ofMassachusetts against Segue, its Chief Executive Officer and a former ChiefFinancial Officer of Segue, captioned Nathan Rice v.SegueSoftware, Inc., et al., Civil No. 99-CV-10891-RGS. The classaction complaint alleged the defendants violated the federal securities laws bymaking material misrepresentations and omissions in certain public disclosuresduring the period beginning on October 13, 1998 through April 9,1999, inclusive. The public disclosures relate to, among other things, Segue'spast and future financial performance and results. On or about May 3,1999, another similar putative class action complaint was filed against Segue,its Chief Executive Officer and a former Chief Financial Officer of Segue inthe United States District Court for the District of Massachusetts, captioned AnthonyMoumouris v. Segue Software, Inc., et al., Civil No. 99-CV-10933RGS***.***  These cases were consolidated underthe caption In Re Segue Software, Inc. Securities Litigation, CivilNo. 99-CV-10891-RGS, and the plaintiffs filed a consolidated amendedcomplaint on September 27, 1999 alleging a putative class period ofJuly 14, 1998 through April 9, 1999, inclusive. The complaints soughtan unspecified amount of damages. On November 8, 1999 each of thedefendants filed a motion to dismiss the amended complaint for failure to statea cause of action, and on July 26, 2000, the United States District Courtfor the District of Massachusetts granted Segue's Motion to Dismiss theputative securities class action litigation brought against the above threedefendants. The dismissal was entered "with prejudice." Theplaintiffs appealed the decision to the First Circuit, and, inDecember 2000 while the appeal was still pending, the parties and Segue'sinsurers reached an agreement in principle to settle the matter for an agreedupon settlement amount. Segue's Directors' and Officers' insurance contributeda substantial portion of such settlement amount, which has been placed inescrow. In April 2001, Segue paid $200,000, its share of the settlement, to theescrow agent. The settlement has received final approval from both theshareholders and the trial court.  ForSegue, this is a closed matter; disbursements of settlement monies are theresponsibility of the escrow agent.

 

 

Variousother claims, charges and litigation have been asserted or commenced againstSegue arising from or related to contractual or employee relations. Managementdoes not believe these claims will have a material adverse effect on thefinancial position or results of operations of Segue.

Segue’semployer practices liability insurance policy has expired.  Based on the terms and deductibles providedby various insurance carriers for extending employer practices liabilitycoverage, Segue has chosen not to purchase an insurance policy.  At this time, Segue will self-insure for anyclaims that may be incurred after October 15, 2001.  To date there have been no claims asserted that will not becovered by the insurance policy that has recently expired.

**8.          SEGMENT REPORTING**

             Operatingsegments are defined as components of the enterprise about which separatefinancial information is available that is reviewed regularly by the chiefoperating decision maker, or decision–making group, in deciding how toallocate resources and in assessing their performance.  Information on Segue’s operating segmentsfollows (in thousands):

 
|                                    |   | **Three months ended September 30,** |       | **Nine months ended September 30,** |       |
|-----------------------------------------|--------|--------------------------------------|------------|-------------------------------------|------------|
|                                    |   | **2001**                             |       | **2000**                            |       | **2001** |   | **2000** |   |
|                                    |   | **Revenue**                          |       | **Gross Margin**                    |       | **Revenue** |   | **Gross Margin** |   | **Revenue** |   | **Gross Margin** |   | **Revenue** |   | **Gross Margin** |   |
|                                    |   |                                 | ** ** |                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Operating  Segment:                     |   |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| eBusiness  product licenses             |   | $                                    | 3,651      |                                |       |   | $ | 8,544 |   |   |   | $ | 12,787 |   |   |   | $ | 27,395 |   |   |   |
| Client/server  testing product licenses |   | 4                                    |       |                                |       | 76 |   |   |   | 47 |   |   |   | 285 |   |   |   |
| Total  software                         |   | $                                    | 3,655      |                                | $          | 3,560 |   | $ | 8,620 |   | $ | 8,030 |   | $ | 12,834 |   | $ | 12,342 |   | $ | 27,680 |   | $ | 25,827 |   |
|                                    |   |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Training  and consulting                |   | $                                    | 1,627      |                                | $          | 686 |   | $ | 2,076 |   | $ | 660 |   | $ | 6,231 |   | $ | 2,648 |   | $ | 6,280 |   | $ | 1,671 |   |
| Maintenance                             |   | 3,421                                |       | 2,762                               |       | 3,440 |   | 2,641 |   | 10,918 |   | 8,501 |   | 9,341 |   | 7,174 |   |
| Total  services                         |   | $                                    | 5,048      |                                | $          | 3,448 |   | $ | 5,516 |   | $ | 3,301 |   | $ | 17,149 |   | $ | 11,149 |   | $ | 15,621 |   | $ | 8,845 |   |
|                                    |   |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  revenue                          |   | $                                    | 8,703      |                                | $          | 7,008 |   | $ | 14,136 |   | $ | 11,331 |   | $ | 29,983 |   | $ | 23,491 |   | $ | 43,301 |   | $ | 34,672 |   |
|                                         |        |                                      |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

             Thefollowing table presents revenue and long-lived asset information by geographicarea for the three and nine months ended and as of September 30, (inthousands):

 
|           |   | **Total Revenue**      |   |                  |   |                  |   |
|----------------|--------|------------------------|--------|-----------------------|--------|-----------------------|--------|
|           |   | **Three months ended** |   | **Nine months ended** |   | **Long Lived Assets** |   |
|           |   | **September 30,**      |   | **September 30,**     |   | **September 30,**     |   |
|           |   | **2001**               |   | **2000**              |   | **2001**              |   | **2000** |   | **2001** |   | **2000** |   |
|           |   |                   |   |                  |   |                  |   |   |   |   |   |   |
| United  States |   | $                      | 7,664  |                  | $      | 12,265                |   | $ | 26,049 |   | $ | 39,120 |   | $ | 3,831 |   | $ | 4,993 |   |
| Foreign        |   | 1,039                  |   | 1,871                 |   | 3,934                 |   | 4,181 |   | 869 |   | 957 |   |
|           |   |                   |   |                  |   |                  |   |   |   |   |   |   |   |
|           |   | $                      | 8,703  |                  | $      | 14,136                |   | $ | 29,983 |   | $ | 43,301 |   | $ | 4,700 |   | $ | 5,950 |   |
|           |   |                   |   |                  |   |                  |   |   |   |   |   |   |   |
|                |        |                        |        |                       |        |                       |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**9.          LIQUIDITY**

             Asdisclosed in the financial statements, Segue had a net loss of $15.7 millionduring the first nine months of fiscal 2001, and has had significant losses inthe recent prior fiscal years. Additionally, Segue’s operations usedsignificant cash during the first nine months of fiscal 2001. Therecoverability of a major portion of the recorded asset amounts shown in theaccompanying balance sheet is dependent upon continued operations of Segue,which in turn is dependent upon the Segue’s ability to increase sales and tosucceed in its future operations. The financial statements do not include anyadjustments relating to the recoverability and classification of recorded assetamounts, and classification and amounts of liabilities that might be necessaryshould Segue be unable to continue operation.

 

             Managementhas taken significant steps to streamline its operations and will continue todo so as the situation warrants.  Thesesteps have included reducing headcount, infrastructure and other expenses andlimiting capital expenditures. Management believes based on its understanding of the marketplace thatfuture sales will occur in a sufficient manner to allow Segue to continue as aviable business.

             AlthoughSegue believes there is currently sufficient cash to meet its working capitalneeds for the next twelve months, delays in the timing of future sales or saleslevels below management’s expectations may cause the Company to re-evaluate itscash position, adjust its operations and take other possible actions.

**10.   RECENT ACCOUNTING DEVELOPMENTS**

             In June 1998, the Financial Accounting StandardsBoard ("FASB") issued SFAS No. 133, "Accounting forDerivative Instruments and Hedging Activities", which was effective forfiscal years beginning after June 15, 1999. SFAS No. 133 must beadopted prospectively and retroactive application is not permitted. SFASNo. 133 requires the Company to record all derivatives on the balancesheet at fair value. Changes in derivative fair values will either be recognizedin earnings as offsets to the changes in fair value of related hedged assets,liabilities and firm commitments or for forecasted transactions, deferred andrecorded as a component of accumulated other comprehensive income (loss) instockholders' equity until the hedged transactions occur and are recognized inearnings. The ineffective portion of a hedging derivative's change in fairvalue will immediately be recognized in earnings. In June 1999, the FASBissued SFAS No. 137, "Accounting for Derivative Instruments andHedging Activities—Deferral of the Effective Date of FASB StatementNo. 133", which delayed the effective date. SFAS No. 133 is noweffective for fiscal years beginning after June 15, 2000. We adopted SFASNo. 133 on January 1, 2001, and there was no material effect on ourconsolidated financial position or results of operations.

             On July 20, 2001, FASB issued SFAS No. 141 “BusinessCombination”, and SFAS No. 142, “Goodwill and Intangible Assets”. SFAS No. 141is effective for all business combinations initiated after June 30, 2001.  SFAS No. 142 is effective for fiscal yearsbeginning after December 15, 2001; however, certain provisions of thisStatement apply to goodwill and other intangible assets acquired between July1, 2001 and the effective date of SFAS 142. Major provisions of these Statements and their effective dates for Segueare as follows:
| • |   | all business combinations initiated  after June 30, 2001 must use the purchase method of accounting.  The pooling of interest method of  accounting is prohibited except for transactions initiated before July 1,  2001.                                                                                                            |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | intangible assets acquired in a  business combination must be recorded separately from goodwill, if they arise  from contractual or other legal rights or are separable from the acquired entity  and can be sold, transferred, licensed, rented or exchanged, either  individually or as part of a related contract, asset or liability. |
| • |   | goodwill, as well as intangible assets  with indefinite lives, acquired after June 30, 2001, will not be amortized.  Effective January 1, 2002, all previously recognized goodwill and intangible  assets with indefinite lives will no longer be subject to amortization.                                                                |
| • |   | effective January 1, 2002, goodwill and  intangible assets with indefinite lives will be tested for impairment  annually and whenever there is an impairment indicator.                                                                                                                                                                   |
| • |   | all acquired goodwill must be assigned  to reporting units for purposes of impairment testing and segment reporting.                                                                                                                                                                                                                      |

                         Segue will continue to amortize goodwillrecognized prior to July 1, 2001, under its current method until January 1,2002, at which time annual and quarterly goodwill amortization of  $1.5 million and $377,000, respectively,will no longer be recognized. By December 31, 2002, we will have completed atransitional fair value based impairment test of goodwill as of January 1,2002.  Impairment losses if any,resulting from the transitional testing will be recognized in the quarter endedMarch 31, 2002, as a cumulative effect of a change in accountingprinciple.  If this test is completed ina quarter subsequent to the quarter ended March 31, 2002, it would meanrestating prior quarters.

**ITEM2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**RESULTSOF OPERATIONS**

             Thefollowing table sets forth certain unaudited quarterly results of operationsexpressed as a percentage of total revenue for the periods indicated:
|                                    |   | **Percentage of Revenue for  Three Months Ended  September 30,** |   | **Percentage of Revenue for  Nine months Ended  September 30,** |   |
|-----------------------------------------|--------|------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|
|                                    |   | **2001**                                                         |   | **2000**                                                        |   | **2001** |   | **2000** |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Revenue:                                |   |                                                             |   |                                                            |   |   |   |   |   |
| Software                                |   | 42.0                                                             | %      | 61.0                                                            | %      | 42.8 | % | 63.9 | % |
| Services                                |   | 58.0                                                             |   | 39.0                                                            |   | 57.2 |   | 36.1 |   |
| Total  revenue                          |   | 100.0                                                            |   | 100.0                                                           |   | 100.0 |   | 100.0 |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Cost  of revenue:                       |   |                                                             |   |                                                            |   |   |   |   |   |
| Cost  of software                       |   | 1.1                                                              |   | 4.2                                                             |   | 1.6 |   | 4.3 |   |
| Cost  of services                       |   | 18.4                                                             |   | 15.6                                                            |   | 20.0 |   | 15.6 |   |
| Total  cost of revenue                  |   | 19.5                                                             |   | 19.8                                                            |   | 21.6 |   | 19.9 |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Gross  margin                           |   | 80.5                                                             |   | 80.2                                                            |   | 78.4 |   | 80.1 |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Operating  expenses:                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Sales  and marketing                    |   | 63.1                                                             |   | 60.2                                                            |   | 71.5 |   | 60.5 |   |
| Research  and development               |   | 22.1                                                             |   | 16.0                                                            |   | 21.5 |   | 16.9 |   |
| General  and administrative             |   | 18.9                                                             |   | 13.1                                                            |   | 20.8 |   | 15.4 |   |
| Amortization  of goodwill               |   | 4.3                                                              |   | 2.6                                                             |   | 3.8 |   | 2.6 |   |
| Restructuring  and other charges        |   | 22.6                                                             |   | -                                                               |   | 14.1 |   | - |   |
| Total  operating expenses               |   | 131.0                                                            |   | 91.9                                                            |   | 131.7 |   | 95.4 |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Loss  from operations                   |   | (50.5                                                            | )      | (11.7                                                           | )      | (53.3 | ) | (15.3 | ) |
| Other  income, net                      |   | 0.9                                                              |   | 1.8                                                             |   | 1.4 |   | 1.8 |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Loss  before provision for income taxes |   | (49.6                                                            | )      | (9.9                                                            | )      | (51.9 | ) | (13.5 | ) |
| Provision  for income taxes             |   | 0.6                                                              |   | 0.3                                                             |   | 0.5 |   | 0.3 |   |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |
| Net  loss                               |   | (50.2                                                            | )%     | (10.2                                                           | )%     | (52.4 | )% | (13.8 | )% |
|                                    |   |                                                             |   |                                                            |   |   |   |   |   |

**SOFTWARE REVENUE**

             Software revenue decreased 58% to $3.7 millionduring the third quarter of 2001 from $8.6 million for the same period in2000. For the nine months ended September 30, 2001, software revenue decreased54% to $12.8 million as compared to $27.7 million for the nine months endedSeptember 30, 2000.  The major factorscontributing to the decrease in third quarter software revenue as compared tosoftware revenue in the same quarter in 2000 were the difficult economicsituation, the poor market for Information Technology capital spending, andincreased competition.  Internationalsoftware revenue accounted for 19%, or $690,000, and 20%, or $2.5 million, oftotal software revenue for the three and nine months ended September 30, 2001,respectively, as compared to 18%, or $1.6 million, and 13%, or $3.6 million,for the same periods in 2000.  Thedecrease in international software revenue, in absolute dollars, in the thirdquarter was due to a slowdown in the European software market.  The percent of international softwarerevenue increased relative to total software because the domestic softwarerevenue decreased dramatically in absolute dollars.

**SERVICESREVENUE**

             Services revenue decreased 8% to $5.0 millionduring the third quarter of 2001 from $5.5 million in the same quarter of2000. For the nine months ended September 30, 2001, services revenue increased10% to $17.1 million as compared to $15.6 million for the nine months endedSeptember 30, 2000.  As compared to thethree and nine months ended September 30, 2000, training and consulting revenuedecreased 22% and 1% for the same periods in 2001, respectively.  The decrease in training and consultingrevenue for the third quarter 2001, as compared to the same quarter in theprior year, is mostly attributable to lower bookings and delivery ofengagements during the quarter.  For thethree months ended September 30, 2001, recognized maintenance revenue decreased1%, as compared to the third quarter in 2000. For the nine months endedSeptember 30, 2001, recognized maintenance revenue increased 17%, as comparedto the same period in 2000.  Thisincrease in recognized maintenance revenue was driven mostly by the largercumulative installed base of software contracts under maintenance, which arepredominately amortized over a 12-month period.

**COST OFSOFTWARE**

             Costof software decreased 84% to $95,000 during the third quarter of 2001 from$590,000 in the same quarter of 2000. For the nine months ended September 30,2001, cost of software decreased 73% to $492,000 from $1.9 million for the sameperiod in 2000. As a percentage of software revenue, cost of software in thethird quarter of 2001 decreased to 3% from 7% in the corresponding prior yearperiod. For the nine months ended September 30, 2001, cost of software as apercentage of software revenue decreased to 4% from 7% in the same period in2000. The decrease in cost of software, both in amount and as a percentage ofsoftware revenue, was primarily due to the decrease in amortization associatedwith the completed technology that was acquired in 1997, which was fullyamortized at December 31, 2000. This amortization was $247,000 per quarter for each quarter from 1998through 2000.  Additionally, royaltyexpense, which is included in cost of software, also decreased because of thereduction of sales of royalty bearing products. The decrease in the dollar amountof cost of software is also attributable to the lower volume of sales in 2001as compared to 2000.

**COST OFSERVICES**

             Cost of services decreased 28% to $1.6 millionduring the quarter ended September 30, 2001 from $2.2 million in the samequarter of 2000.  For the nine monthsended September 30, 2001, cost of services decreased 11% to $6.0 million from$6.8 million in the same period in 2000. During the third quarter of 2001, cost of services as a percentage ofservices revenue decreased to 32% from 40% in the same quarter last year.  For the nine months ended September 30,2001, cost of services as a percentage of services revenue decreased to 35%from 43% in the corresponding prior year period.  Cost of services consists primarily of costs of providing customertechnical support, training and consulting. Cost of services as a percentage ofservices revenue may vary based on the profitability of individual consultingengagements and the utilization rate of in-house consultants. Cost of trainingand consulting in the third quarter of 2001 decreased 34% to $941,000 ascompared to $1.4 million for the same quarter in 2000. For the nine monthsended September 30, 2001, cost of training and consulting decreased 22% to $3.6million as compared to $4.6 million in the corresponding prior year period. Thedecrease is primarily related to lower personnel expenses as a result of theworkforce reductions in 2001, offset by an increase in outsourcing expenseduring the third quarter of 2001.  Forthe three months ended September 30, 2001, cost of maintenance decreased 18% to$659,000 as compared to $799,000 for the third quarter of 2000. The decrease,mostly in personnel related costs, is a result of the workforce reductions thatSegue completed.  For the nine monthsended September 30, 2001, cost of maintenance increased 12% to $2.4 millionfrom $2.2 million for the nine months ended September 30, 2000.  This increase in personnel related expenseis primarily attributable to the expansion of our global technical support centerin Belfast, Northern Ireland, which was required to support the increasedmaintenance revenue in 2001.

**SALESAND MARKETING**

             Sales and marketing expenses decreased 35% to$5.5 million during the third quarter of 2001 from $8.5 million inthe third quarter of 2000.  For the ninemonths ended September 30, 2001, sales and marketing expenses decreased 18% to$21.4 million from $26.2 million in the corresponding prior year period.  A major portion of the decrease in expensesfor the three and nine months ended September 30, 2001, in comparison to thesame periods in 2000, is due to the decrease in commissions, as a result of thelower volume of sales.  Additionally,there have been savings in expenses from reductions to marketing programs,workforce restructurings and elimination of the inside sales force in 2001.

**RESEARCHAND DEVELOPMENT**

             Research and development expenses decreased 15% to $1.9million during the third quarter of 2001 from $2.3 million in the same quarterof 2000.  For the nine months endedSeptember 30, 2001, research and development expenses decreased 12% to $6.5million from $7.3 million in the corresponding prior year period.  The decreases are mainly in personnelrelated costs due to the workforce reductions.

**GENERALAND ADMINISTRATIVE**

             General and administrative expenses decreased 11% to$1.6 million for the third quarter of 2001, as compared to $1.8 millionfor the third quarter of 2000.  For thenine months ended September 30, 2001, general and administrative expensesdecreased 6% to $6.2 million compared to $6.7 million in the correspondingprior year period.  The decreasedexpenses in the third quarter of 2001 as compared to the third quarter of 2000are primarily attributable to reduced bad debt expense during the third quarterand recoveries of amounts previously written off, as well as reductions inconsulting expenses.  The decreases inexpenses for the nine months to date in 2001, as compared to the same period in2000, are primarily attributable to the following: decreased legal expenses in2001, in part due to settling litigation; decreased audit related expenses infirst quarter of 2001 as compared to the first quarter of 2000, which had costsassociated with the restatement of our prior years' Form 10-Qs andForm 10-Ks; decreased consulting and temporary employee expenses.  However, these decreases were partiallyoffset by an increase in bad debt expense of approximately $221,000 for thenine months ended September 30, 2001, as compared to the first nine months of2000, and the adjustment of foreign currency transaction losses of $190,000during the second quarter of 2001.

**AMORTIZATIONOF GOODWILL**

             Amortization of goodwill was $376,000 for each of thethird quarters of 2001 and 2000.  Foreach of the nine months ended September 30, 2001 and 2000, amortization ofgoodwill was $1.1 million.

**RESTRUCTURINGAND OTHER CHARGES**

Duringthe second quarter of 2001, in reaction to the revenue shortfall due to aneconomic downturn, Segue executed a restructuring plan. The restructuringincluded a 20% reduction in workforce, the closing of the research anddevelopment laboratory in the Los Gatos, California office with a shifting ofsome resources to Segue’s Austrian facility, consolidation of space in Segue’sLexington and Los Gatos facilities and the elimination of Segue’s inside salesorganization in favor of a new enterprise-oriented sales model andprocess.  As a result, Segue recognizedrestructuring and other charges of $2.3 million. The restructuring and othercharges included approximately $1.4 million for facility-related costs, whichincludes the accrual of estimated lease obligations associated with the closureof excess office facilities net of anticipated subleasing income, andapproximately $859,000 for severance and other employee-related costs for thetermination of 73 employees.

Nearthe end of the third quarter of 2001, Segue executed an additionalrestructuring plan in light of the deteriorating economic conditions. Therestructuring included a 14% reduction in workforce and further consolidationof space in Segue’s Lexington facility. As a result, Segue recognized restructuring and other charges of $2.0million in the third quarter. The restructuring and other charges includedapproximately $485,000 for severance and other employee-related costs for thetermination of 42 employees and approximately $1.5 million for facility-relatedcosts, including the accrual of estimated lease obligations associated withexcess office facilities, net of anticipated subleasing income.

Duringthe third quarter of 2001, we paid approximately $169,000 for the severance andtermination benefits associated with the restructuring actions from the secondquarter.  No amounts were paid forseverance and benefits associated with the third quarter terminations.  At September 30, 2001, we had approximately$505,000 accrued for severance and benefits associated with both quarters’restructuring actions.

Forthe nine months ended September 30, 2001, Segue has recorded approximately $2.9million of restructuring expense associated with the excess facilities in ourLexington and Los Gatos offices.  Anactive marketing effort to sublease space in Lexington is under way.  During the third quarter, we entered into asublease with a private company for the excess space in the Los Gatosfacility.  The term of the sublease isfrom October 1, 2001 until December 31, 2004, which is approximately the end ofSegue’s lease in Los Gatos.  AtSeptember 30, 2001, the accrual balance related to the obligations associatedwith excess office space in both the Lexington and Los Gatos facilities isapproximately $2.6 million.  This iscomprised of an estimated $5.7 million for future rents payable by Segue onunoccupied space, plus $275,000 in miscellaneous costs related to subleasingthe space, less $3.3 million of estimated sublease income.

**OTHER INCOME, NET**

             Other income decreased 70% to $78,000 during the thirdquarter of 2001 from $256,000 in the same quarter of 2000. For the nine monthsended September 30, 2001, other income decreased 47% to $425,000 from $804,000for the nine months ended September 30, 2000. Other income consists of mostlyinterest income on cash equivalents and short-term investments. The decreaseswere mainly a result of lower balances of short-term investments, whichproduced less interest, and lower interest rates on those investments.

** **

**PROVISIONFOR INCOME TAXES**

             We recorded a provision for foreign and state incometaxes of $50,000 and $166,000 for the three and nine months ended September 30,2001, respectively.  For the three andnine months ended September 30, 2000, we recorded a provision for foreign andstate income taxes of $49,000 and $151,000 respectively.   There was no tax benefit recorded forlosses generated in the US in any period due to the uncertainty of realizingsuch benefits.

**LIQUIDITY AND CAPITALRESOURCES**

             Asof September 30, 2001, our principal sources of liquidity included cash, cashequivalents and short-term investments, which totaled $8.4 million ascompared to $17.2 million as of December 31, 2000.

             During the first nine months of2001, we used $8.7 million for operating activities. This was composed ofthe net loss, adjusted for non-cash expenses such as depreciation of fixedassets and amortization of goodwill, plus decreases in deferred revenue, lessdecreases in accounts receivable and other current assets, plus increases inaccounts payable and accrued expenses.

***            ***Ourprimary investing activities were liquidations of short-term investments. Wegenerated $2.9 million from maturing investments in the nine months endedSeptember 30, 2001.

***            ***Wegenerated funds of $467,000 from financing activities related to the issuanceof stock under the employee stock purchase plan and exercise of stock optionsduring the nine months of 2001.

             Ourcorporate headquarters in Lexington, Massachusetts are currently under a leasethat expires in October 2007. The annual rental rate is approximately$2.3 million. We have the right to terminate the lease onSeptember 30, 2004 for a fee of approximately $2.3 million.  In addition, we have an obligation toprovide a security deposit if our current assets, as defined in the lease,become less than $20.0 million, as evidenced by Segue’s annual auditedfinancial statements as of each of December 31st. We are required toprovide audited financial statements for each fiscal year ending December 31stby March 31st of the following year.  As of September 30, 2001, current assets, as defined in thelease, were $13.9 million.  The amountof the security deposit declines by $350,000 for each year that passes from thecommencement of the lease.  At September30, 2001, the amount of the security deposit, if required, would beapproximately $1.5 million.

             InDecember 2000, we settled certain lawsuits, including both theBlack & White litigation and the securities litigation matter that isreferenced in Item 1 of Part II of this Form 10-Q, for which weaccrued Segue's portion of the settlements, approximately $750,000. No amountswere paid on these lawsuit settlements in 2000. As of May 2001, we hadpaid the accrued settlement amounts in full.

Duringthe second quarter of 2001, in reaction to the revenue shortfall due to aneconomic downturn, we executed a restructuring plan, which is expected toresult in savings once fully implemented of approximately $5.9 million on anannual basis.  Among the expectedsavings are savings in rent of $800,000 and wages of $5.1 million.  The restructuring included a 20% reductionin workforce, the closing of the research and development laboratory in our LosGatos, California office with a shifting of some resources to our Austrianfacility, consolidation of space in our Lexington and Los Gatos facilities andthe elimination of our inside sales organization in favor of a newenterprise-oriented sales model and process. As a result, we recognized restructuring and other charges of $2.3million. The restructuring and other charges included approximately $1.4million for facility-related costs, which includes the accrual of estimatedlease obligations associated with the closure of excess office facilities netof anticipated subleasing income, and approximately $859,000 for severance andother employee-related costs for the termination of 73 employees.

             Near the end of the third quarter of 2001, Segueexecuted an additional restructuring plan in light of the deterioratingeconomic conditions. The restructuring included a 14% reduction in workforceand further consolidation of space in Segue’s Lexington facility.  As a result, Segue recognized restructuringand other charges of $2.0 million in the third quarter. The restructuring andother charges included approximately $485,000 for severance and otheremployee-related costs for the termination of 42 employees and approximately$1.5 million for facility-related costs, including the accrual of estimatedlease obligations associated with excess office facilities, net of anticipatedsubleasing income.   This restructuringis expected to save approximately $3.4 million in personnel related expenses onan annual basis, once fully implemented.

Duringthe third quarter of 2001, we paid approximately $169,000 for the severance andtermination benefits associated with the restructuring actions from the secondquarter.  No amounts were paid forseverance and benefits associated with the third quarter terminations.  At September 30, 2001, we had approximately$505,000 accrued for severance and benefits associated with both quarters’restructuring actions.

             For the nine months ended September 30, 2001, Seguehas recorded approximately $2.9 million of restructuring expense associatedwith the excess facilities in our Lexington and Los Gatos offices.  An active marketing effort to sublease spacein Lexington is under way.  During thethird quarter, we entered into a sublease with a private company for the excessspace in the Los Gatos facility.  Theterm of the sublease is from October 1, 2001 until December 31, 2004, which isapproximately the end of Segue’s lease in Los Gatos.  At September 30, 2001, the accrual balance related to theobligations associated with excess office space in both the Lexington and LosGatos facilities is approximately $2.6 million.  This is comprised of an estimated $5.7 million for future rentspayable by Segue on unoccupied space, plus $275,000 in miscellaneous costsrelated to subleasing the space, less $3.3 million of estimated subleaseincome.

             We have historically had losses.This, accompanied by the economic downturn of 2001 and the slowdown ofInformation Technology capital spending, has resulted in lower sales volume,which has required Segue to continue utilizing significant amounts of cash andcash equivalents to fund operations.

             We have reduced our workforce and overhead expenses asdescribed above and curtailed capital spending and other uses of cash.  Based on these factors, it is uncertainwhether Segue will be profitable in the fourth quarter of 2001.

             Long-term cash requirements, otherthan for normal operating expenses, are anticipated for the development of newsoftware products and enhancements of existing products, the possible openingof additional offices, and the possible acquisition of software products ortechnologies complementary to our business.

             Assumingthat Segue can execute on current plans to grow revenue through itsrestructured sales program, its focus on enterprise customers, and itsintroduction and success of new and enhanced products, and the economy does notworsen, we believe that cash, cash equivalents and short-term investments, aswell as cash flows from operations, will be sufficient to meet our workingcapital and debt requirements for the next twelve months.  However, if there are no recoveries orimprovements in the business or the economy worsens, we may need to obtainadditional financing or take other actions in order to fund our working capitalresource requirements during the next twelve months. In view of thesecircumstances, Segue is evaluating the availability of additional financing tofund working capital requirements. However, there can be no assurance that, if necessary, we would besuccessful in obtaining financing or that, if necessary, we could do so onterms acceptable or favorable to Segue. Additionally, the financial statements do not include any adjustmentsrelating to the recoverability and classification of recorded asset amounts,and classification and amounts of liabilities that might be necessary shouldSegue be unable to continue funding its operations.

             To date, inflation has not had a material impact on ourfinancial results.

**FACTORS THAT MAY AFFECT FUTURE RESULTS**

             The Company's business is subject to many uncertaintiesand risks. This Form 10-Q also contains certain forward-looking statementswithin the meaning of the Private Securities Reform Act of 1995. The Company'sfuture results may differ materially from its current results and actualresults could differ materially from those projected in the forward lookingstatements as a result of certain risk factors, including but not limited tothose set forth below, other one-time events and other important factors disclosedpreviously and from time to time in Segue's other filings with the SEC.

             **Ourquarterly results may fluctuate***.*  Segue's quarterly revenue and operating results are difficult topredict and may fluctuate significantly from quarter to quarter. If ourquarterly revenue or operating results fall below the expectations of investorsor public market analysts, the price of our common stock could fallsubstantially. Our quarterly revenue may fluctuate significantly for severalreasons, including: the timing and success of introductions of our new productsor product enhancements or those of our competitors; uncertainty created bychanges in the market, including the decline in the dot-com eBusiness marketand the decline in IT spending, in particular; difficulty in predicting thesize and timing of individual orders; software bugs or other product qualityproblems; competition and pricing; customer order deferrals or reductions as aresult of general economic decline; ability to increase sales from enterprisecompanies; and general economic conditions. Substantial portions of Segue's operating expenses are related topersonnel, facilities and marketing and sales programs. The level of spendingfor such expenses can not be adjusted quickly and is based, in significantpart, on our expectations of future revenues. If actual revenue levels arebelow management's expectations for a certain quarter, results of operationsare likely to be adversely affected. Furthermore, Segue has often recognized asubstantial portion of its product revenues in the last month of a quarter,with these revenues frequently concentrated in the last weeks or days of aquarter. As a result, product revenues in any quarter are substantiallydependent on orders booked and shipped in the latter part of that quarter andrevenues from any future quarter are not predictable with any significantdegree of accuracy. Segue typically does not experience order backlog. Forthese reasons, Segue believes that period-to-period comparisons of its resultsof operations are not necessarily meaningful and should not be relied upon asindications of future performance.

             **We maynot be profitable in the future.**  Since Segue began operations, it hasgenerally experienced losses. Losses have resulted in an accumulated deficit ofapproximately $51.5 million as of September 30, 2001. Segue had net incomeof $144,000 in 1996; a net loss of $2.5 million in 1997, which included acharge of $117,000 for purchased research and development in process and $718,000for severance charges; a net loss of $5.1 million in 1998, which includeda charge of $1.5 million related to our acquisitions of Eventus andBlack & White, and a charge of $667,000 related to write-offs of anon-recurring engineering fee and guaranteed royalties; a net loss of$15.9 million in 1999, which included $2.0 million for restructuringcosts, $481,000 for severance of senior executives; a net loss of$8.6 million in 2000, which included $750,000 for various litigationsettlement costs, and a loss of $15.7 million for the nine-month periodended September 30, 2001, which included $4.2 million for restructuringcharges. During the first nine months of 2001, we experienced significantrevenue shortfalls. We initiated aggressive cost savings measures over thefirst nine months of 2001, in an effort to reduce expenses and enhance thepossibility of breakeven. These cost saving measures may not be effective, andare not necessarily indicative of future operating results. Failure to achieveprofitability may adversely affect the market price of Segue's common stock

             **Continueddecline in business conditions and Information Technology (IT) spending couldcause further decline in revenue.**  The level of future IT spending remains very uncertainparticularly in light of the decline in the business climate throughout2001.  The events of September 11, 2001have exacerbated these conditions.  IfIT spending continues to decline, Segue’s revenues could be further adverselyimpacted.

             **Segue maynot derive substantial incremental revenue from its alliances and SilkElitePartner Program**.  In aneffort to augment product revenue derived from the efforts of its direct salesforce, Segue has focused on expanding its key strategic alliances and onbuilding a successful SilkElite Partner Program.  The SilkElite Partners Program focuses on resellers, consultingpartners and distributors.  SilkElitePartners both resell Segue products and use Segue software products in thedelivery of consulting services.  Thesuccess of the expansion of key strategic alliances and the SilkElite Programis uncertain, faces strong competition, and takes time and significantresources to develop.  Should Segue failto generate substantial incremental revenue from its strategic alliances or itsSilkElite Program, the financial results and stock price could be adverselyaffected.

             **Ourfuture success will depend on our ability to respond rapidly and effectively totechnological and other market changes, including the successful introductionof new and enhanced products***.* The nature of the web-based automated software testing and eBusinesstesting markets in which we compete is characterized by rapidly changingtechnology, rapidly evolving customer needs and desires, changes in industrystandards and practices and frequent releases of new product or enhancements bycompetitors. To be competitive, Segue must develop and introduce productenhancements and new products that address the increasingly sophisticated andvaried needs of our existing and potential customers. Over 90% of Segue'sproduct revenue in 2000 and the first nine months of 2001 were generated fromits SilkPerformer and SilkTest products. In the second quarter of 2001, weintroduced our new web-based enterprise-monitoring product, SilkVision.  In the third quarter, Segue announced analliance to integrate and resell a test management tool, T-Plan.  In Addition, Segue also introduced a Unicodemulti-lingual testing capability for the company’s regression testing tool,SilkTest International.   If we fail todevelop and introduce new products and enhancements successfully and on atimely basis, or maintain our level of product revenue from SilkPerformer andSilkTest, or fail to generate substantial incremental revenue from our newproducts, our business may be materially adversely affected.

**             We mayface liquidity issues.**  We have taken steps to conserve our use ofcash, including significantly reducing headcount, infrastructure and otherexpenses, and limiting capital expenditures in order to compensate in part forour recent decline in revenues, to improve our liquidity and to achieve greaterefficiencies. Segue believes that based on potential incremental revenue fromits strategic alliances, its SilkElite Partner Program, and its new productsand product enhancements, that future sales will be sufficient to allow us tocontinue as a viable business.  Iffuture sales are not sufficient, however, we may have to raise additionalfinancing to fund working capital needs.  If we fail to generate substantial incremental revenue, or we are notsuccessful in raising additional financing, we may not have sufficient workingcapital resources and our business may be materially adversely affected.

**             We maynot be successful in subletting excess office space.**  Segue is taking steps to sublet its excessoffice space. The real estate market is changing rapidly and these efforts maynot be successful or may take significant time and resources.  If these efforts are not successful, Seguewill not realize its estimated cost savings.

**             We mayhave difficulty managing organizational change and operating the businessefficiently with fewer resources***.*  In 2000 and early 2001, Segue reorganizedits sales force, appointed new leaders in its support services, consulting andproduct development areas, created a new strategic alliance program, appointeda new head of international sales, added a General Counsel, a new VicePresident of Product Marketing, and a new Senior Vice President of WorldwideSales, eliminated the inside sales group, introduced a new sales process,shifted research and development resources and consolidated several of itsactivities as a result of reduced headcount. Over the first nine months of2001, Segue reduced its headcount by over 30% since the beginning of the year.The success of these organizational changes is uncertain and Segue’s ability tomanage its business efficiently with fewer resources could adversely affect itsbusiness.

             **Seguefaces significant competition from other software companies***.*  The market for web-based software qualitymanagement and testing tools is intensely competitive and subject to rapidtechnological change. We expect competition to intensify even further in thefuture. Segue currently encounters competition from a number of public andprivate companies, including Mercury Interactive Corporation, Rational SoftwareCorporation and Compuware Corporation. Many of our current and potentialcompetitors have longer operating histories, greater name recognition, largerinstalled customer bases, and significantly greater financial, technical andmarketing resources than we do. Therefore, they may be able to respond morequickly to new or changing opportunities, technologies, standards or customerrequirements or may be able to devote greater resources to the promotion andsale of their products than we can. An increase in competition could result inprice reductions and loss of market share. Such competition and any resultingreduction in profitability could have a material adverse effect on ourbusiness, operating results and financial condition.

             **Segue'sbusiness could be adversely affected if its products contain errors***.*  Software products as complex as ours maycontain undetected errors or "bugs" which result in product failures.The occurrence of errors could result in loss of or delay in revenue, loss ofmarket share, failure to achieve market acceptance, diversion of developmentresources, significant repair and replacement costs, injury to our reputation,or damage to our efforts to build brand awareness, any of which could have amaterial adverse effect on our business, operating results and financialcondition.

             **Certainlawsuits have been filed against Segue.** Various claims, chargesand litigation have been asserted or commenced against Segue arising from orrelated to contractual or employee relations. Management does not believe theseclaims will have a material adverse effect on the financial position or resultsof operations of Segue.

             **We musthire and retain skilled personnel in a difficult economic environment. **Qualified personnel remain in demandthroughout the software industry. Our success depends in large part upon ourability to attract, train, motivate and retain highly skilled employees,particularly sales and marketing personnel, software engineers and other seniorpersonnel. The failure to attract and retain the highly skilled personnel thatare integral to our direct sales, product development, service and supportteams may limit the rate at which we can generate sales and develop newproducts or product enhancements. Our ability to retain our qualified staff maybe impacted by our financial results over the first three quarters of2001.  All of this could have a materialadverse effect on our business, operating results and financial condition.

             **We facemany risks associated with international business activities.**  We derived approximately 12% of totalrevenue from international customers in the third quarter of 2001 and 13% inthe first nine months of 2001. The international market for software productsis highly competitive and we expect to face substantial competition in thismarket from established and emerging companies. Segue faces many risksassociated with international business activities including currency fluctuations,imposition of government controls, export license requirements, restrictions onthe export of critical technology, political and economic instability,tailoring of products to local requirements, trade restrictions, changes intariffs and taxes, difficulties in staffing and managing internationaloperations, longer accounts receivable payment cycles and the burdens ofcomplying with a wide variety of foreign laws and regulations. To the extent weare unable to continue to expand international sales in a timely andcost-effective manner, our business could be materially adversely affected.

             **Segue'ssuccess depends on our ability to protect our software and other proprietarytechnology***.* The unauthorized reproduction or other misappropriation of ourproprietary technology could enable third parties to benefit from Segue'stechnology without paying us for it. This could have a material adverse effecton our business, operating results and financial condition. Although we havetaken steps to protect our proprietary technology, these efforts may beinadequate. We currently rely on a combination of patent, trademark, copyrightand trade secret laws and contractual provisions to protect our proprietaryrights in our products. Currently, we have three issued patents and a fourthpending. There can be no assurance that these patents would be upheld ifchallenged. Moreover, the laws of other countries in which we market ourproducts may afford little or no effective protection of our intellectualproperty. If we resort to legal proceedings to enforce our intellectualproperty rights or protect our trade secrets, the proceedings could beburdensome and expensive and could involve a high degree of risk. If we were todiscover that any of Segue’s products violated third party proprietary rights,there can be no assurance that we would be able to obtain licenses oncommercially reasonable terms to continue licensing our software withoutsubstantial reengineering or that any effort to undertake such reengineering wouldbe successful. Any claim of infringement could cause Segue to incur substantialcosts defending against the claim, even if the claim is invalid, and coulddistract management resources from our business. Furthermore, a party makingsuch a claim could secure a judgment that requires us to pay substantialdamages or result in an injunction. Any of these events could have a materialadverse effect on our business, operating results and financial condition.

**ITEM 3. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

             The following discussion about ourmarket risk disclosures involves forward-looking statements. Actual resultscould differ materially from those discussed in the forward-looking statements.We are exposed to market risk related to changes in interest rates and foreigncurrency exchange rates. We do not use derivative financial instruments forspeculative or trading purposes.

             INTEREST RATE RISK. Segue is exposed to market risk fromchanges in interest rates primarily through its investing and borrowingactivities. In addition, our ability to finance future acquisition transactionsor working capital needs may be impacted if we are unable to obtain appropriatefinancing at acceptable rates and terms. Our investing strategy to manage interestrate exposure is to invest in short-term, highly secure and liquid investments.We maintain a portfolio of highly liquid cash equivalents and short-terminvestments (primarily in high-grade corporate commercial paper). As ofSeptember 30, 2001, the fair value of our short-term investments approximatedmarket value.

             FOREIGN CURRENCY RISK. Segue faces exposure to movementsin foreign currency exchange rates. These exposures may change over time asbusiness practices evolve and could have a material adverse effect on ourbusiness, financial condition and results of operations. We do not usederivative financial instruments or other financial instruments to hedgeeconomic exposures or for trading. Historically, our primary exposures havebeen related to the operations of our foreign subsidiaries. As of September 30,2001, the total cumulative impact of foreign currency changes was $429,000. Theintroduction of the Euro as a common currency for most members of the Europeanmonetary union took place in our fiscal year of 1999. As of September 30, 2001,the impact of Euro has not been significant to our business.

**PART II. OTHER INFORMATION**

**ITEM 1.LEGAL PROCEEDINGS**

Onor about April 27, 1999, a putative class action complaint was filed inthe United States District Court for the District of Massachusetts againstSegue, its Chief Executive Officer and a former Chief Financial Officer ofSegue, captioned Nathan Rice v.Segue Software, Inc., et al.,Civil No. 99-CV-10891-RGS. The class action complaint alleged the defendantsviolated the federal securities laws by making material misrepresentations andomissions in certain public disclosures during the period beginning onOctober 13, 1998 through April 9, 1999, inclusive. The publicdisclosures relate to, among other things, Segue's past and future financialperformance and results. On or about May 3, 1999, another similar putativeclass action complaint was filed against Segue, its Chief Executive Officer anda former Chief Financial Officer of Segue in the United States District Courtfor the District of Massachusetts, captioned Anthony Moumouris v. SegueSoftware, Inc., et al., Civil No. 99-CV-10933RGS***.*** These cases wereconsolidated under the caption In Re Segue Software, Inc. SecuritiesLitigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a consolidated amended complaint onSeptember 27, 1999 alleging a putative class period of July 14, 1998through April 9, 1999, inclusive. The complaints sought an unspecifiedamount of damages. On November 8, 1999 each of the defendants filed amotion to dismiss the amended complaint for failure to state a cause of action,and on July 26, 2000, the United States District Court for the District ofMassachusetts granted Segue's Motion to Dismiss the putative securities classaction litigation brought against the above three defendants. The dismissal wasentered "with prejudice." The plaintiffs appealed the decision to theFirst Circuit, and, in December 2000 while the appeal was still pending,the parties and Segue's insurers reached an agreement in principle to settlethe matter for an agreed upon settlement amount. Segue's Directors' andOfficers' insurance contributed a substantial portion of such settlement amountwhich has been placed in escrow, and, with this insurance contribution, thesettlement will not have a material adverse affect upon Segue's financialposition or results of operation.  Thesettlement has received final approval from both the shareholders and the trialcourt.  For Segue, this is a closedmatter; disbursements of settlement monies are the responsibility of the escrowagent.

Variousother claims, charges and litigation have been asserted or commenced againstSegue arising from or related to contractual or employee relations. Managementdoes not believe these claims will have a material adverse effect on thefinancial position or results of operations of Segue.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

Notapplicable.

**ITEM 5.OTHER INFORMATION**

Notapplicable.

**ITEM 6.EXHIBITS AND REPORTS ON FORM 8-K**
| (a)    | Exhibits                 |
|--------|--------------------------|
|   |                     |
|   | None.                    |
|   |                     |
| (b)    | Reports on Form 8-K |
|   | None.                    |

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

Date:November 14, 2001.
|   | **SEGUE SOFTWARE, INC.** |
|--------|--------------------------|
|   |                     |   |   |
|   | By:                      |   | /s/ STEPHEN B. BUTLER |
|   |                     |   |   |
|   |                     |   | Stephen B. Butler   Chief Executive Officer |
|   |                     |   |   |
|   | By:                      |   | /s/ DOUGLAS ZACCARO |
|   |                     |   |   |
|   |                     |   | Douglas Zaccaro   Chief Financial Officer |
|   |                     |   |   |