<PAGE>
 
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                  FORM 10-Q/A


(Mark One)
    
    [X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF 
         THE SECURITIES EXCHANGE ACT OF 1934      

         FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998

         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF 
         THE SECURITIES EXCHANGE ACT OF 1934

         FOR THE TRANSITION PERIOD FROM _____ TO _____.

                   Commission file number: 0-27794

                             SEGUE SOFTWARE, INC.
            (Exact name of registrant as specified in its charter)

Delaware                                                     95-4188982
(State or other jurisdiction of                           (I.R.S. Employer
incorporation or organization)                            Identification No.)


                     201 Spring Street Lexington, MA 02421
                    (Address of principal executive offices)

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

    
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such a shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.    YES [X]     NO [_]      


     The number of shares of Registrant's Common Stock outstanding as of
November 3, 1998, was 8,336,374.
<PAGE>
 
                             SEGUE SOFTWARE, INC.
                                  FORM 10-Q/A
               FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
                                     INDEX


                                                                       Page No.
                                                                       --------
PART I.        FINANCIAL INFORMATION

Item 1.        Consolidated Financial Statements:
               
               Consolidated Balance Sheets (unaudited)
      
                  September 30, 1998 and December 31, 1997                   2
      
               Consolidated Statements of Operations (unaudited)
   
                  Three and nine months ended September 30, 1998 and 1997    3
   
               Consolidated Statements of Cash Flows (unaudited)

                  Nine months ended September 30, 1998 and 1997              4

               Notes to Consolidated Financial Statements (unaudited)        5

Item 2.        Management's Discussion and Analysis of Financial
    
                  Condition and Results of Operations                        9 

PART II.       OTHER INFORMATION

Item 2.        Changes in Securities and Use of Proceeds                    16

Item 6.        Exhibits and Reports on Form 8-K                             17

Signatures                                                                  18

Exhibits Index                                                              19 
     
                                       1
<PAGE>
 
PART I.  FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

                              SEGUE SOFTWARE, INC.
                          CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                  (UNAUDITED)
                                        
<TABLE>    
<CAPTION>
                                                                               SEPTEMBER 30,        DECEMBER 31,
                                                                                   1998                1997
                                                                                   ----                ----
<S>                                                                            <C>                  <C>
                                                                                 (RESTATED)
ASSETS                                                                       
Current assets:                                                              
 Cash and cash equivalents                                                       $ 37,679            $ 22,975           
 Short-term investments                                                                 -              14,385           
 Accounts receivable, net of allowances of $230 and $345                            8,218               4,308           
 Other current assets                                                               1,590                 615           
                                                                                 --------            --------           
   Total current assets                                                            47,487              42,283           
                                                                                                                        
Property and equipment, net                                                         2,906               2,252           
Other assets                                                                        1,489               1,502           
                                                                                 --------            --------           
   Total assets                                                                  $ 51,882            $ 46,037           
                                                                                 ========            ========           
                                                                                                                        
LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                    
Current liabilities:                                                                                                    
 Short-term subordinated notes payable                                           $    883            $    883           
 Accounts payable                                                                   1,078                 860           
 Accrued compensation and benefits                                                  1,302               1,127           
 Accrued royalties                                                                    347                 147           
 Accrued expenses                                                                   1,541               1,268           
 Deferred revenue                                                                   3,084               2,477           
                                                                                 --------            --------           
   Total current liabilities                                                        8,235               6,762           
                                                                                                                        
Subordinated notes payable                                                          3,532               3,532           
                                                                                                                        
Stockholders' equity:                                                                                                   
 Series A preferred stock, par value $.01 per share;  5,000 shares                                                      
  authorized; no shares issued and outstanding                                          -                   -           
 Common stock, par value $.01 per share; 30,000 shares authorized; 8,322                                                
  and 7,630 shares issued and outstanding                                              83                  76           
 Additional paid-in capital                                                        51,190              48,479           
 Unearned compensation                                                                (26)               (105)          
 Cumulative translation adjustment                                                    (41)                  -           
 Accumulated deficit                                                              (11,091)            (12,707)          
                                                                                 --------            --------           
   Total stockholders' equity                                                      40,115              35,743           
                                                                                 --------            --------           
   Total liabilities and stockholders' equity                                    $ 51,882            $ 46,037           
                                                                                 ========            ========            
</TABLE>       

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

                                       2
<PAGE>
 
                             SEGUE SOFTWARE, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                  (UNAUDITED)
                                        
<TABLE>    
<CAPTION>
                                                           Three months ended                      Nine months ended
                                                           ------------------                      -----------------           
                                                             September 30,                           September 30,
                                                             -------------                           -------------             
                                                        1998                1997                1998                1997
                                                        ----                ----                ----                ----      
                                                     (restated)                              (restated)
<S>                                                <C>                 <C>                 <C>                 <C>
Revenue:
 Software                                             $ 6,149            $ 3,436                $17,846             $11,306
 Services                                               3,704              1,601                  8,272               4,484
                                                      -------            -------                -------             -------
   Total revenue                                        9,853              5,037                 26,118              15,790
                                                                                          
Cost of revenue:                                                                          
 Cost of software                                         528                392                  1,507                 779
 Cost of services                                       1,905                705                  3,954               1,926
                                                       ------            -------                -------             -------
   Total cost of revenue                                2,433              1,097                  5,461               2,705
                                                                                          
Gross margin                                            7,420              3,940                 20,657              13,085
                                                                                          
Operating expenses:                                                                       
 Sales and marketing                                    4,739              3,006                 12,771               8,406
 Research and development                               1,496              1,288                  4,662               3,665
 General and administrative                               953                781                  2,720               2,344
                                                       ------            -------                -------             -------
   Total operating expenses                             7,188              5,075                 20,153              14,415
                                                       ------            -------                -------             -------
                                                                                          
Income (loss) from operations                             232             (1,135)                   504              (1,330)
Other income, net                                         411                550                  1,225               1,630
                                                       ------            -------                -------             -------
                                                                                          
Income (loss) before provision for income taxes           643               (585)                 1,729                 300
Provision for income taxes                                 57                  -                    113                  56
                                                       ------            -------                -------             -------
                                                                                          
Net income (loss)                                      $  586            $  (585)               $ 1,616             $   244
                                                       ======            =======                =======             =======
                                                                                          
Net income (loss) per common share -basic              $  .07            $  (.08)               $   .20             $   .03  
Net income (loss) per common share - diluted           $  .07            $  (.08)               $   .18             $   .03
Weighted average common shares outstanding -  basic     8,234              7,374                  8,017               7,299
Weighted average common shares outstanding -  diluted   8,965              7,374                  8,764               7,908
</TABLE>     

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

                                       3
<PAGE>
 
                             SEGUE SOFTWARE, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (IN THOUSANDS)
                                  (UNAUDITED)
                                        
<TABLE>    
<CAPTION>
                                                                               Nine months ended
                                                                                 September 30,
                                                                            ------------------------       
                                                                            1998                1997
                                                                            ----                ----       
                                                                         (restated)
<S>                                                                      <C>                <C>           
Cash flows from operating activities:                                                                     
 Net income                                                                $ 1,616           $   244      
 Adjustments to reconcile net income to net cash provided                                               
  by (used in) operating activities:                                                                      
   Depreciation and amortization                                             1,715               759      
   Loss on disposal of property and equipment                                    7                 4      
   Noncash compensation charges                                                 25               108      
   Changes in operating assets and liabilities:                                                           
     Accounts receivable                                                    (3,910)             (430)     
     Other current assets                                                     (939)             (248)     
     Accounts payable                                                          218              (180)     
     Accrued expenses, royalties, compensation and benefits                    448              (317)     
     Deferred revenue                                                          607               295      
                                                                           -------          --------      
Net cash provided by (used in) operating activities                           (213)              235      
                                                                           -------          --------      
                                                                                                          
Cash flows from investing activities:                                                                     
 Additions to property and equipment                                        (1,677)           (1,067)     
 Additions to other assets                                                    (564)             (279)     
 Maturities of short-term investments                                       16,200            47,500      
 Purchases of short-term investments                                        (1,815)          (37,313)     
                                                                           -------          --------      
Net cash provided by investing activities                                   12,144             8,841      
                                                                           -------          --------      
                                                                                                          
Cash flows from financing activities:                                                                     
 Proceeds from exercise of stock options and stock purchase plan             2,773               663      
                                                                           -------          --------      
Net cash provided by financing activities                                    2,773               663      
                                                                           -------          --------      
                                                                                                          
Net increase in cash and cash equivalents                                   14,704             9,739      
Cash and cash equivalents, beginning of period                              22,975             7,112      
                                                                           -------          --------      
                                                                                                          
Cash and cash equivalents, end of period                                   $37,679          $ 16,851      
                                                                           =======          ========       
</TABLE>     

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

                                       4
<PAGE>
 
                             SEGUE SOFTWARE, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                                        
1.  BASIS OF PRESENTATION

     The financial statements included herein have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. The Company believes that the disclosures are adequate to make the
information presented not misleading. However, it is suggested that these
financial statements be read in conjunction with the Company's audited financial
statements for the year ended December 31, 1997, included in its 1997 Annual
Report on Form 10-K.

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

2.  RESTATEMENT OF FINANCIAL STATEMENTS
    
     On April 12, 1999, the Company announced that it would reverse certain
revenue transactions relating to the third quarter of 1998 based on management's
identification of sales practices that did not comply with the Company's
policies. As a result, the Company has restated its financial statements for the
third quarter of 1998. The restatement was required to appropriately record
product sales that included rights of return or exchange. The principal effects
of this restatement on operating results for the quarter were a reduction of
software revenue of $363,000 from $6,512,000 to $6,149,000; a reduction of sales
and marketing expenses of $57,000 from $4,796,000 to $4,739,000; a reduction of
net income of $311,000 from $897,000 to $586,000 and a reduction in net income
per diluted share of $0.03 from $0.10 to $0.07.      
    
     The consolidated financial statements and related notes to consolidated
financial statements set forth in this Form 10-Q/A reflect the restatement. The
following table summarizes the changes in the Company's consolidated results of
operations for the three and nine months ended September 30, 1998 and changes in
its consolidated balance sheet as of September 30, 1998 as a result of the
restatement (in thousands):      

                                       5
<PAGE>
 
<TABLE>    
<CAPTION>
                                       Three months ended                 Nine months ended
                                       -------------------                ------------------
                                       September 30, 1998                 September 30, 1998
                                       -------------------                ------------------
                                  As Previously           As        As Previously          As
                                     Reported          Restated       Reported          Restated
                                     --------          --------       --------          --------
<S>                                <C>               <C>            <C>                <C>
Revenue:
    Software                         $  6,512         $   6,149       $ 18,209          $ 17,846     
    Services                            3,709             3,704          8,277             8,272     
        Total revenue                  10,221             9,853         26,486            26,118     
Gross margin                            7,788             7,420         21,025            20,657     
Sales and marketing expense             4,796             4,739         12,828            12,771     
Total operating expenses                7,245             7,188         20,210            20,153     
Income from operations                    543               232            815               504     
Income before provision                                                                               
    for income taxes                      954              643           2,040             1,729    
Net income                                897              586           1,927             1,616    
Net income per common                                                                               
    share - basic                        0.11             0.07            0.24              0.20    
Net income per common                                                                               
    share - diluted                      0.10             0.07            0.22              0.18     
</TABLE>     

 
<TABLE>    

                                                  As of September 30, 1998
                                                  ------------------------
                                                 As Previously        As
                                                   Reported         Restated
                                                   --------         --------
<S>                                             <C>             <C>  
     Accounts receivable, net of allowances       $  8,685       $   8,218
     Total current assets                           47,954          47,487
     Total assets                                   52,349          51,882
     Accrued compensation and benefits               1,359           1,302
     Accrued expenses                                1,582           1,541
     Deferred revenue                                3,142           3,084
     Total current liabilities                       8,391           8,235
     Accumulated deficit                           (10,780)        (11,091)
     Total stockholders' equity                     40,426          40,115
     Total liabilities and stockholders' equity     52,349          51,882
            
</TABLE>      


3.  NET INCOME (LOSS) PER COMMON SHARE

     The following table sets forth the computation of basic and diluted net
income (loss) per share (in thousands, except per share data):


<TABLE>
<CAPTION>
                                                      Three months ended             Nine months ended
                                                         September 30,                 September 30,
                                                         -------------                 -------------
                                                     1998            1997           1998           1997
                                                     ----            ----           ----           ----
<S>                                               <C>            <C>            <C>             <C> 
Net income (loss)                                 $   586         $  (585)       $ 1,616         $  244
</TABLE> 

                                       6

<PAGE>
 
<TABLE>     
<S>                                                      <C>           <C>             <C>             <C>  
Weighted average shares used in net income
 (loss) per share - basic                                8,234          7,374           8,017          7,299
 
 
Effect of dilutive securities:  Employee and
 director stock options                                    731              -             747            609
                                                        ------         ------          ------         ------
 
Weighted average shares used in net income               8,965          7,374           8,764          7,908
 (loss) per share - diluted                             ======         ======          ======         ======

Net income (loss) per common share-basic                $  .07         $ (.08)         $  .20         $  .03
Net income (loss) per common share-diluted              $  .07         $ (.08)         $  .18         $  .03
</TABLE>     

     Options to purchase approximately 82,000 shares of common stock outstanding
at September 30, 1998 were excluded from the calculation of diluted net income
per share because the exercise prices of those options exceeded the average
market price of common stock for the three months ended September 30, 1998.
Options to purchase approximately 695,000 shares of common stock outstanding at
September 30, 1997 were excluded from the calculation of diluted loss per share
as the effect of their inclusion would have been anti-dilutive for the three
months ended September 30, 1997.  Options to purchase 207,000 and 633,000 shares
of common stock outstanding at September 30, 1998 and 1997, respectively, were
excluded from the calculation of diluted net income (loss) per share because the
exercise prices of those options exceeded the average market price of common
stock for the nine months ended September 30, 1998 and 1997, respectively.

4.  OTHER ASSETS
    
     In March 1998, the Company entered into an agreement with a vendor whereby
the vendor licensed specific software to the Company for purposes of marketing
and distribution.  Under the initial terms of the agreement, the Company paid
$780,000 during the second quarter of 1998, which represented a nonrefundable
non-recurring engineering and initial license fee ("NRE") of $480,000 and
$300,000 of guaranteed royalties.  An additional $200,000 for guaranteed
royalties was to be paid by September 30, 1998.        

     In October 1998, the Company amended this agreement as follows:  (i) the
remaining payment for guaranteed royalties was removed, (ii) the Company
committed to spend $200,000 in the initial 18-month term and each subsequent
one-year term of the agreement on defined marketing activities, and (iii) the
Company agreed to make guaranteed annual royalty payments beginning on October
1, 1999 of $300,000 for each one-year term of the agreement.  The agreement
terminates on September 30, 2001 unless earlier voluntarily terminated by the
Company at the conclusion of any current one-year term.

                                       7
<PAGE>
     
     The NRE fee is being amortized into cost of software revenue on a straight-
line basis over two years, beginning in the second quarter of 1998, and the
royalty expense is being recognized as cost of software revenue based upon sales
of the related products.  For the three and nine months ended September 30,
1998, royalty expense related to this agreement was immaterial. As of September
30, 1998, other current assets included $290,000 related to the guaranteed
royalties, and other long-term assets included $360,000 related to NRE payments.
     
    
     Based on minimal sales of the licensed products and management's decision
in the first quarter of 1999 to cease selling the licensed products related to
the above agreement in order to reduce the complexity of its product portfolio
and focus on its own product line, the Company wrote off the remaining balances
of the NRE and prepaid royalties as non-recurring charges as of December 31,
1998.      

5.  COMMITMENTS

     In August 1998, the Company moved its corporate headquarters to Lexington,
Massachusetts under a nine year lease for 40,500 to 67,500 square feet, which
expires in October 2007.  The Company has the right to terminate the lease on
September 30, 2004 for a fee of approximately $2.2 million.

     Future minimum payments under the lease are as follows (in thousands):
<TABLE> 
<CAPTION> 

          <S>                                            <C>  
          August 1, 1998 - December 31, 1998             $   523
          1999                                             1,860
          2000                                             2,093
          2001                                             2,093
          2002                                             2,093
          Thereafter                                      10,406
                                                         -------
                                                         $19,068
                                                         ======= 
</TABLE> 

6. PROVISION FOR INCOME TAXES
                         

     The Company recorded a provision for foreign and state income taxes of
$57,000 for the third quarter of 1998, no provision for the third quarter of
1997, and a total of $113,000 and $56,000 for the nine months ended September
30, 1998 and 1997, respectively. The Company did not record provisions for
federal income taxes due to utilization of net operating loss carryforwards.

7.  RECENT ACCOUNTING PRONOUNCEMENTS
    
     Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income".
SFAS 130 requires the reporting of comprehensive income in addition to net
income from operations.  Comprehensive income is a more inclusive reporting
methodology that includes disclosure of certain financial information that
historically has not been recognized in the calculation of net income.  The
adoption of SFAS 130 had no impact on the Company's net income or stockholders'
equity.  Total comprehensive income, net of taxes, for the three and nine months
ended September 30, 1998, was $545,000 and $1,575,000, respectively, which
consists of net income and the net changes in foreign currency translation
adjustment.  For the three and nine months ended September 30, 1997,
comprehensive income (loss) equaled net income (loss).      

                                       8
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

     The following table sets forth certain unaudited quarterly results of
operations expressed as a percentage of total revenue for the periods indicated:

<TABLE>    
<CAPTION>
                                               Percentage of Revenue for            Percentage of Revenue for            
                                            Three Months Ended September 30,     Nine Months Ended September 30,         
                                            --------------------------------     -------------------------------         
                                                1998                1997             1998                1997            
                                                ----                ----             ----                ----            
<S>                                            <C>                 <C>              <C>                 <C>            
Revenue:                                                                                                                 
 Software                                        62.4%               68.2%            68.3%               71.6%          
 Services                                        37.6                31.8             31.7                28.4           
                                                -----              ------            -----               -----           
   Total revenue                                100.0               100.0            100.0               100.0           
                                                                                                                         
Cost of revenue:                                                                                                         
 Cost of software                                 5.4                 7.8              5.8                 4.9           
 Cost of services                                19.3                14.0             15.1                12.2           
                                                -----              ------            -----               -----           
   Total cost of revenue                         24.7                21.8             20.9                17.1           
                                                                                                                         
Gross margin                                     75.3                78.2             79.1                82.9           
                                                                                                                         
Operating expenses:                                                                                                      
 Sales and marketing                             48.1                59.7             48.9                53.2           
 Research and development                        15.2                25.5             17.9                23.2           
 General and administrative                       9.6                15.5             10.4                14.9           
                                                -----               -----            -----               -----           
   Total operating expenses                      72.9               100.7             77.2                91.3           
                                                                                                                         
Income (loss) from operations                     2.4               (22.5)             1.9                (8.4)          
Other income, net                                 4.1                10.9              4.7                10.3           
                                                 ----              ------            -----               -----           
Income (loss) before provision for                                                                                       
 income taxes                                     6.5               (11.6)             6.6                 1.9           
Provision for income taxes                         .6                   -               .4                  .4           
                                                -----              ------            -----               -----           
Net income (loss)                                 5.9%             (11.6)%             6.2%                1.5%          
                                                =====              ======            =====               =====            
</TABLE>     

REVENUE

     Revenue from Software.  Software revenue increased 79% to $6.1 million
during the third quarter of 1998 from $3.4 million in the third quarter of 1997.
For the nine months ended September 30, 1998, software revenue increased 58% to
$17.8 million from $11.3 million for the nine months ended September 30, 1997.
The increases in software revenue are primarily the result of increased unit
shipments due to an increase in the

                                       9
<PAGE>
 
demand for automated testing products; the introduction of new and upgraded
products; increased market acceptance of the families of products including Web
application testing and load testing products introduced in 1997; and expansion
of sales and marketing activities. The absolute dollar increases in software
revenue came largely through the direct domestic channel. International revenue
accounted for 11% and 13% of total software revenue in the three and nine months
ended September 30, 1998, and 11% of total software for each of the three and
nine months ended September 30, 1997.

     The mix of software revenue changed from 1997 to 1998.  SilkTest and
SilkPerformer, which target the e-commerce testing markets, were not available
until May 1997 and September 1997, respectively.  Total e-commerce software
revenue represented 65% and 55% of total software revenue in 1998, respectively,
and 31% and 16% of total software revenue in the three and nine months ended
September 30, 1997, respectively.  QA Performer and SilkPerformer, which target
the load testing markets, in total represented 36% and 25% of total software
revenue in the three and nine months ended September 30, 1998 and 1997,
respectively.
    
     Revenue from Services.  Service revenue increased 131% to $3.7 million
during the third quarter of 1998 from $1.6 million in the third quarter of 1997.
As compared to the three months ended September 30, 1997, training and
consulting revenue increased 328% and maintenance revenue increased 39% for the
three months ended September 30, 1998. For the nine months ended September 30,
1998, service revenue increased 84% to $8.3 million from $4.5 million for the
corresponding prior year period. For the nine months ended September 30, 1998,
training and consulting revenue increased 179%, while maintenance revenue
increased 37% over the comparable period in 1997. These increases were driven
largely by an increase in software licenses sold. The increase in training and
consulting revenue is also due to the introduction of the LiveQuality scenario
testing solutions, which consist of a combination of product and consulting
services, in the second quarter of 1998.      

COST OF REVENUE

     Cost of Software.  Cost of software increased 35% to $528,000 during the
third quarter of 1998 from $392,000 in the third quarter of 1997.  For the nine
months ended September 30, 1998, cost of software increased 93% to $1.5 million
from $779,000 for the nine months ended September 30, 1997.  As a percent of
software revenue, costs of software in the current quarter decreased to 9% from
11% in the corresponding prior year period.  For the nine months ended September
30, 1998, cost of software as a percent of software revenue increased to 8% from
7% in the corresponding prior year period.  The absolute dollar increases are
mainly due to the amortization of intangible assets primarily related to the
SQLBench acquisition and the NRE fee noted below, and the cost of upgrading the
installed base with new versions of various products, partially offset by a
decrease in royalties payable to third parties.

     In March 1998, the Company entered into an agreement with a vendor whereby
the vendor licensed specific software to the Company for purposes of marketing
and

                                       10
<PAGE>
 
distribution.  Under the initial terms of the agreement, the Company paid
$780,000 during the second quarter of 1998, which represented an NRE fee of
$480,000 and $300,000 of guaranteed royalties.  An additional $200,000 for
guaranteed royalties was to be paid by September 30, 1998.

     In October 1998, the Company amended this agreement as follows:  (i) the
remaining payment for guaranteed royalties was removed, (ii) the Company
committed to spend $200,000 in the initial 18-month term and each subsequent
one-year term of the agreement on defined marketing activities, and (iii) the
Company agreed to make guaranteed annual royalty payments beginning on October
1, 1999 of $300,000 for each one-year term of the agreement.  The agreement
terminates on September 30, 2001 unless earlier voluntarily terminated by the
Company at the conclusion of any current one-year term.
    
     The NRE fee is being amortized into cost of software revenue over two
years, beginning in the second quarter of 1998, and the royalty expense is being
recognized as cost of software revenue based upon sales of the related products.
For the three and nine months ended September 30, 1998, royalty expense related
to this agreement was immaterial. As of September 30, 1998, other current assets
included $290,000 related to the guaranteed royalties, and other long-term 
assets included $360,000 related to NRE payments.      
    
     Based on minimal sales of the licensed products and management's decision
in the first quarter of 1999 to cease selling the licensed products related to
the above agreement in order to reduce the complexity of its product portfolio
and focus on its own product line, the Company wrote off the remaining balances
of the NRE and prepaid royalties as non-recurring charges as of December 31,
1998.      
    
     Cost of Services.  Cost of services increased 170% to $1.9 million during
the third quarter of 1998 from $705,000 in the third quarter of 1997.  For the
nine months ended September 30, 1998, cost of services increased 105% to $4.0
million from $1.9 million for the nine months ended September 30, 1997. As a
percent of services revenue, costs in the third quarter of 1998 increased to 51%
from 44% in the corresponding prior year period.  For the nine months ended
September 30, 1998, cost of services as a percent of services revenue increased
to 48% from 43% in the corresponding prior year period.  The increases are
largely due to the fact that the Company began to use third party consultants to
assist in LiveQuality solution implementations in the second quarter of 1998.
The cost of third party consultants is generally higher than the cost of
internal resources.  The increases are also due to increased headcount.  From
September 30, 1997 to September 30, 1998, the Company increased its headcount in
the training and consulting and technical support groups by 40%.        

OPERATING EXPENSES

     Sales and Marketing. Sales and marketing expenses increased 58% to $4.7
million during the third quarter of 1998 from $3.0 million in the third quarter
of 1997.  For the

                                       11
<PAGE>
 
nine months ended September 30, 1998, sales and marketing expenses increased 52%
to $12.8 million from $8.4 million for the first nine months of 1997. The
absolute dollar increases are largely due to increased headcount in the sales
group, commissions as a result of higher revenue levels, and travel costs. These
increases are partially offset by decreases in marketing programs such as
advertising and seminars. From September 30, 1997 to September 30, 1998, the
Company increased its headcount in sales by 82%.

     Research and Development.  Research and development expenses increased 16%
to $1.5 million during the third quarter of 1998 from $1.3 million in the third
quarter of 1997.  For the nine months ended September 30, 1998, research and
development expenses increased 27% to $4.7 million from $3.7 million for the
nine months ended September 30, 1997.  The absolute dollar increases are largely
due to the operations of the Austria facility.

     General and Administrative.  General and administrative expenses increased
22% to $953,000 during the third quarter of 1998 from $781,000 in the third
quarter of 1997.  For the nine months ended September 30, 1998, general and
administrative expenses increased 16% to $2.7 million from $2.3 million for the
nine months ended September 30, 1997.  The absolute dollar increases are largely
due to increased headcount and related recruiting costs.  From September 30,
1997 to September 30, 1998, the Company increased its headcount in the general
and administrative groups by 17%.

OTHER INCOME, NET

     Other income, net decreased 25% to $411,000 during the third quarter of
1998 from $550,000 in the third quarter of 1997.  For the nine months ended
September 30, 1998, other income, net decreased 25% to $1.2 million from $1.6
million for the nine months ended September 30, 1997.  These decreases are
largely due to interest expense resulting from the Company's issuance of
subordinated notes in December 1997.

PROVISION FOR INCOME TAXES

     The Company recorded a provision for foreign and state income taxes of
$57,000 for the third quarter of 1998, no provision for the third quarter of
1997, and a total of $113,000 and $56,000 for the nine months ended September
30, 1998 and 1997, respectively. The Company did not record provisions for
federal income taxes due to utilization of net operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

     As of September 30, 1998, the Company had cash, cash equivalents and short-
term investments totaling $37.7 million as compared to cash, cash equivalents
and short-term investments of $37.4 million as of December 31, 1997.

                                       12
<PAGE>
 
     In the first nine months of 1998, the Company used $213,000 for operating
activities, resulting from the growth in accounts receivable and other current
assets, offset by net income and increased deferred revenue.

     The Company generated $12.1 million from investing activities in the first
nine months of 1998, mainly as a result of maturities of short-term investments.

     The Company generated funds from financing activities of $2.8 million in
the first nine months of 1998, related to the exercise of stock options and
issuance of stock pursuant to the employee stock purchase plan.

     In August 1998, the Company moved its corporate headquarters to Lexington,
Massachusetts under a nine year lease for 40,500 to 67,500 square feet, which
expires in October 2007.  The Company has the right to terminate the lease on
September 30, 2004 for a fee of approximately $2.2 million.

  Future minimum payments under the lease are as follows (in thousands):

     August 1, 1998 - December 31, 1998              $    523
     1999                                               1,860
     2000                                               2,093
     2001                                               2,093
     2002                                               2,093
     Thereafter                                        10,406
                                                      -------
                                                      $19,068
                                                      =======

     See Cost of Revenue for other commitments requiring use of financial
resources in the future.


     Long-term cash requirements, other than normal operating expenses, are
anticipated for the development of new software products and enhancements of
existing products, the opening of additional international offices, and the
possible acquisition of software products or technologies complementary to the
Company's business.

     Assuming there is no significant change in the Company's business, the
Company believes that the existing cash and cash equivalents as well as cash
flows from operations will be sufficient to meet its working capital
requirements for at least the next twelve months.

YEAR 2000 COMPLIANCE

     The year 2000 presents potential concerns for business and consumer
computing.  The consequences of this issue may include systems failures and
business process interruption.  It may also include additional business and
competitive differentiation. If the Company, its significant customers, or
suppliers fail to make necessary modifications and conversions on a timely
basis, the year 2000 issue could have a material adverse effect on the Company's
operations.  There are two other related issues which could also lead to

                                       13
<PAGE>
 
incorrect calculations or failures: i) some systems' programming assigns special
meaning to certain dates, such as 9/9/99, and ii) the year 2000 is a leap year.
To address these year 2000 issues with its internal systems, including
information technology (IT) and non-IT systems, the Company initiated a program
designed to deal with the most critical systems, packaged software applications,
first. Year 2000 compliance testing is complete for the Company's internal
software systems.  The internal hardware systems will be tested for year 2000
compliance in the first quarter of 1999.  In addition, the Company will begin
work on various types of contingency planning to address potential problem areas
with internal systems in the first quarter of 1999.  Although the assessment is
still underway, management currently believes that all material systems will be
compliant by the year 2000 and that the cost to address the issues is not
material. However, this estimate does not include potential costs related to any
customer or other claims or the cost of internal software and hardware replaced
in the normal course of business. The total cost estimate is based on the
current assessment of the projects and is subject to change as the projects
progress. The costs incurred to date related to these programs are minimal.

     The Company has also initiated formal communications with its significant
vendors, mainly of IT packaged applications, to determine the extent to which
the Company is vulnerable to those third parties' failure to remedy their own
year 2000 issues.  The Company has received written assurances of year 2000
compliance from all significant vendors.  Most of the vendors under existing
contracts with the Company are under no contractual obligation to provide such
information to the Company.  The Company is taking steps with respect to new
vendor agreements to ensure that the vendors' products and internal systems are
year 2000 compliant.  The Company has no mission-critical suppliers of products
or services.

     The Company also assesses the capability of its products to handle the year
2000. To assist customers in evaluating their year 2000 issues, the Company has
a description on its website which indicates the capability of Segue's products
to handle the year 2000.  All Segue products are year 2000 compliant.  However,
the assessment of whether a complete system will operate correctly depends on
the BIOS capability and software design and integration, and for many end-users
this will include BIOS and software provided by companies other than Segue.

     The Company anticipates that substantial litigation may be brought against
vendors, including the Company, of all component products of systems that are
unable to properly manage data related to year 2000.  The Company's agreements
with customers typically contain provisions designed to limit the Company's
liability for such claims.  It is possible, however, that these measures will
not provide protection from liability claims, as a result of existing or future
federal, state or local laws or ordinances or unfavorable judicial decisions.
Any such claims, with or without merit, could result in a material adverse
effect on the Company's business, financial condition and results of operations,
including increased warranty costs, customer satisfaction issues and potential
lawsuits.

     Based on currently available information, management does not believe that
the year 2000 matters discussed above related to internal systems or products
sold to

                                       14
<PAGE>
 
customers will have a material adverse impact on the Company's financial
condition or overall trends in results of operations; however, it is uncertain
to what extent the Company may be affected by such matters. In addition, there
can be no assurance that the failure to ensure year 2000 capability by a
supplier or another third party would not have a material adverse effect on the
Company.

IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

     This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934.  The Company's actual results could
differ materially from those set forth in the forward-looking statements.
Various important factors, including but not limited to the following, may cause
the Company's future results to differ materially from those set forth in the
forward-looking statements: risks associated with the Company's limited
operating history; the dependence upon license revenues from the Company's
principal products; uncertainties regarding the development of the automated
software testing marketplace; the dependence upon the growth of a viable
commercial marketplace for the Internet's World Wide Web and Internet-related
products; changes in technology and industry standards; the Company's ability to
develop and introduce product enhancements and new products; risks related to
the management of the Company's growth; risks related to the Company's ability
to integrate acquisitions already completed as well as others that may occur;
risks related to the development of the Company's sales and marketing strategy;
risks related to Year 2000 compliance of the Company's internal systems and
compliance by the Company's suppliers and customers; the Company's ability to
attract, train and retain qualified personnel; the development of an
international market and distribution channel for the Company's products; the
Company's ability to develop strategic partnerships; the timing of the receipt
of orders from major customers; increased competition, including competition
from the recent consolidation in the automated software quality market; and
general economic conditions.  In addition, the Company has significantly changed
the executive management team and the sales management team under the direction
of a new Chief Executive Officer.  In conjunction with these management changes,
the Company has refocused its sales and marketing approach to focus on e-
commerce applications.  There can be no assurance that the Company will be able
to effectively manage such change.  Furthermore, a significant portion of the
Company's revenue within a quarter is typically not realized until late in that
quarter.  As a result, it may be difficult for the Company to predict its total
revenue for a quarter or to quickly adapt its spending levels within a quarter
to reflect changes in demand for its products.  The market price of the
Company's common stock has been, and in the future will likely be, subject to
significant fluctuations in response to variations in quarterly operating
results and other factors, such as announcements of technological innovations or
new products by the Company or its competitors, or other events.  For a more
detailed discussion of those factors affecting future operating results, see the
discussion contained in the Company's Annual Report on Form 10-K for the year
ended

                                       15
<PAGE>
 
December 31, 1997, under the heading "Certain Factors Affecting Future Operating
Results".

PART II.  OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS
    
     The Company completed the initial public offering (IPO) of its Common Stock
in April 1996.  The IPO was made pursuant to a Registration Statement on Form S-
1, filed with the Securities and Exchange Commission pursuant to Rule 462(b)
under the Securities Act of 1933 (Commission File No. 333-1488), which was
declared effective as of  March 28, 1996.  The IPO commenced on April 2, 1996
and terminated shortly thereafter after the sale into the public market of all
of the registered shares of Common Stock.      

     The 3,162,500 shares of Common Stock sold by the Company and selling
security holders in the IPO were offered for sale in the United States by a
syndicate of underwriters represented by Alex. Brown & Sons Incorporated, Adams,
Harkness & Hill, Inc., and Soundview Financial Group, Inc.

     The Company registered an aggregate of 2,412,500 shares of Common Stock
(including 412,500 shares issued upon the exercise of the underwriters'
overallotment options) for sale in the IPO at a per share price of $18.00 for an
aggregate offering price of approximately $43.4 million.  All of such shares
were registered for the Company's account.  Selling security holders registered
an aggregate of 750,000 shares of Common Stock for sale in the IPO at a per
share price of $18.00 for an aggregate offering price of $13.5 million.  All of
such shares were registered for the selling security holders' accounts.  As
stated above, all of such shares were sold shortly after the commencement of the
offering.

     In connection with the IPO, the Company incurred the following expenses:
<TABLE> 
<CAPTION> 
      
      <S>                                                   <C> 
      Underwriting discounts and commissions                $ 3,039,750
      Expenses paid to underwriters                              10,999
      Other direct expenses                                     847,281
                                                             ----------
      Total expenses                                         $3,898,030
</TABLE> 

     After deducting the expenses set forth above, the Company received
approximately $39.5 million in net proceeds of the IPO.  As of September 30,
1998, the Company had used $4.4 million of the proceeds to acquire SQLBench in
December 1997, approximately $4.0 million for the purchase of property and
equipment, and approximately $1.5 million for working capital.  The remaining
$29.6 million was invested in temporary investments, mainly consisting of
government agency paper and commercial paper.

     No payments were made to directors, officers, or persons owning 10 percent
or more of the Common Stock of the Company.

                                       16
<PAGE>
 
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

     (a)   Exhibits:
              27.1  Financial Data Schedule
     (b)  Reports on Form 8-K:
             None.

                                       17
<PAGE>
 
                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
    
Date: April 15, 1999      


                                       SEGUE SOFTWARE, INC.
 


                                       /s/ STEPHEN B. BUTLER
                                       ---------------------
                                        Chief Executive Officer


                                       /s/ CARL D. BLANDINO
                                       --------------------
                                        Chief Financial Officer and Senior 
                                        Vice President of Administration

                                       18
<PAGE>
 
                               INDEX TO EXHIBITS

Exhibit
No.            Description
--------------------------

27.1  Financial Data Schedule

                                       19