##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended June 30, 2005
 o
    
    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.
  Delaware
    
    95-4188982(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 201 Spring Street, Lexington, MA 02421
 (781) 402-1000
 
 Indicate by check mark whether the registrant: þ o
 o þ




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SEGUE SOFTWARE, INC.
 FORM 10-Q
 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
 INDEX
 PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Financial Statements:Condensed Consolidated Balance Sheets (unaudited) June 30, 2005 and December 31, 2004Condensed Consolidated Statements of Operations (unaudited) Three Months and Six Months Ended June
30, 2005 and 2004Condensed Consolidated Statements of Cash Flows (unaudited) Six Months Ended June 30, 2005 and 2004Notes to Condensed Consolidated Financial Statements (unaudited)Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
    
    Quantitative and Qualitative Disclosures about Market RiskItem 4.
    
    Controls and ProceduresPART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal ProceedingsItem 4.
    
    Submission of Matters to a Vote of Security HoldersItem 5.
    
    Other InformationItem 6.
    
    Exhibits and Reports on Form 8-KSignaturesCertificationsEX-31.1 Section 302 Certification of CEOEx-31.2 Section 302 Certification of CFOEX-32.1 Section 906 Certification of CEOEX-32.2 Section 906 Certification of CFO




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PART I. FINANCIAL INFORMATION




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ITEM 1. Condensed Consolidated Financial Statements
 SEGUE SOFTWARE, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands except share data)
 (Unaudited)June 30,
    
    December 31,2005
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    12,399
    
    
    $
    11,028Accounts receivable, net of allowances of $273 and $281, respectively
    
    
    6,258
    
    
    
    6,421Other current assets
    
    
    1,076
    
    
    
    1,013Total current assets
    
    
    19,733
    
    
    
    18,462Property and equipment, net
    
    
    743
    
    
    
    749Goodwill, net
    
    
    1,506
    
    
    
    1,506Other assets
    
    
    486
    
    
    
    604Total assets
    
    $
    22,468
    
    
    $
    21,321LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    686
    
    
    $
    564Accrued compensation and benefits
    
    
    1,507
    
    
    
    1,602Accrued lease obligations on excess space
    
    
    859
    
    
    
    1,059Accrued expenses
    
    
    1,003
    
    
    
    1,134Deferred revenue
    
    
    10,350
    
    
    
    10,524Total current liabilities
    
    
    14,405
    
    
    
    14,883Stockholders equity:Preferred stock, par value $.01 per share; 9,000 shares authorized;
949 and 921 shares of Series B and 605 and 570 shares of Series C
preferred stock issued and outstanding, respectively
    
    
    5,090
    
    
    
    4,726Common stock, par value $.01 per share; 30,000 shares authorized;
10,378 and 10,195 shares issued, respectively
    
    
    104
    
    
    
    102Additional paid-in capital
    
    
    58,028
    
    
    
    57,959Cumulative translation adjustment
    
    
    253
    
    
    
    429Unearned stock-based compensation
    
    
    (39
    )
    
    
    (47
    )Accumulated deficit
    
    
    (54,773
    )
    
    
    (56,131
    )8,663
    
    
    
    7,038Less treasury stock, at cost, 145 and 145 shares, respectively
    
    
    (600
    )
    
    
    (600
    )Total stockholders equity
    
    
    8,063
    
    
    
    6,438Total liabilities and stockholders equity
    
    $
    22,468
    
    
    $
    21,321




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SEGUE SOFTWARE, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands except per share data)
 (Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Revenue:Software
    
    $
    3,689
    
    
    $
    3,597
    
    
    $
    7,308
    
    
    $
    7,172Services
    
    
    5,277
    
    
    
    4,477
    
    
    
    10,120
    
    
    
    8,948Gross revenue
    
    
    8,966
    
    
    
    8,074
    
    
    
    17,428
    
    
    
    16,120Less vendor consideration to a customer
    
    
    (57
    )
    
    
    (36
    )
    
    
    (125
    )
    
    
    (58
    )Net revenue
    
    
    8,909
    
    
    
    8,038
    
    
    
    17,303
    
    
    
    16,062Cost of revenue:Cost of software
    
    
    101
    
    
    
    92
    
    
    
    211
    
    
    
    177Cost of services
    
    
    1,267
    
    
    
    1,294
    
    
    
    2,386
    
    
    
    2,606Total cost of revenue
    
    
    1,368
    
    
    
    1,386
    
    
    
    2,597
    
    
    
    2,783Gross margin
    
    
    7,541
    
    
    
    6,652
    
    
    
    14,706
    
    
    
    13,279Operating expenses:Sales and marketing
    
    
    3,769
    
    
    
    3,489
    
    
    
    7,276
    
    
    
    6,961Research and development
    
    
    1,922
    
    
    
    1,635
    
    
    
    3,770
    
    
    
    3,285General and administrative
    
    
    1,303
    
    
    
    1,046
    
    
    
    2,444
    
    
    
    2,228Total operating expenses
    
    
    6,994
    
    
    
    6,170
    
    
    
    13,490
    
    
    
    12,474Income from operations
    
    
    547
    
    
    
    482
    
    
    
    1,216
    
    
    
    805Other income (expense), net
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    15Interest income, net
    
    
    70
    
    
    
    16
    
    
    
    114
    
    
    
    37Income before provision for income taxes
    
    
    617
    
    
    
    493
    
    
    
    1,330
    
    
    
    857Provision (benefit) for income taxes
    
    
    (110
    )
    
    
    (24
    )
    
    
    (28
    )
    
    
    2Net income
    
    
    727
    
    
    
    517
    
    
    
    1,358
    
    
    
    855Preferred stock dividend-in-kind
    
    
    (95
    )
    
    
    (173
    )
    
    
    (364
    )
    
    
    (340
    )Net income applicable to common shares
    
    $
    632
    
    
    $
    344
    
    
    $
    994
    
    
    $
    515Net income per common share  Basic
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.05Net income
per common share  Diluted*
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.09
    
    
    $
    0.05Weighted average common shares outstanding  Basic
    
    
    10,205
    
    
    
    9,906
    
    
    
    10,151
    
    
    
    9,869Weighted
average common shares outstanding 
Diluted*
    
    
    10,992
    
    
    
    10,633
    
    
    
    11,236
    
    
    
    10,646
 
 *
    
    The assumed conversion of preferred shares into common shares is not included because their
inclusion would be anti-dilutive.




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SEGUE SOFTWARE, INC
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In Thousands)
 (Unaudited)
 Six months ended June 30,2005
    
    2004Increase (decrease) in cashCash flows from operating activities:Net income
    
    $
    1,358
    
    
    $
    855Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    217
    
    
    
    437Stock-based compensation
    
    
    8
    
    
    
    13Changes in operating assets and liabilities:Accounts receivable
    
    
    28
    
    
    
    674Other current assets
    
    
    (60
    )
    
    
    (179
    )Accounts payable
    
    
    106
    
    
    
    (269
    )Accrued expenses, lease obligations on excess space, compensation, benefits and other
    
    
    (393
    )
    
    
    (351
    )Deferred revenue
    
    
    (45
    )
    
    
    439Net cash provided by operating activities
    
    
    1,219
    
    
    
    1,619Cash flows from investing activities:Additions to property and equipment
    
    
    (237
    )
    
    
    (148
    )Decreases (additions) to other assets
    
    
    117
    
    
    
    (7
    )Purchases of short-term investments
    
    
    (35
    )
    
    
    Net cash used in investing activities
    
    
    (155
    )
    
    
    (155
    )Cash flows from financing activities:Proceeds from exercise of stock options and stock purchase plan
    
    
    435
    
    
    
    281Net cash provided by financing activities
    
    
    435
    
    
    
    281Effect of exchange rate changes on cash
    
    
    (128
    )
    
    
    (9
    )Net increase in cash and cash equivalents
    
    
    1,371
    
    
    
    1,736Cash and cash equivalents, beginning of period
    
    
    11,028
    
    
    
    7,495Cash and cash equivalents, end of period
    
    $
    12,399
    
    
    $
    9,231Supplemental disclosure of non-cash investing and financing transactions:Net cash paid (refunded) for income taxes during the six months ended June 30
    
    $
    (96
    )
    
    $
    (53
    )Distribution
of Preferred stock dividend-in-kind
    
    $
    364
    
    
    $
    340




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SEGUE SOFTWARE, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 1. Basis of Presentation
   2. Liquidity
    3. Recent Accounting Developments
 Share-Based Payment Accounting for Stock Issued to Employees
  Share-Based
Payment
 Accounting for Income Taxes




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4. Other Assets
  5. Equity Transactions




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For the three months ended
    
    For the six months endedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Net income applicable to common sharesAs reported
    
    $
    632
    
    
    $
    344
    
    
    $
    994
    
    
    $
    515Deduct: Total stock-based employee
compensation expense determined
under the fair value based method
for all awards
    
    
    (279
    )
    
    
    (427
    )
    
    
    (632
    )
    
    
    (906
    )Pro forma
    
    $
    353
    
    
    $
    (83
    )
    
    $
    362
    
    
    $
    (391
    )Net income (loss) per common share 
basic and dilutedAs reported  basic
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.05As reported  diluted
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.09
    
    
    $
    0.05Pro forma  basic
    
    $
    0.03
    
    
    $
    (0.01
    )
    
    $
    0.04
    
    
    $
    (0.04
    )Pro forma  diluted
    
    $
    0.03
    
    
    $
    (0.01
    )
    
    $
    0.03
    
    
    $
    (0.04
    )
  2005
    
    2004
    
    2003Risk-free interest rate
    
    
    4.04
    %
    
    
    3.93
    %
    
    
    3.80
    %Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Expected life (years)
    
    
    7
    
    
    
    7
    
    
    
    7Expected volatility
    
    
    66
    %
    
    
    65
    %
    
    
    80
    %
 6. Restructuring Charges




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7. Provision for Income Taxes
  8. Net Income Per Common Share
  Three months ended June 30,
    
    Six months ended June 30,2005
    
    2004
    
    2005
    
    2004Net income applicable to common shares
    
    $
    632
    
    
    $
    344
    
    
    $
    994
    
    
    $
    515Weighted average shares used in net income
per share  basic
    
    
    10,205
    
    
    
    9,906
    
    
    
    10,151
    
    
    
    9,869Incremental common shares issuable
under employee stock option plans
    
    
    787
    
    
    
    727
    
    
    
    1,085
    
    
    
    777Weighted average shares used in net income
per share  diluted
    
    
    10,992
    
    
    
    10,633
    
    
    
    11,236
    
    
    
    10,646Net income per common share  basic
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.05Net income per common share  diluted
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.09
    
    
    $
    0.05
  9. Other Comprehensive Income
  Three months ended June 30,
    
    Six months ended June 30,2005
    
    2004
    
    2005
    
    2004Net income
    
    $
    727
    
    
    $
    517
    
    
    $
    1,358
    
    
    $
    855Foreign translation adjustments
    
    
    (104
    )
    
    
    (13
    )
    
    
    (176
    )
    
    
    (44
    )Comprehensive income
    
    $
    623
    
    
    $
    504
    
    
    $
    1,182
    
    
    $
    811
 10. Commitments and Contingencies
 Legal Proceedings
  Lease Commitments




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Gross
    
    Sublease
    
    NetCommitment
    
    Income
    
    Amount2005
    
    $
    1,009
    
    
    $
    (49
    )
    
    $
    9602006
    
    
    2,003
    
    
    
    (100
    )
    
    
    1,9032007
    
    
    1,698
    
    
    
    (85
    )
    
    
    1,6132008
    
    
    382
    
    
    
    0
    
    
    
    3822009
    
    
    341
    
    
    
    0
    
    
    
    341Thereafter
    
    
    241
    
    
    
    0
    
    
    
    241Total
    
    $
    5,674
    
    
    $
    (234
    )
    
    $
    5,440
  Royalty Commitments
    Contingencies
  11. Segment Reporting




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Three months ended June 30,
    
    Six months ended June 30,2005
    
    2004
    
    2005
    
    2004Gross
    
    
    
    
    
    Gross
    
    
    
    
    
    Gross
    
    
    
    
    
    GrossRevenue
    
    Margin
    
    Revenue
    
    Margin
    
    Revenue
    
    Margin
    
    Revenue
    
    MarginSoftware licenses
    
    $
    3,689
    
    
    $
    3,588
    
    
    $
    3,597
    
    
    $
    3,505
    
    
    $
    7,308
    
    
    $
    7,097
    
    
    $
    7,172
    
    
    $
    6,995Training and consulting
    
    
    985
    
    
    
    407
    
    
    
    705
    
    
    
    193
    
    
    
    1,486
    
    
    
    455
    
    
    
    1,437
    
    
    
    354Maintenance
    
    
    4,292
    
    
    
    3,603
    
    
    
    3,772
    
    
    
    2,990
    
    
    
    8,634
    
    
    
    7,279
    
    
    
    7,511
    
    
    
    5,988Total services
    
    
    5,277
    
    
    
    4,010
    
    
    
    4,477
    
    
    
    3,183
    
    
    
    10,120
    
    
    
    7,734
    
    
    
    8,948
    
    
    
    6,342Less vendor
consideration to a
customer
    
    
    (57
    )
    
    
    (57
    )
    
    
    (36
    )
    
    
    (36
    )
    
    
    (125
    )
    
    
    (125
    )
    
    
    (58
    )
    
    
    (58
    )Total
    
    $
    8,909
    
    
    $
    7,541
    
    
    $
    8,038
    
    
    $
    6,652
    
    
    $
    17,303
    
    
    $
    14,706
    
    
    $
    16,062
    
    
    $
    13,279
  Total Net RevenueThree months ended
    
    Six months ended
    
    Long Lived AssetsJune 30,
    
    June 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004
    
    2005
    
    2004United States
    
    $
    7,152
    
    
    $
    6,609
    
    
    $
    14,018
    
    
    $
    13,182
    
    
    $
    1,031
    
    
    $
    1,478Foreign
    
    
    1,757
    
    
    
    1,429
    
    
    
    3,285
    
    
    
    2,880
    
    
    
    199
    
    
    
    243$
    8,909
    
    
    $
    8,038
    
    
    $
    17,303
    
    
    $
    16,062
    
    
    $
    1,230
    
    
    $
    1,721
 
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview




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Critical Accounting Policies
   Revenue Recognition
    Bad Debt Reserve
 Restructuring and Impairment Charges




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Goodwill
 Preferred Stock Dividend-In-Kind
     Deferred Tax Valuation Allowance
  Results of Operations




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Percentage of Revenue for
    
    Percentage of Revenue forThree Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004Revenue:Software
    
    
    41.4
    %
    
    
    44.7
    %
    
    
    42.2
    %
    
    
    44.7
    %Services
    
    
    59.2
    
    
    
    55.7
    
    
    
    58.5
    
    
    
    55.7Gross revenue
    
    
    100.6
    
    
    
    100.4
    
    
    
    100.7
    
    
    
    100.4Less vendor consideration to a customer
    
    
    (0.6
    )
    
    
    (0.4
    )
    
    
    (0.7
    )
    
    
    (0.4
    )Net revenue
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Cost of revenue:Cost of software
    
    
    1.1
    
    
    
    1.1
    
    
    
    1.2
    
    
    
    1.1Cost of services
    
    
    14.2
    
    
    
    16.1
    
    
    
    13.8
    
    
    
    16.2Total cost of revenue
    
    
    15.3
    
    
    
    17.2
    
    
    
    15.0
    
    
    
    17.3Gross margin
    
    
    84.7
    
    
    
    82.8
    
    
    
    85.0
    
    
    
    82.7Operating expenses:Sales and marketing
    
    
    42.3
    
    
    
    43.4
    
    
    
    42.1
    
    
    
    43.3Research and development
    
    
    21.6
    
    
    
    20.3
    
    
    
    21.8
    
    
    
    20.5General and administrative
    
    
    14.6
    
    
    
    13.0
    
    
    
    14.1
    
    
    
    13.9Total operating expenses
    
    
    78.5
    
    
    
    76.7
    
    
    
    78.0
    
    
    
    77.7Income from operations
    
    
    6.2
    
    
    
    6.1
    
    
    
    7.0
    
    
    
    5.0Other income (expense), net
    
    
    0.0
    
    
    
    (0.1
    )
    
    
    0.0
    
    
    
    0.1Interest income, net
    
    
    0.8
    
    
    
    0.2
    
    
    
    0.7
    
    
    
    0.2Income before provision for income taxes
    
    
    7.0
    
    
    
    6.2
    
    
    
    7.7
    
    
    
    5.3Provision (benefit) for income taxes
    
    
    (1.2
    )
    
    
    (0.3
    )
    
    
    (0.2
    )
    
    
    0.0Net income
    
    
    8.2
    %
    
    
    6.5
    %
    
    
    7.9
    %
    
    
    5.3
    %
 Software Revenue
    Services Revenue




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Vendor Consideration to a Customer
  Cost of Software
  Cost of Services




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Sales and Marketing
     Research and Development
   General and Administrative




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Interest
and Other Income (Expense)
   Provision for Income Taxes
   Liquidity and Capital Resources




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Risks and Factors That May Affect Future Results
  Our results may fluctuate.
  We may not be profitable in the future.
  Business conditions and Information Technology (IT) spending could cause a decline in revenue.




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We may not derive substantial incremental revenue from our alliances and SilkElite Partner
Program.
   Our future success will depend on our ability to respond rapidly and effectively to
technological and other market changes, including the successful introduction of new and enhanced
products.
  We may face liquidity issues.
 Our stock price may be volatile.
 We face significant competition from other software companies.




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Our business could be adversely affected if our products contain errors.
 We must hire and retain skilled personnel in a difficult economic environment.
 Our earnings may be adversely affected by the new accounting treatment for stock options and
we may be forced to change our employee compensation and benefits practices. Share-Based Payment Accounting
for Stock Issued to Employees
 We face many risks associated with international business activities.
 Our success depends on our ability to protect our software and other proprietary technology.
 
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk




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Interest Rate Risk.
 Foreign Currency Risk.
 
 ITEM 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls over Financial Reporting




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PART II. OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
  
 ITEM 4. Submission of Matters to a Vote of Security Holders
   Votes For
    
    Votes WithheldJoseph K. Krivickas
    
    
    11,316,258
    
    
    
    24,595John R. Levine
    
    
    11,327,565
    
    
    
    13,288Howard L. Morgan
    
    
    11,191,954
    
    
    
    148,899Robert W. Powers, Jr.
    
    
    11,328,293
    
    
    
    12,560Jyoti Prakash
    
    
    11,177,819
    
    
    
    163,034James H. Simons
    
    
    11,194,682
    
    
    
    146,171
  Votes
    
    Votes
    
    VotesFor
    
    Against
    
    WithheldRatification of an amendment to
the Companys Restated Certificate
of Incorporation to change the
dividend and redemption rights of
the Companys Series B Preferred
Stock, par value $.01 per share
    
    
    6,768,165
    
    
    
    21,754
    
    
    
    4,875Ratification of the appointment of
Grant Thornton LLP as independent
public accountants for the fiscal
year ending December 31, 2005
    
    
    11,313,975
    
    
    
    11,728
    
    
    
    15,150




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##### Table of Contents



ITEM 5. Other Information
    
 ITEM 6. Exhibits
  31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 SIGNATURES
   SEGUE SOFTWARE, INC.By:
    
    /s/       JOSEPH K. KRIVICKASJoseph K. KrivickasChief Executive OfficerBy:
    
    /s/       MICHAEL F. SULLIVANMichael F. SullivanChief Financial Officer