**UNITED STATES**

# **SECURITIES AND EXCHANGE COMMISSION**

## **Washington,D.C. 20549**

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### ** **

### **FORM 10-Q**

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

 

**For the Quarterly Period Ended March 31, 2002**

** **
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15() OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|----------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom         to         **

 

**Commission file number 0-27794**

 

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**SEGUE SOFTWARE, INC.**

(Exact name of registrantas specified in its 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** |

 

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Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such a shorterperiod that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý  No o

 

The number of shares of Registrant’s Common Stockoutstanding as of May 7, 2002 was 9,553,000

 

 

**SEGUE SOFTWARE, INC.**

 

**FORM 10-Q**

 

**FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002**

 

**INDEX**

 
|     |   |                                                                                                          |
|----------|--------|---------------------------------------------------------------------------------------------------------------|
| PART I.  |   | FINANCIAL INFORMATION                                                                                         |
|     |   |                                                                                                          |
| Item  1. |   | Condensed  Consolidated Financial Statements:                                                                 |
|     |   |                                                                                                          |
|     |   | Condensed Consolidated  Balance Sheets (unaudited) March 31, 2002 and December 31, 2001             |
|     |   |                                                                                                          |
|     |   | Condensed  Consolidated Statements of Operations (unaudited) Three months ended  March 31, 2002 and 2001 |
|     |   |                                                                                                          |
|     |   | Condensed  Consolidated Statements of Cash Flows (unaudited) Three months ended  March 31, 2002 and 2001 |
|     |   |                                                                                                          |
|     |   | 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  2. |   | Changes  in Securities and Use of Proceeds                                                                    |
|     |   |                                                                                                          |
| Item  4. |   | Submission  of Matters to a Vote of Security Holders                                                          |
|     |   |                                                                                                          |
| Item 5.  |   | Other Information                                                                                             |
|     |   |                                                                                                          |
| Item 6.  |   | Exhibits and  Reports on Form 8-K                                                                        |
|     |   |                                                                                                          |
|     |   | Signatures                                                                                                    |

 

2

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**PARTI. FINANCIAL INFORMATION**

 

**ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**SEGUE SOFTWARE, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(IN THOUSANDS EXCEPT PER SHARE DATA)**

**(UNAUDITED)**

 
|                                                                                                                                                    |   | **March 31,  2002** |       | **December 31,  2001** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------------|------------|
|                                                                                                                                                    |   |                |       |                   |       |
| **ASSETS**                                                                                                                                              |   |                | ** ** |                   | ** ** |
| Current assets:                                                                                                                                         |   |                |       |                   |       |
| Cash and cash equivalents                                                                                                                               |   | $                   | 7,738      |                   | $          | 2,326 |   |
| Short-term investments                                                                                                                                  |   | 800                 |       | 4,949                  |       |
| Accounts receivable, net of allowances of $535 and  $594, respectively                                                                                  |   | 4,862               |       | 5,332                  |       |
| Other current assets                                                                                                                                    |   | 987                 |       | 1,384                  |       |
| Total current assets                                                                                                                                    |   | 14,387              |       | 13,991                 |       |
|                                                                                                                                                    |   |                |       |                   |       |
| Property and equipment, net                                                                                                                             |   | 3,277               |       | 3,730                  |       |
| Goodwill, net                                                                                                                                           |   | 1,506               |       | 1,506                  |       |
| Other assets                                                                                                                                            |   | 388                 |       | 417                    |       |
| Total assets                                                                                                                                            |   | $                   | 19,558     |                   | $          | 19,644 |   |
|                                                                                                                                                    |   |                | ** ** |                   | ** ** |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                          |   |                | ** ** |                   | ** ** |
| Current liabilities:                                                                                                                                    |   |                |       |                   |       |
| Accounts payable                                                                                                                                        |   | $                   | 2,575      |                   | $          | 1,903 |   |
| Accrued compensation and benefits                                                                                                                       |   | 1,596               |       | 1,184                  |       |
| Accrued lease obligations on excess space                                                                                                               |   | 2,328               |       | 2,405                  |       |
| Accrued expenses                                                                                                                                        |   | 1,239               |       | 1,601                  |       |
| Deferred revenue                                                                                                                                        |   | 7,448               |       | 8,072                  |       |
| Total current liabilities                                                                                                                               |   | 15,186              |       | 15,165                 |       |
|                                                                                                                                                    |   |                |       |                   |       |
| Commitments and contingencies (Note 9)                                                                                                                  |   | —              |       | —                 |       |
|                                                                                                                                                    |   |                |       |                   |       |
| Stockholders’ equity:                                                                                                                              |   |                |       |                   |       |
| Preferred stock, par value $.01 per share; 9,000  shares authorized; 667 and 0 shares issued and outstanding of Series B  preferred stock, respectively |   | 7                   |       | —                 |       |
| Common stock, par value $.01 per share; 30,000 shares  authorized; 9,688 and 9, 599 shares issued, respectively                                         |   | 97                  |       | 96                     |       |
| Additional paid-in capital                                                                                                                              |   | 60,270              |       | 58,150                 |       |
| Cumulative translation adjustment                                                                                                                       |   | (100                | )          | (197                   | )          |
| Accumulated deficit                                                                                                                                     |   | (55,302             | )          | (52,970                | )          |
|                                                                                                                                                    |   | 4,972               |       | 5,079                  |       |
| Less treasury stock, at cost, 145 and 145 shares,  respectively                                                                                         |   | (600                | )          | (600                   | )          |
| Total stockholders’ equity                                                                                                                         |   | 4,372               |       | 4,479                  |       |
| Total liabilities and stockholders’ equity                                                                                                         |   | $                   | 19,558     |                   | $          | 19,644 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

3

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**SEGUE SOFTWARE, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** (IN THOUSANDS EXCEPTPER SHARE DATA)**

**(UNAUDITED)**

** **
|                                                        |   | **Three months ended March 31,** |   |
|-------------------------------------------------------------|--------|----------------------------------|--------|
|                                                        |   | **2002**                         |   | **2001** |   |
| Revenue:                                                    |   |                             |   |   |   |
| Software                                                    |   | $                                | 3,315  |   | $ | 5,522 |   |
| Services                                                    |   | 4,731                            |   | 6,370 |   |
| Subtotal revenue                                            |   | 8,046                            |   | 11,892 |   |
| Adjustment  relating to payment to a customer               |   | (1,000                           | )      | — |   |
| Net revenue                                                 |   | 7,046                            |   | 11,892 |   |
|                                                        |   |                             |   |   |   |
| Cost of revenue:                                            |   |                             |   |   |   |
| Cost of software                                            |   | 230                              |   | 241 |   |
| Cost of services                                            |   | 1,255                            |   | 2,579 |   |
| Total cost of  revenue                                      |   | 1,485                            |   | 2,820 |   |
|                                                        |   |                             |   |   |   |
| Gross margin                                                |   | 5,561                            |   | 9,072 |   |
|                                                        |   |                             |   |   |   |
| Operating  expenses:                                        |   |                             |   |   |   |
| Sales and  marketing                                        |   | 4,426                            |   | 8,362 |   |
| Research and  development                                   |   | 1,302                            |   | 2,477 |   |
| General and  administrative                                 |   | 1,478                            |   | 2,533 |   |
| Amortization of  goodwill                                   |   | —                           |   | 376 |   |
| Restructuring charges                                       |   | 683                              |   | — |   |
| Total operating  expenses                                   |   | 7,889                            |   | 13,748 |   |
|                                                        |   |                             |   |   |   |
| Loss from  operations                                       |   | (2,328                           | )      | (4,676 | ) |
| Other income,  net                                          |   | 21                               |   | 217 |   |
| Loss before  provision for income taxes                     |   | (2,307                           | )      | (4,459 | ) |
| Provision for  income taxes                                 |   | 25                               |   | 50 |   |
| Net loss                                                    |   | (2,332                           | )      | (4,509 | ) |
| Dividends on  preferred stock                               |   | 6                                |   | — |   |
| Net loss  applicable to common shares                       |   | $                                | (2,338 | ) | $ | (4,509 | ) |
|                                                        |   |                             |   |   |   |
| Net loss per  common share—basic  and diluted          |   | $                                | (0.25  | ) | $ | (0.48 | ) |
| Weighted average  shares outstanding—basic and diluted |   | 9,491                            |   | 9,353 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

4

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**SEGUE SOFTWARE, INC**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

**(UNAUDITED)**

 
|                                                                                       |   | **Three months ended March 31,** |   |
|--------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                       |   | **2002**                         |   | **2001** | ** ** |
| Increase  (decrease) in cash                                                               |   |                             |   |   |   |
|                                                                                       |   |                             |   |   |   |
| Cash flows from  operating activities:                                                     |   |                             |   |   |   |
| Net loss                                                                                   |   | $                                | (2,332 | ) | $ | (4,509 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |   |                             |   |   |   |
| Depreciation and  amortization                                                             |   | 500                              |   | 981 |   |
| Changes in  operating assets and liabilities:                                              |   |                             |   |   |   |
| Accounts  receivable                                                                       |   | 444                              |   | 3,500 |   |
| Other current  assets                                                                      |   | 385                              |   | 166 |   |
| Accounts payable                                                                           |   | 676                              |   | (269 | ) |
| Accrued  expenses, lease obligations on excess  space, compensation, benefits and other    |   | 99                               |   | (1,955 | ) |
| Deferred revenue                                                                           |   | (606                             | )      | (1,172 | ) |
|                                                                                       |   |                             |   |   |   |
| Net cash used in  operating activities                                                     |   | (834                             | )      | (3,258 | ) |
|                                                                                       |   |                             |   |   |   |
| Cash flows from  investing activities:                                                     |   |                             |   |   |   |
| Additions to  property and equipment                                                       |   | (43                              | )      | (138 | ) |
| Maturities of  short-term investments                                                      |   | 4,949                            |   | 3,885 |   |
| Purchases of  short-term investments                                                       |   | (800                             | )      | (8,810 | ) |
| Other, net                                                                                 |   | 30                               |   | (138 | ) |
|                                                                                       |   |                             |   |   |   |
| Net cash  provided by (used in) investing activities                                       |   | 4,136                            |   | (5,201 | ) |
|                                                                                       |   |                             |   |   |   |
| Cash flows from  financing activities:                                                     |   |                             |   |   |   |
| Proceeds from  exercise of stock options and stock purchase plan                           |   | 127                              |   | 367 |   |
| Proceeds from  the issuance of convertible preferred stock                                 |   | 2,000                            |   | — |   |
|                                                                                       |   |                             |   |   |   |
| Net cash  provided by financing activities                                                 |   | 2,127                            |   | 367 |   |
|                                                                                       |   |                             |   |   |   |
| Effect of  exchange rate changes on cash                                                   |   | (17                              | )      | (35 | ) |
|                                                                                       |   |                             |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                      |   | 5,412                            |   | (8,127 | ) |
| Cash and cash  equivalents, beginning of period                                            |   | 2,326                            |   | 9,379 |   |
|                                                                                       |   |                             |   |   |   |
| Cash and cash  equivalents, end of period                                                  |   | $                                | 7,738  |   | $ | 1,252 |   |
|                                                                                            |        |                                  |        |  |  |  |  |  |  |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

5

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**SEGUE SOFTWARE, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.             BASIS OF PRESENTATION**

 

The financialstatements included herein have been prepared by Segue, without audit, pursuantto the rules and regulations of the Securities and Exchange Commission. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beencondensed or omitted pursuant to such rules and regulations.  We believe that the disclosures are adequateto make the information presented not misleading.  However, it is suggested that these financial statements be readin conjunction with Segue’s audited financial statements for the year endedDecember 31, 2001, included in its 2001 Annual Report on Form 10-K.

 

This financialinformation reflects, in the opinion of management, all adjustments of a normalrecurring nature necessary to present fairly the results for the interimperiods.  Results of interim periods maynot be indicative of results for the full year.

 

Certain prior year amounts have been reclassified to conform to thecurrent year presentation.  Thesereclassifications had no effect on the previously reported results ofoperations or retained earnings.

 

**2.             RECENT ACCOUNTING DEVELOPMENTS**

 

 

On July 20, 2001, FASB issued Statement of Financial Standards (“SFAS”)No. 141 “Business Combination” (“SFAS No. 141”), and SFASNo. 142, “Goodwill and Intangible Assets” (“SFAS No. 142”).  SFAS No. 141 is effective for allbusiness combinations initiated after June 30, 2001. SFAS No. 142 iseffective for fiscal years beginning after December 15, 2001; however,certain provisions of this Statement apply to goodwill and other intangibleassets acquired between July 1, 2001 and the effective date of SFASNo. 142.  Major provisions of thesestatements and their effective dates for Segue are as follows:

 
| • | All  business combinations initiated after June 30, 2001 must use the  purchase method of accounting.                                                                                                                                                                                                                                 |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                       |
| • | 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  and intangible assets with indefinite lives, acquired after June 30,  2001, are not 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 adopted SFASNo. 142 effective January 2002.  Seguecontinued to amortize goodwill recognized prior to July 1, 2001, under itscurrent method until December 31, 2001, after which date the annual and quarterlygoodwill amortization of $1.5 million and $377,000, respectively, ceasedto be amortized.  By December 31,2002, we will have completed a transitional fair value based impairment test ofgoodwill as of January 1, 2002. Impairment losses if any, resulting from the transitional testing willbe recognized in the quarter ended March 31, 2002, as a cumulative effectof a change in accounting principle. If this test results in a charge toearnings, it may mean restating prior quarterly results.  As of March 31, 2002, Segue has notcompleted the transitional fair value testing of the goodwill to determine ifan impairment loss exists or the amount of any such loss, however, it could notbe greater than $1.5 million, the net amount of goodwill that is on thebalance sheet at March 31, 2002.

 

6

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In accordance withthe adoption of SFAS No. 142, the following table presents what the net lossand net loss per common share for each of the periods would have been exclusiveof the goodwill amortization.

 
|                                           |   | **For the three  months ended March 31,** |   |
|------------------------------------------------|--------|------------------------------------------------|--------|
|                                           |   | **2002**                                       |   | **2001** |   |
| In thousands, except per share data            |   |                                           |   |   |   |
|                                           |   |                                           |   |   |   |
| Reported net  loss                             |   | $                                              | (2,332 | ) | $ | (4,509 | ) |
| Add back:  Goodwill amortization               |   | —                                         |   | 376 |   |
| Adjusted net  loss                             |   | $                                              | (2,332 | ) | $ | (4,133 | ) |
|                                           |   |                                           |   |   |   |
| Basic and  diluted loss per common share:      |   |                                           |   |   |   |
| Reported net  loss applicable to common shares |   | $                                              | (.25   | ) | $ | (.48 | ) |
| Add back:  Goodwill amortization               |   | —                                         |   | .04 |   |
| Adjusted net  loss applicable to common shares |   | $                                              | (.25   | ) | $ | (.44 | ) |

 

On October 3, 2001, the FASB issued SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”.  SFAS No. 144 addresses the accounting and reporting for theimpairment or disposal of long-lived assets. It replaces SFAS No. 121.  SFAS No. 144 provides a singleaccounting model for the disposal of long-lived assets. New criteria must bemet to classify the asset as an asset held-for-sale.  This statement also focuses on reporting the effects of adisposal. This statement is effective for fiscal years beginning afterDecember 15, 2001.  The Companyadopted this statement as of January 2002 and does not expect this adoption tohave a material impact to the Company’s financial position or results ofoperations.

 

In November 2001, the Emerging Issues Task Force (“EITF”) issued EITFIssue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer(Including a Reseller of the Vendor’s Products)”.  This EITF provides guidance with respect to the statement ofoperations classification, recognition and measurement of consideration given bya vendor to a customer or reseller. This EITF presumes any consideration to be an adjustment of the sellingprices of the vendor’s products or services, which should be deducted fromrevenue when recognized in the vendor’s statement of operations, unless thereis an identifiable and quantifiable benefit received for theconsideration.  This EITF is effectivefor annual and interim periods beginning after December 15, 2001.  Upon adoption, financial statements forprior periods presented for comparative purposes should be reclassified tocomply with the requirements under the EITF.  In January 2002, the Company adopted this EITF.  During the quarter ended March 31, 2002, theCompany committed to making a payment of $1.0 million to a customer.  Under the provisions of EITF Issue No. 01-9,this $1.0 million was considered to be a reduction in revenue and is presentedin the statement of operations as such. Per the contract with the customer, this payment is a one-timeexpenditure.  There were no other materialpayments made by the Company in this quarter or prior quarters that would beconsidered for reclassification under the guidance in EITF Issue No. 01-9.

 

**3.             OTHER ASSETS**

 

Included in otherassets at March 31, 2002 and December 31, 2001 is an interest bearingpromissory note receivable of approximately $305,000 from Segue’s chiefexecutive officer. Interest on the outstanding balance is to be calculated on amonthly basis using the current prime rate as published in the Wall StreetJournal.  Interest shall be payable oneach anniversary of the note, beginning on March 22, 2002.  The Compensation Committee of the Company’sboard of directors approved adding the interest due on the loan as of March 22,2002 to the principal balance.  Theborrower must use the proceeds from any Company paid bonus or gain on theexercise of Company stock options to pay any outstanding balance on thenote.  The note is payable in full onMarch 22, 2006 and is secured by a Second Mortgage and Security Agreementbetween Segue and its chief executive officer.

 

**4.             PREFERREDSTOCK**

 

On March 22, 2002, the Company and S-7 Associates LLC, a companymanaged by the Chairman of Segue’s Board of Directors, Dr. James H. Simons(“S-7 Associates”), signed an agreement under which S-7 Associates purchased666,667 shares of the Company’s Series B 12% Convertible Preferred Stock(“Preferred Stock”) in consideration for a payment of $2.0 million.  The Preferred Stock is senior to commonstock as to dividend and liquidation rights and is convertible at the option ofthe holder into shares of common stock of Segue at a conversion price of $3.00per share, subject to adjustment upon the occurrence of certaintransactions.  The holders of thePreferred Stock are entitled to vote together with the common stock on anas-converted basis, and in addition, are entitled to elect one director of theCompany as a separate class.  Dividendson the Preferred Stock are

 

7

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12%per annum and will be paid-in-kind semiannually.  The Preferred Stock is callable at the option of the Company onor after March 31, 2004 at 133% of its face value (“LiquidationPreference”).  If there is a sale of allor substantially all of the Company’s assets or equity, the Preferred Stock caneither be redeemed at the Liquidation Preference or converted to common stock.Pursuant to a registration rights agreement, the Company has agreed, subject tocertain limitations, to register, under the Securities Act of 1933, the resaleof common stock into which the Preferred Stock may be converted.  The registration rights expire on March 22,2007.  Based on written confirmationreceived from Nasdaq, the Company did not need to seek shareholder approval ofthis transaction.

 

**5.             RESTRUCTURING CHARGES**

 

During the first quarter of 2002, Segue executed a restructuringplan.  The restructuring included areduction in workforce of approximately 5% in the quarter.  As a result, Segue recognized restructuringand other charges of approximately $683,000. The restructuring charges included approximately $559,000 for severanceand other employee–related costs for the termination of 12 employees andapproximately $124,000 for facility–related costs, which includes theaccrual of estimated lease obligations associated with the excess officefacilities in our Lexington office, net of anticipated subleasing income.

 

Near the end of the third quarter of 2001, Segue executed arestructuring plan in light of continued deteriorating economicconditions.  The restructuring includeda 14% reduction in workforce and further consolidation of space in Segue’sLexington facility.  As a result, Seguerecognized restructuring and other charges of approximately $2.0 millionin the third quarter.  The restructuringand other charges included approximately $485,000 for severance and otheremployee–related costs for the termination of 42 employees andapproximately $1.5 million for facility–related costs, including theaccrual of estimated lease obligations associated with excess officefacilities, net of anticipated subleasing income.

 

During the second quarter of 2001, in reaction to lower revenue, Segueexecuted a restructuring plan.  Therestructuring included a 20% reduction in workforce and the closing of theresearch and development lab in the Los Gatos. As a result, Segue recognized restructuring and other charges ofapproximately $2.3 million.  Therestructuring and other charges included approximately $1.4 million forfacility–related costs, which includes the accrual of estimated leaseobligations associated with the closure of excess office facilities net ofanticipated subleasing income, and approximately $859,000 for severance, andother employee–related costs for the termination of 73 employees.

 

During the first quarter of 2002, we paid approximately $52,000 of the$137,000 accrued at December 31, 2001 for the severance and terminationbenefits associated with the restructuring actions from 2001 and we paidapproximately $104,000 for the restructuring action from Q1 2002.  At March 31, 2002, we had approximately$540,000 accrued for severance and benefits associated with all of therestructuring actions noted above.

 

During the first quarter of 2002, we entered into asublease with a private company for a small amount of the excess space in ourLexington office.  The term of thesublease is from May 2002 through October 2007, which is the end of Segue’slease in Lexington.  At March 31, 2002,the accrual balance related to the obligations associated with all of theexcess office space noted above is approximately $2.3 million.  This is comprised of an estimated$4.7 million for future rents payable by Segue on unoccupied space, plus$225,000 in miscellaneous costs related to subleasing the space, lessapproximately $2.6 million of estimated future sublease income.

 

**6.             PROVISIONFOR INCOME TAXES**

 

Segue recorded provisions forforeign and state income taxes of $25,000 and $50,000 for the three monthsended March 31, 2002 and 2001, respectively.  There was no tax benefit recorded for losses generated in theU.S. in either period due to the uncertainty of realizing such benefits.

 

8

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**7.             NET LOSS PER COMMON SHARE**

 

The followingtable sets forth the computation of basic and diluted loss per share (inthousands, except per share data):

 
|                                                                       |   | **Three  months ended March 31,** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                       |   | **2002**                          |   | **2001** |   |
|                                                                       |   |                              |   |   |   |
| Net loss  applicable to common shares                                      |   | $                                 | (2,338 | ) | $ | (4,509 | ) |
| Weighted average  shares used in net loss per share—basic and diluted |   | 9,491                             |   | 9,353 |   |
| Net loss per  common share—basic and diluted                          |   | $                                 | (0.25  | ) | $ | (0.48 | ) |

 

Excluded from thecalculation of diluted earnings per share for the three months endedMarch 31, 2002 and 2001 were options to purchase 3,375,201 and 3,426,559shares of common stock, respectively, and 666,667 and 0 shares of common stockthat can be converted from convertible preferred stock, respectively, becausetheir inclusion would be anti-dilutive.

 

**8.             COMPREHENSIVE LOSS**

 

SFAS No. 130, “ReportingComprehensive Income” (“SFAS 130”) requires the reporting of comprehensiveincome in addition to net income from operations.  Comprehensive income is a more inclusive reporting methodologythat includes disclosure of certain financial information that historically hasnot been recognized in the calculation of net income.  To date, Segue’s comprehensive income items have consistedexclusively of foreign translation adjustments.  The following table sets forth the computation of comprehensiveloss (in thousands):

 
|                             |   | **Three  months ended March 31,** |   |
|----------------------------------|--------|-----------------------------------|--------|
|                             |   | **2002**                          |   | **2001** | ** ** |
|                             |   |                              |   |   |   |
| Net loss                         |   | $                                 | (2,332 | ) | $ | (4,509 | ) |
| Foreign  translation adjustments |   | 97                                |   | (190 | ) |
| Comprehensive  loss              |   | $                                 | (2,235 | ) | $ | (4,699 | ) |

 

**9.             COMMITMENTSAND CONTINGENCIES**

 

Under theprovision of Segue’s lease obligation at its Lexington facility, Segue has anobligation to provide a security deposit if Segue’s current assets, as defined in the lease, become less than$20.0 million, as evidenced by Segue’s annual audited financial statementsas of each December 31st. As of March 31, 2002, current assets, as defined in the lease, were$13.4 million.  The amount of thesecurity deposit declines by $350,000 for each year that passes from thecommencement of the lease.  AtMarch 31, 2002, the amount of the security deposit required isapproximately $1.5 million. As of March 31, 2002, there has been norequest from the landlord for Segue to make this deposit yet.

 

In January 2002, Segue entered into an agreement to be theexclusive external remote hosting application performance monitoring andscalability testing software provider to IBM Global Infrastructure and SystemsManagement Services (ISM), a division within IBM Global Services, for theinfrastructure used by ISM for this service for a period of three years throughDecember 31, 2004.  As part of thisagreement, the Company agreed to pay $1.0 million to IBM to be used tohelp fund the costs of deploying the remote monitoring infrastructure.  This amount was charged to earnings, as areduction to revenue, in the first quarter of 2002 and the payment was made inApril 2002.  Segue also agrees toprovide certain amounts of training to IBM employees at no charge.

 

In September 2001, the Company signed a distributionagreement with T-Plan Ltd., of the United Kingdom.  Under the agreement, Segue will sell and marketthe T-Plan product that has been modified to integrate with other Segueproducts, under the name SilkPlan, for which Segue will pay T-Plan Ltd. aroyalty for each unit sold.  Under theterms of the agreement, Segue must pay T-Plan Ltd. a minimum quarterlyroyalty of $45,000 for the period ending March 31, 2002, $75,000 for theperiod ending June 30, 2002, and $100,000 for subsequent quarters.  Either party may cancel the agreement at anytime by giving the other party

 

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written notice to that effect at least ninety daysprior to such termination.  Otherremaining royalty arrangements are not significant.

 

As of October 15, 2001, theCompany’s employer’s practices liability insurance policy expired.  Due to insurance market conditions, theCompany did not renew the policy, but purchased a one-year extended reportingprovision that covered claims made during the period October 15, 2001 throughOctober 15, 2002, arising from occurrences prior to October 15, 2001.  In March 2002, the Company purchased a newemployer’s practices liability insurance policy with an exclusion for claimsmade that were based on occurrences before March 15, 2002.  Based on the coverage under the extendedreporting endorsement and the new policy, the Company is self-insured for anyclaims made that are based on occurrences between October 15, 2001 and March15, 2002.  The Company is not aware ofthe assertion of any claims based on occurrences during this period.

 

**10.          SEGMENT REPORTING**

 

The Company considers that it has the following reportable operatingsegments based on differences in products and services.  Operating segments are defined as componentsof the enterprise about which separate financial information is available thatis reviewed regularly by the chief operating decision maker, or decision–makinggroup, in deciding how to allocate resources and in assessing theirperformance. Software licenses substantially consist of sales of our Silkproduct line.  These operating segmentsare reviewed only to the gross margin level. The company does not maintain and can not separate balance sheetinformation or full profit and loss information for these segments.

 
|                                          |   | **Three  months ended March 31, 2002** |        | **Three  months ended March 31, 2001** |   |
|-----------------------------------------------|--------|----------------------------------------|-------------|----------------------------------------|--------|
|                                          |   | **Revenue**                            |        | **Gross  Margin**                      |   | **Revenue** |   | **Gross  Margin** |   |
|                                          |   |                                   |        |                                   |   |   |   |   |   |
| Software  licenses                            |   | $                                      |  3,315 |                                   | $      |  3,085 |   | $ |  5,522 |   | $ |  5,281 |   |
|                                          |   |                                   |        |                                   |   |   |   |   |   |
| Training and  consulting                      |   | 1,302                                  |        | 611                                    |   | 2,487 |   | 859 |   |
| Maintenance                                   |   | 3,429                                  |        | 2,865                                  |   | 3,883 |   | 2,932 |   |
|                                          |   |                                   |        |                                   |   |   |   |   |   |
| Total services                                |   | 4,731                                  |        | 3,476                                  |   | 6,370 |   | 3,791 |   |
|                                          |   |                                   |        |                                   |   |   |   |   |   |
| Adjustment  relating to payment to a customer |   | (1,000                                 | )           | (1,000                                 | )      | — |   | — |   |
|                                          |   |                                   |        |                                   |   |   |   |   |   |
| Total                                         |   | $                                      |  7,046 |                                   | $      |  5,561 |   | $ |  11,892 |   | $ |  9,072 |   |

 

The followingtable presents revenue and long-lived asset information by geographic area asof and for the quarters ended March 31 (in thousands):

 
|          |   | **Total  Revenue March 31,** |        | **Long Lived  Assets March 31,** |   |
|---------------|--------|-----------------------------------|-------------|---------------------------------------|--------|
|          |   | **2002**                          |        | **2001**                              |   | **2002** |   | **2001** |   |
|          |   |                              |        |                                  |   |   |   |   |   |
| United States |   | $                                 |  6,019 |                                  | $      |  10,094 |   | $ |  3,020 |   | $ |  4,422 |   |
| Foreign       |   | 1,027                             |        | 1,798                                 |   | 645 |   | 977 |   |
|          |   |                              |        |                                  |   |   |   |   |   |
| Total revenue |   | $                                 |  7,046 |                                  | $      |  11,892 |   | $ |  3,665 |   | $ |  5,399 |   |

 

**11.          LIQUIDITY**

 

The Company has generally incurred losses since it began operations,which has resulted in an accumulated deficit of approximately$55.3 million at March 31, 2002. As a result, the Company has used, and expects to continue to use,significant amounts of cash, cash equivalents and short-term investments tofund its operations.  Therecoverability of a major portion of the recorded asset amounts shown in theaccompanying balance sheet is dependent upon the continued operations of Segue,which in turn is dependent upon Segue’s ability to increase sales and tosucceed in its future operations.  Thefinancial

 

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statements do not includeany adjustments relating to the recoverability and classification of recordedasset amounts, and classification and amounts of liabilities that might benecessary should Segue be unable to continue operations.

 

Management hastaken significant steps to streamline its operations and will continue to do soas the situation warrants.  These stepshave included reducing headcount, infrastructure and other expenses andlimiting capital expenditures.  Managementbelieves, based on its understanding of the marketplace, that future sales willoccur in a sufficient manner to allow Segue to continue as a viable business.

 

In March 2002, the Company sold 666,667 shares of Preferred Stock to S-7Associates LLC, a company managed by the Chairman of Segue’s Board ofDirectors, for $2.0 million.  Withthis investment, Segue believes there is currently sufficient cash to meet itsforecasted working capital needs. Delays in the timing of future sales or sales levels below management’sexpectations may cause the Company to re-evaluate its cash position, adjust itsoperations and/or take other possible actions.

 

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

 

**RESULTSOF OPERATIONS**

 

The followingtable sets forth certain unaudited quarterly results of operations expressed asa percentage of total revenue for the periods indicated:

 

|                                          |   | **Percentage  of Revenue for the  Three months ended March 31,** |   |
|-----------------------------------------------|--------|------------------------------------------------------------------|--------|
|                                          |   | **2002**                                                         |   | **2001** | ** ** |
|                                          |   |                                                             |   |   |   |
| Revenue:                                      |   |                                                             |   |   |   |
| Software                                      |   | 47.1                                                             | %      | 46.4 | % |
| Services                                      |   | 67.1                                                             |   | 53.6 |   |
| Gross revenue                                 |   | 114.2                                                            |   | 100.0 |   |
| Adjustment  relating to payment to a customer |   | (14.2                                                            | )      | — |   |
| Net revenue                                   |   | 100.0                                                            |   | 100.0 |   |
| Cost of revenue:                              |   |                                                             |   |   |   |
| Cost of software                              |   | 3.3                                                              |   | 2.0 |   |
| Cost of services                              |   | 17.8                                                             |   | 21.7 |   |
| Total cost of  revenue                        |   | 21.1                                                             |   | 23.7 |   |
|                                          |   |                                                             |   |   |   |
| Gross margin                                  |   | 78.9                                                             |   | 76.3 |   |
|                                          |   |                                                             |   |   |   |
| Operating  expenses:                          |   |                                                             |   |   |   |
| Sales and  marketing                          |   | 62.8                                                             |   | 70.3 |   |
| Research and  development                     |   | 18.5                                                             |   | 20.8 |   |
| General and  administrative                   |   | 21.0                                                             |   | 21.3 |   |
| Amortization of  goodwill                     |   | —                                                           |   | 3.2 |   |
| Restructuring  charges                        |   | 9.7                                                              |   | — |   |
| Total operating  expenses                     |   | 112.0                                                            |   | 115.6 |   |
|                                          |   |                                                             |   |   |   |
| Loss from  operations                         |   | (33.1                                                            | )      | (39.3 | ) |
| Other income,  net                            |   | 0.3                                                              |   | 1.8 |   |
| Loss before  provision for income taxes       |   | (32.8                                                            | )      | (37.5 | ) |
| Provision for  income taxes                   |   | 0.3                                                              |   | 0.4 |   |
| Net loss                                      |   | (33.1                                                            | )%     | (37.9 | )% |

 

**SOFTWAREREVENUE**

 

Software revenuedecreased 40% to $3.3 million during the first quarter of 2002 from $5.5million for the same period in 2001. The main factor for the first quartersoftware revenue decrease as compared to the same quarter in 2001 was thecontinued tightness of expenditures in the information technology (“IT”)market. Additionally, we continue to face a difficult competitive environment.  International software revenue accounted for18%, or $600,000, and 23%, or $1.3 million, of total software revenue for thethree months ended March 31, 2002 and 2001, respectively.

 

**SERVICESREVENUE**

 

Services revenue decreased 26% to$4.7 million during the first quarter of 2002 from $6.4 million inthe same quarter of 2001.  As comparedto the three months ended March 31, 2001, recognized maintenance revenuedecreased 12% and training and consulting revenue decreased 48% for the firstquarter of 2002.  The decrease inrecognized maintenance revenue was driven largely by lower software licensessold during 2001 in comparison to those in 2000, as such there is a smallerbase of software licenses with new maintenance that is being amortized over thecontract period, predominately 12 months. The decreased revenue from training and consulting engagements in thefirst quarter of 2002, as compared to the same period of 2001, is primarilyattributable to lower sales of software licenses, which is a major driver forthese types of services.

 

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**ADJUSTMENT RELATING TO PAYMENT TO ACUSTOMER**

 

In January 2002, the Company committed tomaking a payment of $1.0 million to IBM (see notes 2 and 9 to the CondensedConsolidated Financial Statements). Under the provisions of EITF Issue No. 01-9, this $1.0 million wasconsidered to be a reduction in revenue and is presented in the statement ofoperations as such.  Per the contractwith the customer, this payment is a one-time expenditure.  There were no other material payments madeby the Company in this quarter or prior quarters that would be considered forreclassification under the guidance in EITF Issue No. 01-9.

 

**COST OFSOFTWARE**

 

Cost of softwaredecreased 5% to $230,000 during the first quarter of 2002 from $241,000 in thefirst quarter of 2001.  As a percentageof software revenue, costs of software in the first quarter of 2002 increasedto 7% from 4% in the corresponding prior-year period.  The decrease in cost of software in absolute dollar amount is theresult of lower volume of software license sales in the first quarter of 2002,as compared to the same period in 2001. The increase in the cost of software as a percentage of software revenuein the first quarter of 2002 is due to increased royalties and distributorfees.

 

**COST OFSERVICES**

 

Cost of services decreased 51% to$1.3 million during the first quarter of 2002 from $2.6 million in thesame period of 2001.  Cost of servicesas a percentage of services revenue decreased to 27%  in the first quarter of 2002 from 40% in the correspondingprior-year period.  Cost of servicesconsists primarily of costs of providing customer technical support, trainingand consulting.  Cost of services as apercentage of service revenue may vary based on the profitability of individualconsulting engagements and the use and utilization rate of in-house consultantsversus third party outsourced consultants. Cost of training and consulting in the first quarter of 2002 decreased58% to $691,000, as compared to $1.6 million for the same quarter in 2001.  This decrease is primarily personnel-relatedexpenses due to the reductions in headcount that took place in 2001, as well asdecreases in travel and outsourcing expenses, all of which were part of thecost savings strategy to align better the expenses with revenue.  During the three–month period endedMarch 31, 2002, cost of maintenance decreased 41% to $564,000, as compared to$951,000 for the same period in 2001. This decrease, in mainly personnel-relatedexpenses, is a result of the reductions in workforce with the further shiftingof support responsibilities to our global technical support center in Belfast,Northern Ireland where the operating expenses are generally lower.

 

**SALESAND MARKETING**

 

Sales and marketing expensesdecreased 47% to $4.4 million during the first quarter of 2002 from$8.4 million in the first quarter of 2001. Almost half of the decrease isattributable to decreases in personnel–related expenses as a result ofthe reductions in headcount from the restructuring actions in the past twelvemonths.  Additionally, lower amount oftotal commissions on the lower volume of sales, less expenditures for marketingprograms and reduced spending on business travel and entertainment alsocontributed to the decrease in sales and marketing expenses in the firstquarter of 2002, as compared to the same period in 2001.

 

**RESEARCHAND DEVELOPMENT**

 

Research anddevelopment expenses decreased 47% to $1.3 million for the first quarterof 2002 in comparison to $2.5 million for the same period in 2001.  The vast majority of this decrease isattributable to decreases in personnel–related expenses as a result ofthe reductions in headcount from the restructuring actions in second and thirdquarters of 2001.  Segue may not be able to reduce costs in researchand development any further without impacting its ability to develop newproducts and to enhance existing products.

 

**GENERALAND ADMINISTRATIVE**

 

General and administrative expensesdecreased 42% to $1.5 million during the first quarter of 2002 from$2.5 million for the same period in 2001. This decrease was primarily due to decreases in personnel–relatedexpenses, as a result of the reductions in headcount from the restructuringactions in 2001 and recoveries of bad debts in the first quarter of 2002, ascompared to significant bad debt expense for the same period last year.  The overall decrease in general andadministrative expenses was partially offset by an increase in foreign currencyexpense for the three-month period ended March 31, 2002.

 

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**AMORTIZATIONOF GOODWILL**

 

As required by SFAS No. 142, Seguediscontinued the amortization of goodwill effective January 1, 2002.  As of March 31, 2002, we have not yetcompleted the transitional fair value testing of the goodwill to determine ifan impairment loss exists.  For thefirst quarter of 2001, amortization of goodwill was $376,000.

 

**RESTRUCTURING CHARGES**

 

During the first quarter of 2002, Segue executed a restructuring plan.The restructuring included a reduction in workforce of approximately 5%. As aresult, Segue recognized restructuring and other charges of approximately$683,000.  The restructuring chargesincluded approximately $559,000 for severance and other employee–relatedcosts for the termination of 12 employees and approximately $124,000 forfacility–related costs, which includes the accrual of estimated leaseobligations associated with the excess office facilities in our Lexingtonoffice, net of anticipated subleasing income. We anticipate that this restructuring will save approximately $1.0million in annual wages once it is fully implemented.  There were no restructuring charges in the first quarter of 2001.

 

**OTHERINCOME, NET**

 

Other income, net decreased 90% to$21,000 during the first quarter of 2002 from $217,000 in the same quarter of2001.  Other income consists mainly ofinterest income on cash equivalents and short-term investments.  The decrease in interest income was primarilydue to lower balances of cash equivalents and short-term investments in thefirst quarter of 2002 in comparison to the same period in 2001, and lowerinterest rates on those investments.

 

**PROVISIONFOR INCOME TAXES**

 

We recorded aprovision for foreign and state income taxes of $25,000 and $50,000 for thefirst quarter of 2002 and 2001, respectively. There was no tax benefit recorded for losses generated in the U. S. inany period due to the uncertainty of realizing such benefits.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

As ofMarch 31, 2002, our principal sources of liquidity included cash, cashequivalents and short-term investments totaling $8.5 million as comparedto $7.3 million as of December 31, 2001.

 

During the firstthree months of 2002, we used $834,000 for operating activities, resulting fromthe net loss, adjusted for depreciation of fixed assets, as well as decreasesin deferred revenue, offset by increases in accounts payable and accruedexpenses and decreases in accounts receivable and other current assets.

 

Our investing activities generated cash of $4.1 million in thefirst quarter of 2002, which primarily came from maturing short-terminvestments. We continued to keep purchases of property and equipment lowduring the quarter.  In the future,Segue may need to make increased expenditures on property and equipment aspresent equipment ages.

 

We generated fundsfrom financing activities of $2.1 million during the first quarter of 2002.$2.0 million of this is related to the issuance of convertible preferred stockand the balance is from the issuance of stock under the employee stock purchaseplan and the exercise of stock options.

 

In 2001 and the first quarter of 2002, Segue had executed variousrestructuring actions, for which we had accrued severance, benefits andestimated lease obligations on excess office space, net of estimated subleasingincome.  During the first quarter of2002, we paid approximately $52,000 for the severance and termination benefitsassociated with the restructuring actions from 2001 and approximately $104,000for the restructuring action from Q1 2002. At March 31, 2002, we had approximately $540,000 accrued for severanceand benefits associated with all of the restructuring actions.  During the first quarter of 2002, we enteredinto a sublease with a private company for a small amount of the space in ourLexington office. The term of the sublease is from May 2002 through October2007, which is the end of Segue’s lease in Lexington.   At March 31, 2002, the accrual balance related to theobligations associated with all of the excess office space that resulted fromthe restructurings is approximately $2.3 million. This is comprised of anestimated $4.7 million for future rents payable by Segue on

 

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unoccupiedspace, plus $225,000 in miscellaneous costs related to subleasing the space,less approximately $2.6 million of estimated future sublease income.

 

In January 2002, Segue entered into an agreement to be theexclusive external remote hosting application performance monitoring andscalability testing software provider to IBM Global Infrastructure and SystemsManagement Services (ISM), a division within IBM Global Services, for theinfrastructure used by ISM for this service for a period of three years throughDecember 31, 2004. As part of this agreement, the Company agreed to pay$1.0 million to IBM to be used to help fund the costs of deploying theremote monitoring infrastructure.   Thisamount was paid in April 2002.

 

Under theprovision of Segue’s lease obligation at its Lexington facility, Segue has anobligation to provide a security deposit if Segue’s current assets, as defined in the lease, become less than$20.0 million, as evidenced by Segue’s annual audited financial statementsas of each December 31st. As of March 31, 2002, current assets, as defined in the lease, were$13.4 million.  The amount of thesecurity deposit declines by $350,000 for each year that passes from thecommencement of the lease.  AtMarch 31, 2002, the amount of the security deposit required isapproximately $1.5 million. As of March 31, 2002, there has been norequest from the landlord for Segue to make this deposit yet.

 

Long-term cash requirements, other than for normal operating expensesand those described above, are anticipated for the development of new softwareproducts and enhancements of existing products, and the possible acquisition ofsoftware products or technologies complementary to our business.

 

We have historically had losses. This, accompanied by the economicdownturn of 2001 and the slowdown of Information Technology capital spending,has resulted in lower sales volume, which has required Segue to continueutilizing significant amounts of cash and cash equivalents to fund operations.

 

We have reduced our workforce and overhead expenses as described aboveand curtailed capital spending and other uses of cash. But, in order to achieveand sustain profitability and to get to positive cash flow from operations,Segue must grow its revenue. It is uncertain as to whether or when this willoccur.

 

Segue actively pursued additional financing to fund working capitalrequirements. On March 22, 2002, the Company and S-7 Associates LLC, acompany managed by the Chairman of Segue’s Board of Directors, Dr. JamesH. Simons (“S-7 Associates”), signed an agreement under which S-7 Associatespurchased 666,667 shares of the Company’s Series B 12% ConvertiblePreferred Stock (“Preferred Stock”) in consideration for a payment of $2.0 million.The Preferred Stock is senior to common stock as to dividend and liquidationrights and is convertible at the option of the holder into shares of commonstock of Segue at a conversion price of $3.00 per share, subject to adjustmentupon the occurrence of certain transactions. The holders of the Preferred Stockare entitled to vote together with the common stock on an as-converted basis,and in addition, are entitled to elect one director of the Company as aseparate class. Dividends on the Preferred Stock are 12% per annum and will bepaid-in-kind semiannually. The Preferred Stock is callable on or afterMarch 31, 2004 at 133% of its face value (“Liquidation Preference”). Ifthere is a sale of all or substantially all of the Company’s assets or equity,the Preferred Stock can either be redeemed at the Liquidation Preference orconverted to common stock. Pursuant to a registration rights agreement, theCompany has agreed, subject to certain limitations, to register, under theSecurities Act of 1933, the resale of common stock into which the PreferredStock may be converted. The registration rights expire on March 22, 2007.

 

Assuming that Segue can execute on current plans to grow revenue throughits restructured sales program, its focus on enterprise customers, and itsintroduction and success of new and enhanced products, and the business climatefor IT spending does not worsen, we believe that with the funding describedabove, plus current cash, cash equivalents and short-term investments, thatSegue will have sufficient resources to meet its forecasted working capital anddebt requirements.  However, if Seguecan not grow its revenue or the economy worsens, we may need to take otheractions in order to fund our working capital resource requirements.   These actions may possibly include furtherreductions in workforce or raising additional capital.  At this time, Segue has no plans to takesuch actions.

 

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 our financialresults.

 

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**FACTORSTHAT MAY AFFECT FUTURE RESULTS**

 

The Company’sbusiness is subject to many uncertainties and risks. This Form 10-Qcontains certain forward–looking statements within the meaning of thePrivate Securities Reform Act of 1995. The Company’s future results may differ materially from its currentresults and actual results could differ materially from those projected in theforward–looking statements as a result of certain risk factors, includingbut not limited to those set forth below, other one-time events and otherimportant factors disclosed previously and from time to time in Segue’s otherfilings with the SEC.

 

***Our quarterly results may fluctuate.***  Segue’squarterly revenue and operating results are difficult to predict and mayfluctuate significantly from quarter to quarter.  If our quarterly revenue or operating results fall below theexpectations of investors or public market analysts, the price of our commonstock could fall substantially.  Ourquarterly revenue may fluctuate significantly for several reasons, including:the timing and success of introductions of our new products or productenhancements or those of our competitors; uncertainty created by changes in themarket, including the decline in IT spending, and decline of the generalbusiness climate which make it difficult to predict the size and timing ofindividual orders; software bugs or other product quality problems; competitionand pricing; customer order deferrals or reductions as a result of generalbusiness conditions and budget freezes; ability to increase sales fromenterprise companies; and general economic conditions. Substantial portions ofSegue’s operating expenses are related to personnel, facilities and marketingand sales programs.  The level ofspending for such expenses can not be adjusted quickly and is based, insignificant part, on our expectations of future revenues.  If actual revenue levels are belowmanagement’s expectations, results of operations are 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 revenuesin any quarter are substantially dependent on orders booked and shipped in thelatter part of that quarter and revenues from any future quarter are notpredictable with any significant degree of accuracy.  Segue typically does not experience order backlog. For these reasons,Segue believes that quarter-to-quarter comparisons of its results of operationsare not necessarily meaningful and should not be relied upon as indications offuture performance.

 

***We may not be profitable in thefuture.***  Since Segue began operations, it hasgenerally experienced losses.  Losseshave resulted in an accumulated deficit of approximately $55.3 million asof March 31, 2002.  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$718,000 for severance charges; a net loss of $5.1 million in 1998, whichincluded a charge of $1.5 million related to our acquisitions of Eventusand Black & 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 $17.2 million for the year 2001, whichincluded $4.2 million for restructuring charges; a net loss of $2.3million for the three months ended March 31, 2002, which included $683,000 forrestructuring charges.  For the firstquarter 2002, we experienced significant revenue shortfalls from the sameperiod in prior year. We initiated aggressive cost savings throughout 2001 andcontinued this in the first quarter of 2002, in an effort to reduce expenses,enhance the possibility of breakeven, and conserve cash. These cost savingmeasures may not be effective, and are not necessarily indicative of futureoperating results. Failure to achieve profitability may adversely affect themarket price of Segue’s common stock.

 

***Continued decline in businessconditions and Information Technology (IT) spending could cause further declinein revenue.*** The level of future IT spending in themarketplace remains very uncertain particularly in light of the decline in thebusiness climate throughout 2001.  If ITspending continues to decline, Segue’s revenues could be further adverselyimpacted.

 

***Segue may not derive substantialincremental revenue from its alliances and SilkElite Partner 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 Programfocuses on resellers, consulting partners and distributors.  SilkElite Partners both resell Segueproducts and use Segue software products in the delivery of consultingservices.  The success of the expansionof key strategic alliances and the SilkElite Program is uncertain, faces strongcompetition, and takes time and significant resources to develop.  Should Segue fail to generate substantialincremental revenue from its strategic alliances or its SilkElite Program, thefinancial results and stock price could be adversely affected.

 

***Segue may not generate substantialincremental revenue from the expanded relationship with IBM.***   Seguesigned an expanded contract with IBM Corporation under which Segue is theexclusive external provider of software for IBM Global Infrastructure andSystems Management Services’ new remote infrastructure analysis offering.  IBM will use Segue’s recently introducedmonitoring product, SilkVision and Segue’s enhanced scalability product,SilkPerformer V.  Segue will investsignificant resources in the alliance, including $1.0 million in cash toaccelerate the availability of the new IBM service offering.

 

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Shouldthe IBM service offering not be successful, Segue will not generate substantialincremental revenue and its business could be materially adversely affected.

 

***Selling products and services throughalliances and partnerships may limit our control and interaction with end usersof our products.***  As a result, our ability to forecast salesaccurately, evaluate customer satisfaction and recognize emerging customerrequirements may be limited.  Ourability to develop and maintain customer goodwill could also be affected.  Finally, we will have to resolve potentialconflicts among our sales force and business partners in order to make thepartner program successful.

 

***Our future success will depend on ourability to respond rapidly and effectively to technological and other marketchanges, including the successful introduction of new and enhanced products.***   Thenature of the web-based automated software testing and e-business testingmarkets in which we compete is characterized by rapidly changing technology,rapidly evolving customer needs and desires, changes in industry standards andpractices and frequent releases of new product or enhancements bycompetitors.  To be competitive, Seguemust develop and introduce product enhancements and new products that addressthe increasingly sophisticated and varied needs of our existing and potentialcustomers. Over 90% of Segue’s product revenue in the first quarter of 2002 andall of 2001 was generated from its SilkPerformer and SilkTest products.  In 2001, we introduced our new web-basedenterprise-monitoring product, SilkVision, and our enhanced scalability testingproduct SilkPerformer V.  Segue alsoannounced an alliance to integrate and resell a test management tool fromT-Plan Ltd, that we named SilkPlan. In addition, Segue also introduced a Unicode multi–lingual testingcapability for the Company’s regression testing tool, SilkTestInternational.  If these new productsare not successful or if we fail to continue to develop and introduce newproducts and enhancements on a timely basis, or maintain our level of productrevenue from SilkPerformer and SilkTest, or fail to generate substantialincremental revenue from our new products, our business may be materiallyadversely affected.

 

***We may face liquidity issues.***  We havetaken steps to conserve our use of cash, including significantly reducingheadcount, infrastructure and other expenses, and limiting capital expendituresin order to compensate in part for our recent decline in revenues, to improveour liquidity and to achieve greater efficiencies.  Segue believes that based on potential incremental revenue fromits strategic alliances, its SilkElite Partner Program, the expanded IBMrelationship, and its new products and product enhancements, that future saleswill be sufficient to allow us to continue as a viable business.  Revenue in the first quarter of 2002declined by approximately 41% from revenue in the same period last year.  If future sales are not sufficient orrevenue continues to decline, 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 on terms acceptable to Segue, we maynot have sufficient working capital resources and our business may bematerially adversely affected.

 

***We may not be successful insubletting excess office space.***  Segue istaking aggressive steps to sublet its excess office space.  The real estate market is changing rapidlyand there is significant excess capacity in the Greater Boston market.  These efforts may not be successful or maytake significant time and resources.  Ifthese efforts are not successful, Segue will not realize its estimated costsavings or the amount of estimated future subleasing income (estimated to be$2.6 million at March 31, 2002) used in the restructuring reservecalculation, and real estate costs will continue to affect cash flow.

 

***We may have difficulty managingorganizational change and operating the business efficiently with fewerresources.***   In 2001 and 2002, Segue reorganized itssales force, appointed new leaders in its support services, consulting andproduct development areas, appointed a new head of international sales, a newVice President of Product Marketing, and a new Senior Vice President ofWorldwide Sales, who was terminated in 2002, terminated the Senior VicePresident of Marketing, eliminated the inside sales group in 2001 and re-formeda smaller inside sales group in 2002, created a new strategic alliance program,shifted research and development resources and consolidated several of itsactivities as a result of reduced headcount. During 2001, Segue reduced its headcount by approximately 37% and in thefirst quarter of 2002 reduced headcount by an additional 5%,approximately.  The success of theseorganizational and other changes is uncertain and Segue’s ability to manage itsbusiness efficiently or develop new products and upgrades with fewer resourcescould adversely affect its business.

 

***We may be subjectto risks associated with our past acquisitions and future acquisitions.*** Our product offerings and customerbase have increased due in part to prior acquisitions.  In the future, we may do future acquisitionsto enhance further our product lines. Our prior acquisitions or any future acquisition may not produce therevenue, earnings or business synergies that we had anticipated, and anacquired product, service or technology might not perform as expected.  Prior to completing an acquisition, however,it is difficult to determine if such benefits can actually be realized.  The process of integrating acquiredcompanies into our existing business may also result in unforeseendifficulties.  Acquisitions may requiresignificant financial resources that we might otherwise allocate to otheractivities, including the ongoing development or expansion of our existingoperations.  If Segue pursues a futureacquisition, our management could spend a significant amount

 

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of time and effort inidentifying and completing the acquisition. To pay for a future acquisition, we might use capital stock orcash.  Alternatively, we might borrowmoney from a bank or other lender.  Ifwe use capital stock as we did with our past acquisitions, our stockholderswould experience dilution of their ownership interests.  If we use cash or debt financing, ourfinancial liquidity will be reduced.

 

***Segue facessignificant competition from other software companies.*** The market for web-basedsoftware quality management and testing tools is evolving, intenselycompetitive and subject to rapid technological change.  We expect competition to intensify in thefuture.  Segue currently encounterscompetition from a number of public and private companies, including Mercury InteractiveCorporation, Rational Software Corporation 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 and, therefore, they may be able to respond morequickly to new or changing opportunities, technologies, standards or customerrequirements or they may be able to devote greater resources to the promotionand sale of their products than Segue can. An increase in competition could result in price reductions and loss ofmarket share.  Such competition and anyresulting reduction in profitability could have a material adverse effect onour business, operating results and financial condition.

 

***Segue’s businesscould be adversely affected if its products contain errors.***  Software products as complex as ours may contain undetectederrors or “bugs”, which could result in product failures.  The occurrence of errors could result inloss of or delay in revenue, loss of market share, failure to achieve marketacceptance, diversion of development resources, significant repair andreplacement costs, injury to our reputation, or damage to our efforts to buildbrand awareness, any of which could have a material adverse effect on ourbusiness, operating results and financial condition.

 

***We must hire and retain skilled personnel in a difficulteconomic environment.***  Qualified personnel remain in demand throughout the softwareindustry.  Our success depends in largepart upon our ability to attract, train, motivate and retain highly skilledemployees, particularly sales and marketing personnel, software engineers andother senior personnel.  The failure toattract and retain the highly skilled personnel that are integral to our directsales, product development, service and support teams may limit the rate atwhich we can generate sales and develop new products or productenhancements.  Our ability to attractand retain our qualified staff may be further impacted by our financialresults.  All of this could have amaterial adverse effect on our business, operating results and financialcondition.

 

***We face many risksassociated with international business activities.***  We derived approximately 18% of totalproduct software sales from international customers in the first quarter of2002.  The international market forsoftware products is highly competitive and we expect to face substantialcompetition in this market from established and emerging companies.  Segue faces many risks associated withinternational business activities including currency fluctuations, impositionof government controls, export license requirements, restrictions on the exportof critical technology, political and economic instability, tailoring ofproducts to local requirements, trade restrictions, changes in tariffs andtaxes, difficulties in staffing and managing international operations, longeraccounts receivable payment cycles and the burdens of complying with a widevariety of foreign laws and regulations. To the extent we are unable to continue to expand international sales ina timely and cost-effective manner, our business could be materially adverselyaffected.

 

***Segue’s successdepends on our ability to protect our software and other proprietary technology**.***  Theunauthorized reproduction or other misappropriation of our proprietarytechnology could enable third parties to benefit from Segue’s technologywithout paying us for it.  This couldhave a material adverse effect on our business, operating results and financialcondition.  Although we have taken stepsto protect our proprietary technology, these efforts may be inadequate.  We currently rely on a combination ofpatent, trademark, copyright and trade secret laws and contractual provisions toprotect our proprietary rights in our products.  Currently, we have three issued patents and a fourthpending.  There can be no assurance thatthese patents would be upheld if challenged. Moreover, the laws of other countries in which we market our productsmay afford little or no effective protection of our intellectual property.  If we resort to legal proceedings to enforceour intellectual property rights, the proceedings could be burdensome andexpensive and could involve a high degree of risk.  If we were to discover that any of Segue products violated thirdparty proprietary rights, or protect our trade secrets, there can be noassurance that we would be able to obtain licenses on commercially reasonableterms to continue licensing our software without substantial reengineering orthat any effort to undertake such reengineering would be successful.  Any claim of infringement could cause Segueto incur substantial costs defending against the claim, even if the claim isinvalid, and could distract management resources from our business.  Furthermore, a party making such a claimcould secure a judgment that requires us to pay substantial damages or resultin an injunction.  Any of these eventscould have a material adverse effect on our business, operating results andfinancial condition.

 

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**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The followingdiscussion about our market risk disclosures involves forward–lookingstatements.  Actual results could differmaterially from those discussed in the forward–looking statements.  We are exposed to market risk related tochanges in interest rates and foreign currency exchange rates.  We do not use derivative financialinstruments for speculative or trading purposes.

 

INTEREST RATE RISK.  Segue isexposed to market risk from changes in interest rates primarily through itsinvesting activities.  In addition, ourability to finance future transactions may be impacted if we are unable toobtain appropriate financing at acceptable rates.  Our investing strategy to manage interest rate and marketexposure is to invest in short-term, highly secure and liquid investments.  We maintain a portfolio of highly liquidcash equivalents and short-term investments (primarily in high-grade corporatecommercial paper). As of March 31, 2002, the fair value of our short-terminvestments approximated market value.

 

FOREIGN CURRENCY RISK.  Segue faces exposure to movements in foreign currency exchangerates.  These exposures may change overtime as business practices evolve and could have a material adverse effect onour business, financial condition and results of operations.  We do not use derivative financialinstruments or other financial instruments to hedge economic exposures or fortrading.  Historically, our primaryexposures have been related to the operations of our foreign subsidiaries.  During the first quarter of 2002, weincurred expenses of approximately $161,000 related to foreign currency.  The effect of foreign currency in the firstquarter in 2001 was not significant.  Asof March 31, 2002, the cumulative translation of foreign currency changesrecorded against stockholders’ equity was $100,000.  On January 1, 2002, the Euro became the local currency fortwo of our operating subsidiaries, Austria and Germany.  We anticipate that the impact of the Eurowill have a larger effect than in the past, as we will have both transactionsand translation related to this currency.

 

### **PART II. OTHERINFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

There are no pending lawsuits which management believes will have amaterial adverse affect on the financial position or results of operations ofSegue.

 

**ITEM2. CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

On March 22, 2002, theCompany and S-7 Associates LLC, a company managed by the Chairman of Segue’sBoard of Directors, Dr. James H. Simons (“S-7 Associates”), signed anagreement under which S-7 Associates purchased 666,667 shares of the Company’sSeries B 12% Convertible Preferred Stock (“Preferred Stock”) in considerationfor a payment of $2.0 million.  ThePreferred Stock is senior to common stock as to dividend and liquidation rightsand is convertible at the option of the holder into shares of common stock ofSegue at a conversion price of $3.00 per share, subject to adjustment upon theoccurrence of certain transactions.  Theholders of the Preferred Stock are entitled to vote together with the commonstock on an as-converted basis, and in addition, are entitled to elect onedirector of the Company as a separate class. Dividends on the Preferred Stock are 12% per annum and will bepaid-in-kind semiannually.  ThePreferred Stock is callable on or after March 31, 2004 at 133% of its facevalue (“Liquidation Preference”).  Ifthere is a sale of all or substantially all of the Company’s assets or equity,the Preferred Stock can either be redeemed at the Liquidation Preference orconverted to common stock.  Pursuant toa registration rights agreement, the Company has agreed, subject to certainlimitations, to register, under the Securities Act of 1933, the resale ofcommon stock into which the Preferred Stock may be converted.  The registration rights expire on March 22,2007.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Not applicable.

 

**ITEM 5. OTHER INFORMATION**

 

Not applicable.

 

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**ITEM6. EXHIBITS AND REPORTS ON FORM 8-K**

 

 

(a)                                  Exhibits

None.

 

(b)           Reports onForm 8-K

None.

 

 

### **SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

Date: May 14, 2002.

 
|   | **SEGUE  SOFTWARE, INC.** |
|--------|---------------------------|
|   |                      |   |
|   | By:                       | /s/ STEPHEN B. BUTLER |   |
|   |                      |   |
|   |                      | Stephen B. Butler |
|   |                      | Chief Executive Officer, President and Director |
|   |                      |   |
|   | By:                       | /s/ DOUGLAS ZACCARO |   |
|   |                      |   |
|   |                      | Douglas Zaccaro |
|   |                      | Chief Financial Officer and Treasurer |

 

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