`

**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(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                  |                                                                                               |
| **For  the Quarterly Period Ended March 31, 2003**                                                                                                    |
|                                                                                                                                                  |                                                                                               |
| **o**                                                                                                                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                  |                                                                                               |
| **For the transition period from            to           ** |

 

**Commission file number 0-27794**

 

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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, 2003 was 9,705,041.

 

 

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**SEGUE SOFTWARE, INC.**

 

**FORM 10-Q**

 

**FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003**

 

**INDEX**

 
| PART I.  | FINANCIAL INFORMATION                                                                                         |
|----------|---------------------------------------------------------------------------------------------------------------|
|     |                                                                                                          |
| Item  1. | Condensed  Consolidated Financial Statements:                                                                 |
|     |                                                                                                          |
|     | Condensed  Consolidated Balance Sheets (unaudited) March 31, 2003 and  December 31, 2002            |
|     |                                                                                                          |
|     | Condensed  Consolidated Statements of Operations (unaudited) Three months ended March 31,  2003 and 2002 |
|     |                                                                                                          |
|     | Condensed  Consolidated Statements of Cash Flows (unaudited) Three months ended  March 31, 2003 and 2002 |
|     |                                                                                                          |
|     | 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                                                   |
|     |                                                                                                          |
| Item  4. | Controls and Procedures                                                                                       |
|     |                                                                                                          |
| PART II. | OTHER INFORMATION                                                                                             |
|     |                                                                                                          |
| Item 1.  | Legal Proceedings                                                                                             |
|     |                                                                                                          |
| 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,  2003** |       | **December  31,  2002** |       |
|---------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|-------------------------|------------|
|                                                                                                                            |   |                             |       |                    |       |
| **ASSETS**                                                                                                                      |   |                             | ** ** |                    | ** ** |
| Current  assets:                                                                                                                |   |                             |       |                    |       |
| Cash                                                                                                                            |   | $                                | 5,993      |                    | $          | 5,335 |   |
| Accounts  receivable, net of allowances of $256 and $232, respectively                                                          |   | 5,137                            |       | 6,007                   |       |
| Other  current assets                                                                                                           |   | 806                              |       | 967                     |       |
| Total  current assets                                                                                                           |   | 11,936                           |       | 12,309                  |       |
|                                                                                                                            |   |                             |       |                    |       |
| Property  and equipment, net                                                                                                    |   | 1,745                            |       | 2,089                   |       |
| Goodwill,  net                                                                                                                  |   | 1,506                            |       | 1,506                   |       |
| Other  assets                                                                                                                   |   | 1,189                            |       | 1,291                   |       |
| Total  assets                                                                                                                   |   | $                                | 16,376     |                    | $          | 17,195 |   |
|                                                                                                                            |   |                             | ** ** |                    | ** ** |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                  |   |                             | ** ** |                    | ** ** |
| Current  liabilities:                                                                                                           |   |                             |       |                    |       |
| Accounts  payable                                                                                                               |   | $                                | 723        |                    | $          | 1,256 |   |
| Accrued  compensation and benefits                                                                                              |   | 1,165                            |       | 1,163                   |       |
| Accrued  lease obligations on excess space                                                                                      |   | 1,934                            |       | 2,145                   |       |
| Accrued  expenses                                                                                                               |   | 1,117                            |       | 1,522                   |       |
| Deferred  revenue                                                                                                               |   | 8,699                            |       | 8,408                   |       |
| Total  current liabilities                                                                                                      |   | 13,638                           |       | 14,494                  |       |
|                                                                                                                            |   |                             |       |                    |       |
| Stockholders’  equity:                                                                                                     |   |                             |       |                    |       |
| Preferred  stock, 9,000 shares authorized; 729 and 729 shares of Series B preferred  stock issued and outstanding, respectively |   | 2,147                            |       | 2,147                   |       |
| Common  stock, par value $.01 per share; 30,000 shares authorized; 9,850 and 9,765  shares issued, respectively                 |   | 99                               |       | 98                      |       |
| Additional  paid-in capital                                                                                                     |   | 58,289                           |       | 58,206                  |       |
| Cumulative  translation adjustment                                                                                              |   | 122                              |       | 98                      |       |
| Accumulated  deficit                                                                                                            |   | (57,319)                         |       | (57,248)                |       |
|                                                                                                                            |   | 3,338                            |       | 3,301                   |       |
| Less  treasury stock, at cost, 145 and 145 shares, respectively                                                                 |   | (600)                            |       | (600)                   |       |
| Total  stockholders’ equity                                                                                                |   | 2,738                            |       | 2,701                   |       |
| Total  liabilities and stockholders’ equity                                                                                |   | $                                | 16,376     |                    | $          | 17,195 |   |

 

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

 

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**SEGUE SOFTWARE, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(UNAUDITED)**

** **
|                                                        |   | **Three months ended March 31,** |   |
|-------------------------------------------------------------|--------|----------------------------------|--------|
|                                                        |   | **2003**                         |   | **2002** |   |
| Revenue:                                                    |   |                             |   |   |   |
| Software                                                    |   | $                                | 3,319  |   | $ | 3,315 |   |
| Services                                                    |   | 4,184                            |   | 4,731 |   |
| Subtotal revenue                                            |   | 7,503                            |   | 8,046 |   |
| Adjustment  relating to payment to a customer               |   | (37                              | )      | (1,000 | ) |
| Net revenue                                                 |   | 7,466                            |   | 7,046 |   |
|                                                        |   |                             |   |   |   |
| Cost of revenue:                                            |   |                             |   |   |   |
| Cost of software                                            |   | 64                               |   | 230 |   |
| Cost of services                                            |   | 1,309                            |   | 1,255 |   |
| Total cost of  revenue                                      |   | 1,373                            |   | 1,485 |   |
|                                                        |   |                             |   |   |   |
| Gross margin                                                |   | 6,093                            |   | 5,561 |   |
|                                                        |   |                             |   |   |   |
| Operating  expenses:                                        |   |                             |   |   |   |
| Sales and  marketing                                        |   | 3,559                            |   | 4,426 |   |
| Research and  development                                   |   | 1,458                            |   | 1,302 |   |
| General and  administrative                                 |   | 1,063                            |   | 1,478 |   |
| Restructuring  charges                                      |   | —                           |   | 683 |   |
| Total operating  expenses                                   |   | 6,080                            |   | 7,889 |   |
|                                                        |   |                             |   |   |   |
| Income (Loss)  from operations                              |   | 13                               |   | (2,328 | ) |
| Interest Income                                             |   | 13                               |   | 21 |   |
| Income (Loss)  before provision for income taxes            |   | 26                               |   | (2,307 | ) |
| Provision for  income taxes                                 |   | 97                               |   | 25 |   |
| Net loss                                                    |   | (71                              | )      | (2,332 | ) |
| Preferred stock  dividend-in-kind                           |   | 54                               |   | 6 |   |
| Net loss  applicable to common shares                       |   | $                                | (125   | ) | $ | (2,338 | ) |
|                                                        |   |                             |   |   |   |
| Net loss per  common share—basic and diluted           |   | $                                | (0.01  | ) | $ | (0.25 | ) |
| Weighted average  shares outstanding—basic and diluted |   | 9,659                            |   | 9,491 |   |
|                                                             |        |                                  |        |  |  |  |  |  |

 

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

 

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**SEGUE SOFTWARE, INC**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

**(UNAUDITED)**

 
|                                                                                       |   | **Three months ended March 31,** |    |
|--------------------------------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                                       |   | **2003**                         |    | **2002** |   |
| Increase  (decrease) in cash                                                               |   |                             |    |   |   |
|                                                                                       |   |                             |    |   |   |
| Cash flows from  operating activities:                                                     |   |                             |    |   |   |
| Net loss                                                                                   |   | $                                | (71     | ) | $ | (2,332 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |   |                             |    |   |   |
| Depreciation and  amortization                                                             |   | 393                              |    | 500 |   |
| Changes in  operating assets and liabilities:                                              |   |                             |    |   |   |
| Accounts  receivable                                                                       |   | 904                              |    | 444 |   |
| Other current  assets                                                                      |   | 167                              |    | 385 |   |
| Accounts payable                                                                           |   | (532                             | )  | 676 |   |
| Accrued  expenses, lease obligations on excess space, compensation, benefits and other     |   | (584                             | )       | 99 |   |
| Deferred revenue                                                                           |   | 267                              |    | (606 | ) |
|                                                                                       |   |                             |    |   |   |
| Net cash  provided by (used in) operating activities                                       |   | 544                              |    | (834 | ) |
|                                                                                       |   |                             |    |   |   |
| Cash flows from  investing activities:                                                     |   |                             |    |   |   |
| Additions to  property and equipment                                                       |   | (45                              | )       | (43 | ) |
| Maturities of  short-term investments                                                      |   | —                           |    | 4,949 |   |
| Purchases of  short-term investments                                                       |   | —                           |    | (800 | ) |
| Other assets                                                                               |   | 102                              |    | 30 |   |
|                                                                                       |   |                             |    |   |   |
| Net cash  provided by investing activities                                                 |   | 57                               |    | 4,136 |   |
|                                                                                       |   |                             |    |   |   |
| Cash flows from  financing activities:                                                     |   |                             |    |   |   |
| Proceeds from  exercise of stock options and stock purchase plan                           |   | 83                               |    | 127 |   |
| Proceeds from  the issuance of convertible preferred stock                                 |   | —                           |    | 2,000 |   |
|                                                                                       |   |                             |    |   |   |
| Net cash  provided by financing activities                                                 |   | 83                               |    | 2,127 |   |
|                                                                                       |   |                             |    |   |   |
| Effect of  exchange rate changes on cash                                                   |   | (26                              | )       | (17 | ) |
|                                                                                       |   |                             |    |   |   |
| Net increase in  cash and cash equivalents                                                 |   | 658                              |    | 5,412 |   |
| Cash and cash  equivalents, beginning of period                                            |   | 5,335                            |    | 2,326 |   |
|                                                                                       |   |                             |    |   |   |
| Cash and cash  equivalents, end of period                                                  |   | $                                | 5,993   |   | $ | 7,738 |   |
|                                                                                       |   |                             |    |   |   |   |   |
|  

Supplemental  disclosure of non-cash investing and financing transactions:         |   |                             |    |   |   |   |   |
| Cash paid during the  quarter for interest                                                 |   |                             | —  |   |   | — |   |
| Cash paid during the  quarter for income taxes                                             |   | $                                | 166     |   |   | 30 |   |
|                                                                                            |        |                                  |         |  |  |  |  |  |  |

 

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, 2002, included in its 2002 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.

 

**2.  LIQUIDITY**

 

The Company has incurred losses on an annual basis since it beganoperations, resulting in an accumulated deficit of approximately$57.3 million at March 31, 2003. As a result, the Company has usedsignificant amounts of cash, cash equivalents and short-term investments tofund its operations.  However, theCompany generated approximately $658,000 in overall positive cash flow for thequarter ended March 31, 2003, and generated approximately $1.2 million inpositive cash flow for the quarter ended December 31, 2002.

 

Segue management has taken significant steps to streamline itsoperations over the last two years and will continue to do so as the situationwarrants. These steps have included reducing headcount, infrastructure andother expenses and limiting capital expenditures.  At a minimum, the Company must maintain revenue at the currentlevels for Segue to sustain profitability and positive cash flow. Assuming thatSegue can execute on current plans to maintain or grow revenue, Segue believesthere should be sufficient cash to meet its forecasted working capital needsfor at least the next twelve months. Delays in the timing of future sales orsales levels below management’s expectations may cause the Company tore-evaluate its cash position, adjust its operations and/or take other possibleactions.

 

Long-term cash requirements, other than for normal operating expenses,and for commitments including those detailed in Note 10, are anticipated forthe development of new software products and enhancements of existing products,and the possible acquisition of software products or technologies complementaryto our business.

 

The effects of the steps taken by management have significantly reducedthe Company’s future expected cash outflow. On January 24, 2003, theCompany received approval from its landlord to restructure its corporateheadquarters’ sublease for approximately 33,000 square feet in its Lexingtonfacility.  Under the terms of theoriginal sublease and the restructured agreement, however, Segue was requiredto provide the landlord an initial letter of credit for $700,000. The cashsecurity of $770,000 (letter of credit plus 10%) that was posted is classifiedas restricted cash and is reflected in Other Assets on the Company’s balancesheet. This required letter of credit and the related cash collateral willreduce over time, by formula, to zero by August 2005.

 

The recoverability of a major portion of the recorded asset amountsshown in the accompanying balance sheet are dependent upon the continuedoperations of Segue, which in turn are dependent upon Segue’s ability tomaintain or increase sales and to succeed in its future operations. Thefinancial statements do not include any adjustments relating to therecoverability and classification of recorded asset amounts, and classificationand amounts of liabilities that might be necessary should Segue be unable tocontinue operations.

 

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**3.  RECENT ACCOUNTING DEVELOPMENTS**

 

In November 2001, Emerging Issues Task Force (“EITF”) IssueNo. 01-9, “Accounting for Consideration Given by a Vendor to a Customer(Including a Reseller of the Vendor’s Products)” was issued. This EITF providesguidance with respect to the statement of operations classification,recognition and measurement of consideration given by a vendor to a customer orreseller. This EITF presumes any consideration to be an adjustment of theselling prices of the vendor’s products or services, which should be deductedfrom revenue when recognized in the vendor’s statement of operations, unlessthere is an identifiable and quantifiable benefit received for theconsideration. This EITF is effective for annual and interim periods beginningafter December 15, 2001. Upon adoption, financial statements for priorperiods presented for comparative purposes should be reclassified to complywith the requirements under the EITF. In January 1, 2002, the Companyadopted this EITF. During the quarter ended March 31, 2002, the Companycommitted to making a payment of $1.0 million to a customer, which wasmade in Q2 2002. Under the provisions of EITF Issue No. 01-9, this$1.0 million was considered to be a reduction in revenue and is presented inthe statement of operations as such. Per the contract with the customer, thispayment is a one-time expenditure. Furthermore, in accordance with EITF IssueNo. 01-9, for the period ended March 31, 2003, we recordedapproximately $37,000 as an additional revenue reduction for amounts paid toresellers as referral fees for sales. There were no other material paymentsmade by the Company in this quarter or prior quarters that would be consideredfor reclassification under the guidance in EITF Issue No. 01-9.

 

On July 30, 2002, FASB issued SFAS No. 146, “Accounting forCosts Associated with Exit or Disposal Activities” (“SFAS No. 146”). Thestandard requires companies to recognize costs associated with exit or disposalactivities when they are incurred rather than at the date of a commitment to anexit or disposal plan. Examples of costs covered by the standard include leasetermination costs and certain employee severance costs that are associated witha restructuring, discontinued operation, plant closing, or other exit ordisposal activity. Statement 146 is to be applied prospectively to exit ordisposal activities initiated after December 31, 2002.  The Company has adopted the provisions ofthis FASB.

 

In November 2002, the FASB issued Interpretation No. 45, orFIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires thatupon issuance of a guarantee, a guarantor must recognize a liability for thefair value of an obligation assumed under a guarantee. FIN 45 also requiresadditional disclosures by a guarantor in its interim and annual financialstatements about the obligations associated with guarantees issued. Therecognition provisions of FIN 45 are effective for any guarantees issued ormodified after December 31, 2002. The disclosure requirements areeffective for financial statements of interim or annual periods ending afterDecember 15, 2002.  The adoption ofFIN 45 will not have a material effect on the consolidated financial position,results of operations or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure” (“SFASNo. 148”). The standard amends SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods for voluntary transition toSFAS 123’s fair value method of accounting for stock-based employeecompensation (“the fair value method”). SFAS No. 148 also requiresdisclosure of the effects of an entity’s accounting policy with respect tostock-based employee compensation on reported net income (loss) andearnings (loss) per share in annual and interim financials statements. Thetransition provisions of SFAS No. 148 are effective in fiscal yearsbeginning after December 15, 2002. The Company is currently evaluating thetransition provisions of SFAS No. 148 and has adopted the disclosureprovisions of SFAS No. 148.

 

SFAS No. 123, “Accounting for Stock-Based Compensation,”required the Company to elect either expense recognition under SFASNo. 123 or its disclosure-only alternative for stock-based employeecompensation. The expense recognition provision encouraged by SFAS No. 123requires fair-value based financial accounting to recognize compensationexpense for employee stock compensation plans. The Company adopted SFASNo. 123 in 1997 and elected the disclosure-only alternative. Hadcompensation costs for the Company’s stock and stock option plans beendetermined based on the fair value at the grant dates for awards under thoseplans consistent with the methodology of SFAS No. 123, the Company’s netloss and net loss per share would have been adjusted to the pro forma amountsindicated below for the years ended December 31, (in thousands, except pershare data):

 

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|                                                                                                                                              |   | **Three  months ended March 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                                                              |   | **2003**                          |   | **2002** |   |
|                                                                                                                                              |   |                              |   |   |   |
| Net  loss applicable to common shares                                                                                                             |   |                              |   |   |   |
| As  reported                                                                                                                                      |   | $                                 | (125   | ) | $ | (2,338 | ) |
| Deduct:  Total stock-based employee compensation expense determined under the fair  value based method for all awards, net of related tax effects |   | (742                              | )      | (861 | ) |
| Pro  forma                                                                                                                                        |   | $                                 | (867   | ) | $ | (3,199 | ) |
| Net  loss per common share — basic and diluted                                                                                               |   |                              |   |   |   |
| As  reported                                                                                                                                      |   | $                                 | (0.01  | ) | $ | (0.25 | ) |
| Pro  forma                                                                                                                                        |   | $                                 | (0.09  | ) | $ | (0.34 | ) |

 

 

In January 2003, the FASB issued FIN No. 46, “Consolidationof Variable Interest Entities.” In general, a variable interest entity is acorporation, partnership, trust, or any other legal structure used for businesspurposes that either (a) does not have equity investors with voting rightsor (b) has equity investors that do not provide sufficient financialresources for the entity to support its activities. FIN No. 46 requirescertain variable interest entities to be consolidated by the primary beneficiaryof the entity if the investors do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties. The consolidation requirements of FIN No. 46 applyimmediately to variable interest entities created after January 31, 2003.The consolidation requirements apply to older entities in interim periodsbeginning after June 15, 2003. Certain of the disclosure requirements applyin all financial statements issued after January 31, 2003, regardless ofwhen the variable interest entity was established. Because the Companycurrently has no investments in variable interest entities,  the adoption of the provisions of FINNo. 46 will not have a material impact on the consolidated results ofoperations or financial position.

 

**4.  OTHER ASSETS**

 

Included in other assets at March 31, 2003 is restricted cash of$770,000. This amount represents the security for a letter of credit requiredby our sublease for our Lexington headquarters. This required letter of creditwill reduce over time, by formula, to zero by August 2005. Also includedis the balance on an interest bearing promissory note receivable ofapproximately $225,000 from Segue’s former chief executive officer who resignedon May 2, 2003. Interest on the outstanding balance is to be calculated on amonthly basis using the current prime rate as published in the Wall StreetJournal. Interest is payable on each anniversary of the note, beginning onMarch 22, 2002. The Compensation Committee of the Company’s board ofdirectors approved adding the interest due on the loan as of March 22,2002 to the principal balance included above. The borrower must use theproceeds from any Company paid bonus or gain on the sale of shares of stockunderlying options issued by the Company to pay any outstanding balance on thenote. The note is payable in full on March 22, 2006 and is secured by aSecond Mortgage and Security Agreement. This note receivable is grand fatheredunder the recently enacted Sarbanes-Oxley Act of 2002.  During the quarter ended March 31, 2003, apayment of $111,000 was received by the Company that was used in part to payall interest due, with the remainder being applied to the principal.

 

**5.  EQUITYTRANSACTIONS**

 

On March 22,2002, the Company and S-7 Associates LLC, a company managed and owned by theChairman of Segue’s Board of Directors, Dr. James H. Simons (“S-7Associates”), signed an agreement under which S-7 Associates purchased 666,667shares of the Company’s Series B Preferred Stock (“Preferred Stock”) inconsideration for a payment of $2.0 million.  The Preferred Stock is senior to the common stock as to dividendand liquidation rights and is convertible at the option of the holder intoshares of common stock of Segue at a conversion rate of one share of preferredfor one share of common, subject to adjustment upon the occurrence of certaintransactions.  The holders of the PreferredStock are entitled to vote together with the common stock on an as-convertedbasis, and in addition, are entitled to elect one director of the Company as aseparate class.  Dividends on thePreferred Stock accrue at 12% per annum and are to be paid in additional sharesof preferred stock semiannually.  ThePreferred Stock is callable at the option of the Company on or afterMarch 31, 2004 at 133% of its face value (“Liquidation Preference”).  If there is a sale of all or substantiallyall of the Company’s assets or equity, the Preferred Stock can either beredeemed at the Liquidation Preference or converted to common stock. Pursuantto a registration rights agreement, the Company has

 

8

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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.

 

For the quarter ended March 31, 2003, an additional21,884 shares of Preferred Stock were earned as dividends and will be issued onJune 30, 2003.  Preferred Stockdividends earned for the three months ended March 31, 2003 resulted in anexpense of approximately $54,000 versus $6,000 for the period ended March 22,2002 through March 31, 2002. The fair value of the Preferred Stock, on whichthe preferred dividends are calculated, is estimated by management for thepurpose of determining net loss applicable to common shares.

 

For the three months ended March 31, 2003, there wereno options to purchase common stock exercised by employees and directors, and atotal of 84,809 shares of common stock were purchased and issued to employeesunder the Company’s Employee Stock Purchase Plan.  Total proceeds to Segue for the transactions were approximately$83,000.  For the three months endedMarch 31, 2002, there were options to purchase 10,000 shares of common stockexercised by employees and directors, and a total of 78,816 shares of commonstock were purchased and issued to employees under the Company’s Employee StockPurchase Plan.  Total proceeds to Seguefor the transactions were approximately $127,000.

 

At March 31, 2003, the Company has 3 stock-based employeecompensation plans.  (These plans aredescribed more fully in Note 5 of the Company’s Annual 10-K Report.)  The Company accounts for these plans underthe recognition and measurement principles of APB Opinion No. 25,“Accounting for Stock Issued to Employees”, and related interpretations. Nostock-based employee compensation cost is reflected in net income, as alloptions granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant.

 

**6.  RESTRUCTURINGCHARGES**

 

Since April 1, 2001, Segue has executed various restructuring plansaimed at reducing the expenses of the Company. As a result, Segue has recorded restructuring charges for severance,other employee-related costs, and costs for estimated lease obligationsassociated with excess office facilities in our Lexington and Los Gatosoffices, net of estimated sublease income. The following table summarizes the restructuring actions and chargesincurred by quarter.

 
| **Quarter** |   | **Severance  and  other employee  related costs** |      | **Number of  employees  terminated as part of  restructuring plan** |   | **%  Reduction  in  workforce** |   | **Cost of  estimated  facility obligations,  net of estimated  sublease income** |    | **Office for  which facility  costs accrued** |      | **Total  Restructuring  Charge** |    |
|-------------|--------|---------------------------------------------------|-----------|---------------------------------------------------------------------|--------|---------------------------------|--------|----------------------------------------------------------------------------------|---------|-----------------------------------------------|-----------|----------------------------------|---------|
|        |   |                                              |      |                                                                |   |                            |   |                                                                             |    |                                          |      |                             |    |
| Q1 2003     |   | —                                            |      | —                                                              |   | —                          |   | —                                                                           |    | —                                        |      | —                           |    |
| Total 03    |   | —                                            |      | —                                                              |   |                            |   | —                                                                           |    | —                                        |      | —                           |    |
|        |   |                                              |      |                                                                |   |                            |   |                                                                             |    |                                          |      |                             |    |
| Q4 2002     |   | —                                            |      | —                                                              |   | —                          |   | —                                                                           |    | —                                        |      | —                           |    |
| Q3 2002     |   | —                                            |      | —                                                              |   | —                          |   | $                                                                                | 373,000 |                                          | Lexington |                             | $       | 373,000 |   |
| Q2 2002     |   | —                                            |      | —                                                              |   | —                          |   | 147,000                                                                          |    | Lexington                                     |      | 147,000                          |    |
| Q1 2002     |   | $                                                 | 559,000   |                                                                | 12     |                            | 5      |                                                                             | 124,000 |                                          | Lexington |                             | 683,000 |   |
| Total 02    |   | 559,000                                           |      | 12                                                                  |   |                            |   | 644,000                                                                          |    |                                          |      | 1,203,000                        |    |
|        |   |                                              |      |                                                                |   |                            |   |                                                                             |    |                                          |      |                             |    |
| Q4 2001     |   | —                                            |      | —                                                              |   | —                          |   | —                                                                           |    | —                                        |      | —                           |    |
| Q3 2001     |   | 485,000                                           |      | 42                                                                  |   | 14                              |   | 1,479,000                                                                        |    | Lexington                                     |      | 1,964,000                        |    |
| Q2 2001     |   | 859,000                                           |      | 73                                                                  |   | 20                              |   | 1,398,000                                                                        |    | Lexington and  Los Gatos                      |      | 2,257,000                        |    |
| Q1 2001     |   | —                                            |      | —                                                              |   | —                          |   | —                                                                           |    | —                                        |      | —                           |    |
| Total 01    |   | 1,344,000                                         |      | 115                                                                 |   |                            |   | 2,877,000                                                                        |    |                                          |      | 4,221,000                        |    |
|        |   |                                              |      |                                                                |   |                            |   |                                                                             |    |                                          |      |                             |    |
| Total       |   | $                                                 | 1,903,000 |                                                                | 127    |                            |   |                                                                             | $       | 3,521,000                                     |      |                             |    | $ | 5,424,000 |   |
|             |        |                                                   |           |                                                                     |        |                                 |        |                                                                                  |         |                                               |           |                                  |         |  |  |  |  |  |  |

 

9

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During the firstquarter of 2003, we paid the entire $82,000 accrued at December 31, 2002 forthe remaining severance and termination benefits associated with the restructuringactions from 2002.  At March 31, 2003,we had fulfilled all our liabilities related to severance and benefitsassociated with all of the restructuring actions noted above.

 

At March 31, 2003,the accrual balance related to the obligations associated with all of theexcess office space noted above is approximately $1.9 million.  This is comprised of an estimated$2.7 million for future rents payable by Segue on unoccupied space, plus$54,000 in miscellaneous costs related to subleasing the space, lessapproximately $891,000 of estimated future sublease income.  The Company made no estimate adjustmentsrelated to this accrual for the period ended March 31, 2003.

 

**7.  PROVISION FORINCOME TAXES**

 

Segue recordedprovisions for foreign and state income taxes of $97,000 and $25,000 for thethree months ended March 31, 2003 and 2002, respectively.  There was no tax benefit recorded for lossesgenerated in the U.S. in either period due to the uncertainty of realizing suchbenefits.

 

**8.  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,** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                       |   | **2003**                          |   | **2002** |   |
|                                                                       |   |                              |   |   |   |
| Net loss  applicable to common shares                                      |   | $                                 | (125   | ) | $ | (2,338 | ) |
| Weighted average  shares used in net loss per share—basic and diluted |   | 9,659                             |   | 9,491 |   |
| Net loss per  common share—basic and diluted                          |   | $                                 | (0.01  | ) | $ | (0.25 | ) |

 

Excluded from thecalculation of diluted earnings per share for the three months endedMarch 31, 2003 and 2002 were options to purchase 3,135,961 and 3,375,201shares of common stock, respectively, and 729,492 and 666,667 shares of commonstock that can be converted from convertible preferred stock, respectively,because their inclusion would be anti-dilutive.

 

**9.  COMPREHENSIVE INCOME/(LOSS)**

 

SFAS No. 130,“Reporting Comprehensive Income” (“SFAS 130”) requires the reporting ofcomprehensive income in addition to net income from operations.  Comprehensive income is a more inclusivereporting methodology that includes disclosure of certain financial informationthat historically has not been recognized in the calculation of netincome.  To date, Segue’s comprehensiveincome items have consisted exclusively of foreign translation adjustments.  The following table sets forth thecomputation of comprehensive loss (in thousands):

 
|                             |   | **Three  months ended March 31,** |   |
|----------------------------------|--------|-----------------------------------|--------|
|                             |   | **2003**                          |   | **2002** | ** ** |
|                             |   |                              |   |   |   |
| Net loss                         |   | $                                 | (71    | ) | $ | (2,332 | ) |
| Foreign  translation adjustments |   | 24                                |   | 97 |   |
| Comprehensive  income/(loss)     |   | $                                 | (47    | ) | $ | (2,235 | ) |

 

**10.  COMMITMENTS AND CONTINGENCIES**

 

In March 2003,Segue amended the distribution agreement it had signed in September 2001 withT-Plan Ltd. of the United Kingdom. Under the revised agreement, Segue will continue to sell and market theT-Plan product that has been modified to integrate with other Segue products,under the name SilkPlan Pro; Segue will pay T-Plan Ltd. a royalty for each unitsold.  However, under the revised terms,Segue will no longer pay T-Plan Ltd. a minimum royalty in each quarter.  The Company will now make advance royaltypayments of $50,000 per quarter each year through the year 2005.  These advance royalty payments will becredited against the actual royalties due on a cumulative basis until thetermination of the contract.  Eitherparty may cancel the agreement at any time by giving the other party

 

10

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written notice to that effect at least ninety days prior to suchtermination.  In the event of atermination of the contract, Segue will receive a refund if advance royaltypayments should exceed actual cumulative royalties.  Other remaining royalty arrangements are not significant.

 

In the event of a change of control or the sale of substantially allassets, the Company has certain contractual obligations to executive officers,as well as, other non-employee related contracts. These potential obligations,should a triggering event take place, are less than $2.0 million.

 

Various claims, charges and litigation have been asserted or commencedagainst Segue arising from or related to contractual or employee relations.Management does not believe these claims will have a material adverse effect onthe financial position or results of operations of Segue.

 

**11.   SEGMENT REPORTING**

 

The Companyconsiders that it has the following reportable operating segments based ondifferences in products and services. Operating segments are defined as components of the enterprise aboutwhich separate financial information is available that is reviewed regularly bythe chief operating decision maker, or decision-making group, in decidinghow to allocate resources and in assessing their performance. Software licensessubstantially consist of sales of our Silk product line.  These operating segments are reviewed onlyto the gross margin level.  The Companydoes not maintain and can not separate balance sheet information or full profitand loss information for these segments.

 
|                                          |   | **Three  months ended March 31,  2003** |        | **Three  months ended March 31,  2002** |   |
|-----------------------------------------------|--------|-----------------------------------------|-------------|-----------------------------------------|--------|
|                                          |   | **Revenue**                             |        | **Gross  Margin**                       |   | **Revenue** |   | **Gross  Margin** |   |
|                                          |   |                                    |        |                                    |   |   |   |   |   |
| Software  licenses                            |   | $                                       |  3,319 |                                    | $      |  3,255 |   | $ |  3,315 |   | $ |  3,085 |   |
|                                          |   |                                    |        |                                    |   |   |   |   |   |
| Training and  consulting                      |   | 930                                     |        | 312                                     |   | 1,302 |   | 611 |   |
| Maintenance                                   |   | 3,254                                   |        | 2,563                                   |   | 3,429 |   | 2,865 |   |
|                                          |   |                                    |        |                                    |   |   |   |   |   |
| Total services                                |   | 4,184                                   |        | 2,875                                   |   | 4,731 |   | 3,476 |   |
|                                          |   |                                    |        |                                    |   |   |   |   |   |
| Adjustment  relating to payment to a customer |   | (37                                     | )           | (37                                     | )      | (1,000 | )  | (1,000 | )  |
|                                          |   |                                    |        |                                    |   |   |   |   |   |
| Total                                         |   | $                                       |  7,466 |                                    | $      |  6,093 |   | $ |  7,046 |   | $ |  5,561 |   |

 

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

 
|          |   | **Total  Revenue for Three Months  Ended March 31,** |        | **Long Lived  Assets At March 31,** |   |
|---------------|--------|-----------------------------------------------------------|-------------|------------------------------------------|--------|
|          |   | **2003**                                                  |        | **2002**                                 |   | **2003** |   | **2002** |   |
|          |   |                                                      |        |                                     |   |   |   |   |   |
| United States |   | $                                                         |  5,808 |                                     | $      |  6,019 |   | $ |  2,495 |   | $ |  3,020 |   |
| Foreign       |   | 1,658                                                     |        | 1,027                                    |   | 439 |   | 645 |   |
|          |   |                                                      |        |                                     |   |   |   |   |   |
| Total revenue |   | $                                                         |  7,466 |                                     | $      |  7,046 |   | $ |  2,934 |   | $ |  3,665 |   |

 

11

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**ITEM 2****.   MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF  OPERATIONS**

 

**CRITICAL ACCOUNTING POLICIES**

 

The preparation of financial statements in accordance with accountingprinciples generally accepted in the U.S. requires that management make anumber of assumptions and estimates that affect the reported amounts of assets,liabilities, revenues and expenses in our consolidated financial statements andaccompanying notes. Management bases its estimates on historical experience andvarious other assumptions believed to be reasonable. Although these estimatesare based on management’s best knowledge of current events and actions that mayimpact the Company in the future, actual results may differ from theseestimates and assumptions.

 

Our critical accounting policies are those that affect our financialstatements materially and involve a significant level of judgment bymanagement. Those policies are revenue recognition, reserves for bad debt andrestructuring and impairment charges.

 

**REVENUERECOGNITION**—Segue’srevenue recognition policy follows the guidance prescribed in Statement ofPosition 97-2 (SOP 97-2) and Statement of Position 98-9 (SOP 98-9). These callfor the residual method of revenue for multi-element arrangements whenthe vendor-specific objective evidence (VSOE) of the fair value does notexist for one or more of the delivered elements. Under the residual method, thearrangement fee is recognized as follows: (1) the total fair value of theundelivered elements, as indicated by VSOE, is deferred and subsequentlyrecognized in accordance with relevant sections of SOP 97-2 and (2) thedifference between the total arrangement fee and the amount deferred for theundelivered elements is recognized as revenue related to the deliveredelements.

 

Segue does a thorough review of the VSOE of undelivered itemssemi-annually. If the average actual VSOE is substantially different from thestandard VSOE, the Company adjusts the standards to be more reflective of theactual VSOE. This change may result in more or less revenue being recognizedrelated to the initial delivery. To date, the difference between Segue’sstandard VSOE and the actual VSOE has been immaterial and no adjustments havebeen made.

 

**BAD DEBTRESERVE**—On aregular basis, Segue reviews its accounts receivable aging to determine whichaccounts appear to be uncollectible and records an appropriate reserve. Thisdetermination is based on a complete review of all accounts greater than60 days old and an estimate of default based upon historical rates for allaccounts less than 60 days old.

 

**RESTRUCTURINGAND IMPAIRMENT CHARGES**—Another critical accounting policy relates to the recording ofrestructuring losses. Segue follows the guidance prescribed in EITF 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit an Activity (Including Certain Costs Incurred in aRestructuring)”. As such, in the first quarter of 2002 Segue recorded arestructuring charge of $683,000, which included $559,000 for a 5% workforcereduction and an incremental $124,000 for an additional estimated loss onunused space in our Lexington facility that resulted from workforce reductions.Refer to Note 6 in our Consolidated Financial Statements in thisForm 10-Q for additional information. This estimate for the loss on unusedspace was based on information that was available at that time. Factors thatwere included were anticipated rental rates in the commercial office market andthe estimated timeframe in which we expected to sublease the space. Segueobtained local real estate market data and consulted with its real estateadvisor on these factors to help determine an appropriate reserve for potentiallosses on the unused space. During the fourth quarter of 2002, Segue was ableto reach an agreement in principle with its landlord to restructure thesublease for our Lexington facility. A formal agreement was consummated onJanuary 24, 2003.  There were norestructuring charges for the first quarter of 2003.  At March 31, 2003, the accrual balance related to theobligations associated with excess office space in both the Lexington and LosGatos facilities is approximately $1.9 million. This is comprised of anestimated $2.7 million for future rents payable by Segue on unoccupiedspace, plus $54,000 in miscellaneous costs related to subleasing the space,less approximately $891,000 of estimated sublease income. Segue is under arestructured sublease for the Lexington facility until October 2007.

 

**GOODWILL -**As required by SFAS No. 142, Seguediscontinued the amortization of goodwill effective January 1, 2002.Goodwill represents the excess of cost over the fair value of the net assets ofbusinesses acquired. Goodwill resulted from Segue’s acquisition of SQLBench inDecember 1997 and was being amortized using the straight-line method overfive years.  During the year ended December 31,2002, Segue performed an initial analysis of the transitional fair value of thegoodwill and re-evaluated the fair value of the goodwill during the fourthquarter of 2002. The analysis demonstrated that no impairment existed atDecember 31, 2002 and no adjustment was made. Segue will re-evaluate thefair value of the goodwill during the fourth quarter of 2003. Any futureimpairment loss that may occur would not exceed $1.5 million, which is thenet amount of goodwill that is on the consolidated balance sheet atMarch 31, 2003.

 

12

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**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,** |   |
|--------------------------------------------------|--------|------------------------------------------------------------------|--------|
|                                             |   | **2003**                                                         |   | **2002** | ** ** |
|                                             |   |                                                             |   |   |   |
| Revenue:                                         |   |                                                             |   |   |   |
| Software                                         |   | 44.5                                                             | %      | 47.1 | % |
| Services                                         |   | 56.0                                                             |   | 67.1 |   |
| Gross revenue                                    |   | 100.5                                                            |   | 114.2 |   |
| Adjustment  relating to payment to a customer    |   | (0.5                                                             | )      | (14.2 | ) |
| Net revenue                                      |   | 100.0                                                            |   | 100.0 |   |
| Cost of revenue:                                 |   |                                                             |   |   |   |
| Cost of software                                 |   | 0.9                                                              |   | 3.3 |   |
| Cost of services                                 |   | 17.5                                                             |   | 17.8 |   |
| Total cost of  revenue                           |   | 18.4                                                             |   | 21.1 |   |
|                                             |   |                                                             |   |   |   |
| Gross margin                                     |   | 81.6                                                             |   | 78.9 |   |
|                                             |   |                                                             |   |   |   |
| Operating  expenses:                             |   |                                                             |   |   |   |
| Sales and  marketing                             |   | 47.7                                                             |   | 62.8 |   |
| Research and  development                        |   | 19.5                                                             |   | 18.5 |   |
| General and  administrative                      |   | 14.2                                                             |   | 21.0 |   |
| Restructuring  charges                           |   | —                                                           |   | 9.7 |   |
| Total operating  expenses                        |   | 81.4                                                             |   | 112.0 |   |
|                                             |   |                                                             |   |   |   |
| Income/(Loss)  from operations                   |   | 0.2                                                              |   | (33.1 | ) |
| Other income,  net                               |   | 0.2                                                              |   | 0.3 |   |
| Income/(Loss)  before provision for income taxes |   | 0.4                                                              |   | (32.8 | ) |
| Provision for  income taxes                      |   | 1.3                                                              |   | 0.3 |   |
| Net loss                                         |   | (0.9                                                             | )%     | (33.1 | )% |

 

**SOFTWAREREVENUE**

 

Software revenueremained unchanged at $3.3 million during the first quarter of 2003 ascompared to the same period in 2002. The lack of growth in software revenue in the first quarter of 2003compared to the first quarter in 2002 is a result of global distractions andcontinued softness in IT spending as a result of the continued difficulteconomic environment.  Additionally, wecontinue to face strong competition leading to greater discounts on sales.  International software revenue accounted for33%, or $1.1 million, and 18%, or $600,000, of total software revenue for thethree months ended March 31, 2003 and 2002, respectively.

 

**SERVICESREVENUE**

 

Services revenuedecreased 11% to $4.2 million during the first quarter of 2003 from$4.7 million in the same quarter of 2002. As compared to the three months ended March 31, 2002, recognizedmaintenance revenue decreased 5% and training and consulting revenue decreased29% for the first quarter of 2003.  Thedecrease in recognized maintenance revenue was driven largely by fewer softwarelicenses sold during 2002 in comparison to those in 2001, resulting in asmaller base of software licenses with new maintenance that is being amortizedover the contract period, which is predominately 12 months.  The decreased revenue from training andconsulting engagements in the first quarter of 2003, as compared to the sameperiod of 2002, is primarily attributable to the continued difficult economicconditions in 2003, which caused a decrease in bookings and delivery oftraining and consulting engagements.

 

13

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Additionally, we continueto see an increase in customers using on-line training, which allows them torealize the full value of training while keeping expenses to a minimum.

 

**ADJUSTMENTRELATING TO PAYMENT TO A CUSTOMER**

 

In the first quarter of 2003, the Company made payments of approximately$37,000 to several resellers for referral fees. Under EITF Issue No. 01-9,these payments were considered to be a reduction in revenue and are presentedin the statement of operations as such.  In January 2002, the Company made a one-time payment of $1.0 million toIBM.  There were no other materialpayments made by the Company in the first quarter of 2003 or prior quartersthat would be considered for reclassification under the guidance in EITF IssueNo. 01-9.

 

**COST OFSOFTWARE**

 

Cost of softwaredecreased 72% to $64,000 during the first quarter of 2003 from $230,000 in thefirst quarter of 2002.  As a percentageof software revenue, costs of software in the first quarter of 2003 decreasedto 2% from 7% in the corresponding prior-year period.  The decrease in cost of software in 2003, both in absolute dollaramount and as a percentage of software revenue, was primarily due to areduction in royalties and lower personnel-related costs and allocated costs asa result of the headcount reductions and restructuring of excess office spacein the Lexington facility during 2002.

 

**COST OFSERVICES**

 

Cost of servicesremained relatively flat at $1.3 million during the first quarter of 2003 ascompared to the same period in 2002. Cost of services consists primarily of costs of providing customertechnical support, training and consulting. Cost of services as a percentage of services revenue increased to 31% inthe first quarter of 2003 from 27% in the corresponding prior-year period.  Cost of services as a percentage of servicerevenue may vary based on the profitability of individual consultingengagements and the use and utilization rate of in-house consultants versusthird party outsourcing.  In addition,the major component of the cost of services is salary expense, which isrelatively fixed and on lower service revenue represents a higher percentage.Cost of training and consulting decreased 11% to $618,000 in the first quarterof 2003 compared to $691,000 for the same quarter in 2002.  This decrease is primarily due to reducedoutsourced consulting expenses and telephone expense.  During the three-month period ended March 31, 2003, cost ofmaintenance increased 23% to $691,000, as compared to $564,000 for the sameperiod in 2002. This increase resulted from higher personnel-related expensesand the translation in the foreign currency as compared to the same period lastyear.

 

**SALESAND MARKETING**

 

Sales andmarketing expenses decreased 18% to $3.6 million during the first quarterof 2003 from $4.4 million in the first quarter of 2002. More than half ofthe decrease is attributable to decreases in personnel-related expensesas a result of the reductions in headcount from the restructuring actions inthe past twelve months.  Additionally,reduced expenditures for marketing programs and a reduction in allocatedexpenses also contributed to the decrease in sales and marketing expenses inthe first quarter of 2003, as compared to the same period in 2002.  Reduced allocated expenses consistedprimarily of rent and other facility related costs that are associated with therestructuring of excess office space in our Lexington facility.

 

**RESEARCHAND DEVELOPMENT**

 

Research anddevelopment expenses increased 15% to $1.5 million for the first quarterof 2003 in comparison to $1.3 million for the same period in 2002.  The increase in research and developmentexpenses in 2003 was primarily caused by the exchange rate translation in theEuropean market and increased personnel-related expenses, partially offset bylower telephone expense.  Segue may notbe able to reduce costs in research and development any further withoutimpacting its ability to develop new products and to enhance existing products.

 

**GENERALAND ADMINISTRATIVE**

 

General andadministrative expenses decreased 27% to $1.1 million during the firstquarter of 2003 from $1.5 million for the same period in 2002.  The decrease was primarily due to areduction in foreign currency transaction expense, personnel-relatedexpenses and allocated expenses, which consists primarily of facility relatedcosts that resulted from the restructuring of the excess office space in

 

14

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the Lexingtonfacility.  The overall decrease ingeneral and administrative expenses was partially offset by an increase in baddebt expense as compared to the first quarter of 2002 that includedapproximately $100,000 in bad debt recoveries.

 

**AMORTIZATIONOF GOODWILL**

 

As required bySFAS No. 142, Segue discontinued the amortization of goodwill effective January1, 2002.  During the fourth quarter of2002, Segue evaluated the fair value of the goodwill and found no impairmentexisted and no adjustment was made. Segue will perform an annual test of the transitional fair value of thegoodwill during the fourth quarter of 2003. There was no amortization of goodwill for the quarters ended March 31,2003 and 2002.

 

**RESTRUCTURING CHARGES**

 

There were norestructuring charges in the first quarter of 2003.  During the first quarter of 2002, Segue executed a restructuringplan, which included a reduction in workforce of approximately 5% in thequarter. As a result, Segue recognized restructuring and other charges ofapproximately $683,000.  Therestructuring charges included approximately $559,000 for severance and otheremployee-related costs for the termination of 12 employees andapproximately $124,000 for facility-related costs.  These facility-related costs included theaccrual of estimated lease obligations associated with the excess officefacilities in our Lexington office, net of anticipated subleasing income.

 

**OTHERINCOME, NET**

 

Other income, netdecreased 38% to $13,000 during the first quarter of 2003 from $21,000 in thesame quarter of 2002.  Other incomeconsists mainly of interest income on cash equivalents and short-terminvestments.  The decrease in interestincome was primarily due to lower balances of cash equivalents and short-terminvestments in the first quarter of 2003 in comparison to the same period in2002, and lower interest rates on those investments.

 

**PROVISIONFOR INCOME TAXES**

 

We recorded aprovision for foreign and state income taxes of $97,000 and $25,000 for thefirst quarter of 2003 and 2002, respectively. There was no tax benefit recorded for losses generated in the U. S. inany period due to the uncertainty of realizing such benefits.   The increase in taxes was due toadjustments in foreign tax provisions.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

As of March 31, 2003, our principal sources of liquidity included cashand cash equivalents totaling $6.0 million.

 

Our operating activities generated cash of $544,000 during the firstthree months of 2003, compared to $834,000 cash utilized in the same period in2002.  Cash generated in 2003 resultedfrom the net loss, adjusted for depreciation of property and equipment and theincrease in deferred revenue, the decrease in accounts receivable and othercurrent assets, offset by a decrease in accounts payable and accrued expenses.

 

Our investing activities generated cash of $57,000 in the first quarterof 2003, as compared to $4.1 million in 2002. Cash generated in 2003resulted from an increase in other assets partially offset by purchases inproperty and equipment, as compared to 2002, which primarily came from maturingshort-term investments. We continued to keep purchases of property andequipment low during the first quarter of 2003.  In the future, Segue may need to make increased expenditures onproperty and equipment as present equipment ages.

 

Our financingactivities generated cash of $83,000 and $2.1 million during the first quarterof 2003 and 2002, respectively.  Cashgenerated from financing activities in the first quarter of 2003 was generatedprimarily from the issuance of stock under the employee stock purchase plan,while the first quarter of 2002 also included $2.0 million from the issuance ofconvertible preferred stock.

 

We have historically had annual losses. This, accompanied by thecontinued economic downturn in 2002 and the slowdown of Information Technologycapital spending, has resulted in lower sales volume, which has required Segueto continue utilizing significant amounts of cash and cash equivalents to fundoperations.

 

15

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However, the effects of the steps taken by management havesignificantly reduced the Company’s future expected cash outflow. Furthermore,on January 24, 2003, the Company received approval to restructure itscorporate headquarters sublease by returning approximately 33,000 square feetin its Lexington facility to the landlord. Pursuant to the terms of the restructuring Segue has posted an initialletter of credit for $700,000. The cash security of $770,000 (letter of creditplus 10%) that was posted is classified as restricted cash and is reflected inOther Assets on the Company’s balance sheet. This required letter of creditwill reduce over time, by formula, to zero by August 2005.

 

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 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 continue positive cash flow from operations,Segue must maintain its current revenue level.

 

Assuming that Segue can execute on current plans to maintain revenuethrough its restructured sales program, its focus on enterprise customers, andits introduction and success of new and enhanced products, and the businessclimate for IT spending does not worsen, we believe that with the fundingdescribed above, plus current cash and cash equivalents, Segue will havesufficient resources to meet its working capital and debt requirements for atleast the next twelve months. However, if we are not able to maintain currentbusiness levels or the economy worsens, we may need to take other actions inorder to fund our working capital requirements.

 

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.

 

**FACTORS THAT MAY AFFECT FUTURERESULTS**

 

The Company’s business is subject to many uncertainties and risks. ThisForm 10-Q also contains certain forward-looking statements withinthe meaning of the Private Securities Reform Act of 1995. The Company’s futureresults may differ materially from its current results and actual results coulddiffer materially from those projected in the forward looking statements as aresult of certain risk factors, including but not limited to those set forthbelow, other one-time events and other important factors disclosed previouslyand from time to time in Segue’s other filings with the SEC.

 

***Our quarterly results may fluctuate.*** Segue’s quarterly revenue and operating results are difficult to predictand may fluctuate significantly from quarter to quarter. If our quarterlyrevenue or operating results fall below the expectations of investors or publicmarket analysts, the price of our common stock 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; decline of the general businessclimate, including uncertainty of IT spending; competition and pricing;customer order deferrals or reductions in the size of individual orders as aresult of general business conditions; 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 of spending for such expenses can not be adjustedquickly and is based, in significant part, on our expectations of futurerevenues. If actual revenue levels are below management’s expectations, resultsof operations are likely to be adversely affected. Furthermore, Segue has oftenrecognized a substantial portion of its product revenues in the last month of aquarter, with these revenues frequently concentrated in the last weeks or daysof a quarter. As a result, product revenues in any quarter are substantiallydependent on orders booked and shipped in the latter part of that quarter andrevenues from any future quarter are not predictable with any significantdegree of accuracy. Segue typically does not experience order backlog. Forthese reasons, Segue believes that quarter-to-quarter comparisons of itsresults of operations are not necessarily meaningful and should not be reliedupon as indications of future performance.

 

***We may not be profitable in the future.*** Since Segue began operations, it has generally experienced losses.Losses have resulted in an accumulated deficit of approximately$57.3 million as of March 31, 2003. In the fourth quarter of 2002,Segue reported net income of $857,000, and in the first quarter of 2003 theCompany reported net income from operations of $13,000, but it is uncertainwhether the

 

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Company cansustain profitability in the future. For the period ended March 31, 2003, theCompany had gross revenue of $7.5 million verses $8.0 million in the sameperiod last year.  During 2001 and 2002,we initiated aggressive cost saving measures in an effort to reduce expenses,enhance the possibility of profitability, 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 business conditions and InformationTechnology (IT) spending could cause further decline in revenue.*** The level of future IT spending remains very uncertain particularly inlight of the continued decline in the business climate throughout 2002. If ITspending continues to decline, Segue’s revenues could be further adverselyimpacted.

 

***Segue may not derive substantial incremental revenue fromits alliances and SilkElite Partner Program.***  In an effortto augment product revenue derived from the efforts of its direct sales force,Segue has focused on expanding its key strategic alliances and on building asuccessful SilkElite Partner Program. Segue has built alliances withPeopleSoft, Allen Systems Group, IBM Tivoli, and continued its IBM alliance.The SilkElite Partners Program focuses on resellers, consulting partners anddistributors. SilkElite Partners both resell Segue products and use Seguesoftware products in the delivery of consulting services. The success of thekey strategic alliances and the SilkElite Program is uncertain, faces strongcompetition, and takes time and significant resources to develop. Should Seguefail to generate substantial incremental revenue from its strategic alliancesor its SilkElite Program, the financial results and stock price could beadversely affected.

 

***Segue may not generate substantial incremental revenue fromthe expanded relationship with IBM.***  In 2002,Segue signed an expanded contract with IBM Corporation under which Segue is theexclusive external provider of software for IBM Global Infrastructure andSystems Management Services’ (IGSSMS) new remote infrastructure analysisoffering. IBM will use Segue’s monitoring product, SilkVision, and Segue’senhanced scalability product, SilkPerformer V. Segue invested significantresources in the alliance, including $1.0 million in cash to acceleratethe availability of the new IBM service offering. In early 2003, IBM’s IGSSMSdivision advised the Company that it will no longer offer this service.  Other divisions within IBM are currentlyevaluating whether to offer this service and it is uncertain whether Segue willgenerate any incremental revenue from the expanded relationship.

 

***Our future success will depend on our ability to respondrapidly and effectively to technological and other market changes, includingthe successful introduction of new and enhanced products.*** The nature of the web-based automated software testing and e-businesstesting markets in which we compete is characterized by rapidly changingtechnology, rapidly evolving customer needs and desires, changes in industrystandards and practices and frequent releases of new product or enhancements bycompetitors. To be competitive, Segue must develop and introduce productenhancements and new products that address the increasingly sophisticated andvaried needs of our existing and potential customers. In the first quarter2003, over 85% of Segue’s product revenue were generated from its SilkPerformerand SilkTest products compared to over 96% in same period last year.  Also, in the first quarter of 2003 weofficially released SilkPlan Pro 6.0, a major release to our test managementproduct for which we have a distribution agreement with T-Plan Ltd, a UKbased company.  Further, we releasedenhancements to our SilkTest 6.0 and SilkTest International 6.0 products duringthe first quarter 2003.  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 have taken steps to conserve our use of cash, including significantlyreducing headcount, 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 onexpense savings and potential incremental revenue from its strategic alliances,its SilkElite Partner Program, and its new products and product enhancements,that future sales will be sufficient to allow us to continue as a viablebusiness. In the first quarter of 2003, we did generate about $544,000 inpositive cash flow from operations. Total gross revenue in the first quarter2003 declined by approximately 7% from the same prior year period. If futuresales are not sufficient or revenue continues to be lower comparatively,however, we may have to raise additional financing to fund working capitalneeds. 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 cannot assure a liquid market for our stock.*** In 2002, Segue was informed by NASDAQ that the company was not incompliance with certain listing requirements for continued listing on theirNational Market exchange.  Segue wasable to take steps to remain in compliance with the listing requirements.Continued compliance with the listing requirements of the NASDAQ SmallCapMarket

 

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Exchange, and thusa liquid market for our common stock, are closely related to the financialperformance of the Company. The Company’s future business may not be sufficientto assure continued listing on the NASDAQ SmallCap Exchange.

 

***We may have difficulty operating the business efficientlywith fewer resources.***  Between 2000 and the currentdate, Segue reduced headcount by a total of approximately 50% and implementedseveral cost reduction initiatives, including reduced marketing and salesexpenses. Segue was able to achieve increased productivity with fewer resources.Segue’s ability to increase further its current productivity, as well assustain current performance with fewer resources, is uncertain.

 

***Segue faces significant competition from other softwarecompanies.***  The market for web-based software qualitymanagement and testing tools is intensely competitive and subject to rapidtechnological change. We expect competition to intensify even further in thefuture. Segue currently encounters competition from a number of public andprivate companies, including Mercury Interactive Corporation, Rational SoftwareCorporation (now part of IBM), Compuware Corporation and Empirix. Many of ourcurrent and potential competitors have longer operating histories, greater namerecognition, larger installed customer bases, and significantly greaterfinancial, technical and marketing resources than we do. Therefore, they may beable to respond more quickly to new or changing opportunities, technologies,standards or customer requirements or may be able to devote greater resources tothe promotion and sale of their products than we can. An increase incompetition could result in price reductions and loss of market share. Suchcompetition and any resulting reduction in profitability could have a materialadverse effect on our business, operating results and financial condition.

 

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

 

***We must hire and retain skilled personnel in a difficulteconomic environment.***  Qualified personnel remain indemand throughout the software industry. Our success depends in large part uponour ability to attract, train, motivate and retain highly skilled employees,particularly sales and marketing personnel, software engineers and other seniorpersonnel. The failure to attract and retain the highly skilled personnel thatare integral to our direct sales, product development, service and supportteams may limit the rate at which we can generate sales and develop newproducts or product enhancements. Our ability to retain our qualified staff maybe further impacted by our financial results during 2003. All of this couldhave a material adverse effect on our business, operating results and financialcondition.

 

***We face many risks associated with international businessactivities.***  We derived approximately 22% of totalrevenue from international customers in the first quarter of 2003, compared to15% in the first quarter of 2002. The international market for softwareproducts is highly competitive and we expect to face substantial competition inthis market from established and emerging companies. Segue faces many risksassociated with international business activities including currencyfluctuations, imposition of government controls, export license requirements,restrictions on the export of critical technology, political and economicinstability, tailoring of products to local requirements, trade restrictions,changes in tariffs and taxes, difficulties in staffing and managinginternational operations, longer accounts receivable payment cycles and theburdens of complying with a wide variety of foreign laws and regulations.Continued growth of international sales is important to growth and thestability of Segue. To the extent we are unable to continue to expandinternational sales in a timely and cost-effective manner, our business couldbe materially adversely affected.

 

***Segue’s success depends on our ability to protect oursoftware and other proprietary technology.*** The unauthorized reproduction or othermisappropriation of our proprietary technology could enable third parties tobenefit from Segue’s technology without paying us for it. This could have amaterial adverse effect on our business, operating results and financialcondition. Although we have taken steps to protect our proprietary technology,these efforts may be inadequate. We currently rely on a combination of patent,trademark, copyright and trade secret laws and contractual provisions toprotect our proprietary rights in our products. Currently, we have three issuedpatents and four are pending. There can be no assurance that these patentswould be upheld if challenged. Moreover, the laws of other countries in whichwe market our products may afford little or no effective protection of ourintellectual property. If we were to discover that any of Segue’s productsviolated third party proprietary rights, there can be no assurance that wewould be able to obtain licenses on commercially reasonable terms to continuelicensing our software without substantial reengineering or that any effort toundertake such reengineering would be successful. Any claim of infringementcould cause Segue to incur substantial costs defending against the claim, evenif the claim is invalid, and could distract management resources from ourbusiness. Furthermore, a party making such a claim could secure a judgment thatrequires us to pay substantial damages or result in an injunction. Any of theseevents could have a material adverse effect on our

 

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business, operatingresults and financial condition.

 

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

 

The following discussion about our market riskdisclosures involves forward-looking statements. Actual results could differmaterially from those discussed in the forward-looking statements. We areexposed to market risk related to changes in interest rates and foreigncurrency exchange rates. We do not use derivative financial instruments forspeculative or trading purposes.

 

*INTEREST RATE RISK.*  Segueis exposed to market risk from changes in interest rates primarily through itsinvesting and borrowing activities. In addition, our ability to finance futuretransactions may be impacted if we are unable to obtain appropriate financingat acceptable rates. Our investing strategy to manage interest rate exposure isto invest in short-term, highly secured and liquid investments. We maintain aportfolio of highly liquid cash equivalents and short-term investments(primarily in high-grade corporate commercial paper).

 

*FOREIGN CURRENCY RISK.* Segue faces exposure to movements in foreign currency exchange rates.These exposures may change over time as business practices evolve and couldhave a material adverse effect on our business, financial condition and resultsof operations. We do not use derivative financial instruments or otherfinancial instruments to hedge economic exposures or for trading. Historically,our primary currency exposures have been related to the operations of ourforeign subsidiaries. During the first three months of 2003, we incurredtransaction and re-measurement expenses of approximately $20,000 related toforeign currency. The expense effect of foreign currency for the first threemonths of 2002 was approximately $161,000.  As of March 31, 2003, the cumulative translation of foreigncurrency changes recorded in stockholders’ equity was $122,000.

 

# **ITEM4**.  CONTROLS AND PROCEDURES

 

As required by new Rule 13a-15 under the Securities Exchange Actof 1934, within the 90 days prior to the date of this report, we carriedout an evaluation under the supervision and with the participation of ourmanagement, including our former Chief Executive Officer, Acting Co-ChiefExecutive Officers and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures. In designingand evaluating our disclosure controls and procedures, we and our managementrecognize that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and our management necessarily was required to apply itsjudgment in evaluating and implementing possible controls and procedures. Basedupon that evaluation, our former Chief Executive Officer, Acting Co-ChiefExecutive Officers and Chief Financial Officer concluded that, as of the dateof completion of the evaluation, our disclosure controls and procedures werereasonably effective to ensure that information required to be disclosed by usin the reports we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms. In connection with the new rules, wewill continue to review and document our disclosure controls and procedures,including our internal controls and procedures for financial reporting, on anongoing basis, and may from time to time make changes aimed at enhancing theireffectiveness and to ensure that our systems evolve with our business. Sincethe date of this evaluation we have had no changes in, or affecting, ourdisclosure controls and procedures.

 

# **CHANGESIN INTERNAL CONTROLS—None**

 

### **PART II. OTHERINFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

There are nopending lawsuits which management believes will have a material adverse affecton the financial position or results of operations of Segue.

 

### **ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Not applicable.

 

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**ITEM 5. OTHER INFORMATION**

 

On May 5, 2003, the Company announced that Stephen B. Butler resigned aschief executive officer, president and director to take a position with aprivate company in the electronic design automation market.   The Company has initiated a search processfor a new chief executive officer and has hired an executive search firm toassist in the process.   Until asuccessor chief executive officer is named, the board of directors has electedSamuel J. Gallo, senior vice president and general counsel, and DouglasZaccaro, senior vice president, chief financial officer, and treasurer asacting co-chief executive officers.  Mr.Butler will not stand for re-election to the Board at the Company’s June 6annual meeting, but at the Company’s request, he will be available to Segue asa consultant through the end of May 2003.

 

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

 

(a)  Exhibits

 

99.1      Certification of Acting Co-Chief ExecutiveOfficer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

 

99.2      Certification of Acting Co-Chief ExecutiveOfficer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

(b)  Reports on Form 8-K

 

No reports on Form 8-K were filed during the quarterended March 31, 2003.

 

 

### **SIGNATURES**

 

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

 

Date: May 14, 2003.

 
|   | **SEGUE  SOFTWARE, INC.** |
|--------|---------------------------|
|   |                      |   |
|   | By:                       | /s/ DOUGLAS ZACCARO |   |
|   |                      |   |
|   |                      | Douglas Zaccaro |
|   |                      | Acting Co-Chief Executive Officer and Chief  Financial Officer of the Company |
|   |                      |   |
|   | By:                       | /s/ SAMUEL J. GALLO |   |
|   |                      |   |
|   |                      | Samuel J. Gallo |
|   |                      | Acting Co-Chief Executive Officer of the Company |

 

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**CERTIFICATIONS**

 

Ladies and Gentlemen:

 

I, Samuel J. Gallo,Acting Co-Chief Executive Officer of the Company, hereby certify that:

 

1.             Ihave reviewed this quarterly report on Form 10-Q of Segue Software, Inc.;

 

2.             Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thatstatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the period presented in this quarterly report;

 

4.             Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)        designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b)        evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c)        presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.             Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors:

 

a)        all significant deficiencies in thedesign or operation of internal controls which could adversely affect theregistrant’s ability to record, process, summarize and report financial dataand have identified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)        any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.             Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  May  14, 2003 | /s/  SAMUEL  J. GALLO |                              |
|---------------------------|----------------------------|-----------------------------------|
|                      | Name:                      | Samuel J. Gallo                   |
|                      | Title:                     | Acting Co-Chief Executive Officer |
|                           |                            |                                   |  |

 

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**CERTIFICATIONS**

 

Ladies and Gentlemen:

 

I, Douglas Zaccaro,Acting Co-Chief Executive Officer and Chief Financial Officer of the Company,hereby certify that:

 

1.             Ihave reviewed this quarterly report on Form 10-Q of Segue Software, Inc.;

 

2.             Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thatstatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterly report;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the period presented in this quarterly report;

 

4.             Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)        designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b)        evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c)        presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.             Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)        all significant deficiencies in thedesign or operation of internal controls which could adversely affect theregistrant’s ability to record, process, summarize and report financial dataand have identified for the registrant’s auditors any material weaknesses ininternal controls; and

b)        any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.             Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  May  14, 2003 | /s/ DOUGLAS ZACCARO |                                                           |
|---------------------------|---------------------|----------------------------------------------------------------|
|                      | Name:               | Douglas Zaccaro                                                |
|                      | Title:              | Acting Co-Chief  Executive Officer and Chief Financial Officer |
|                           |                     |                                                                |  |

 

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