<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 1999
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____.
Commission file number: 0-27794
SEGUE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4188982
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 Spring Street Lexington, MA 02421
(Address of principal executive offices)
Registrant's telephone number, including area code: (781) 402-1000
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such a shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
The number of shares of Registrant's Common Stock outstanding as of
November 9, 1999, was 9,086,482.
<PAGE>
SEGUE SOFTWARE, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets (unaudited)
September 30, 1999 and December 31, 1998 2
Consolidated Statements of Operations (unaudited)
Three and nine months ended September 30, 1999
and 1998 3
Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30, 1999 and 1998 4
Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market
Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 25
Item 6 Exhibits and Reports on Form 8-K 27
Signatures 28
Exhibits Index 29
</TABLE>
1
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SEGUE SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,426 $ 16,096
Short-term investments 15,691 17,335
Accounts receivable, net of allowances of $735
and $608 at September 30, 1999 and December 31,
1998, respectively 11,318 8,823
Other current assets 1,588 1,505
-------- --------
Total current assets 34,023 43,759
Property and equipment, net 5,952 3,560
Other assets 818 1,632
-------- --------
Total assets $ 40,793 $ 48,951
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable-current portion $ 2,649 $ 2,983
Accounts payable 1,394 2,464
Accrued compensation and benefits 2,518 1,389
Accrued royalties 169 377
Accrued expenses 2,343 1,346
Deferred revenue 6,841 4,296
-------- --------
Total current liabilities 15,914 12,855
Notes payable 883 883
Commitments and Contingencies (Note 4)
Stockholders' equity:
Preferred stock, par value $.01 per share;
5,000 shares authorized; no shares issued
and outstanding - -
Common stock, par value $.01 per share;
30,000 shares authorized; 9,075 and 8,912 shares
issued and outstanding at September 30, 1999 and
December 31, 1998, respectively 91 89
Additional paid-in capital 54,224 53,190
Accumulated deficit (30,282) (18,046)
Unearned compensation (2) (20)
Accumulated other comprehensive loss (35) -
-------- --------
Total stockholders' equity 23,996 35,213
-------- --------
Total liabilities and stockholders' equity $ 40,793 $ 48,951
======== ========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
2
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SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
------------------ -----------------
September 30, September 30,
------------- -------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Software $ 8,438 $ 6,653 $ 20,851 $19,595
Services 4,332 4,665 12,601 10,035
------- ------- -------- -------
Total revenue 12,770 11,318 33,452 29,630
Cost of revenue:
Cost of software 518 810 1,705 2,220
Cost of services 2,044 1,905 6,801 3,955
------- ------- -------- -------
Total cost of revenue 2,562 2,715 8,506 6,175
Gross margin 10,208 8,603 24,946 23,455
Operating expenses:
Sales and marketing 6,965 5,348 21,958 14,605
Research and development 2,181 2,030 7,641 6,415
General and administrative 1,954 1,097 5,708 3,322
Non-recurring and other charges - - 2,499 -
------- ------- -------- -------
Total operating expenses 11,100 8,475 37,806 24,342
------- ------- -------- -------
Income (loss) from operations (892) 128 (12,860) (887)
Other income, net 192 377 738 1,173
------- ------- -------- -------
Income (loss) before provision for income taxes
(700) 505 (12,122) 286
Provision for income taxes 41 57 114 113
------- ------- -------- -------
Net income (loss) $ (741) $ 448 $(12,236) $ 173
======= ======= ======== =======
Net income (loss) per common share - basic $ (.08) $.05 $(1.36) $.02
Net income (loss) per common share - diluted
$ (.08) $.05 $(1.36) $.02
Weighted average common shares outstanding - basic 9,046 8,763 9,016 8,538
Weighted average common shares outstanding - diluted 9,046 9,546 9,016 9,337
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
3
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SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(12,236) $ 173
Adjustments to reconcile net income (loss)to net cash used in
operating activities:
Depreciation and amortization 1,617 1,809
Loss on disposal of property and equipment - 7
Noncash compensation charges 123 25
Changes in operating assets and liabilities:
Accounts receivable (2,539) (3,631)
Other current assets (76) (962)
Other assets 504 -
Accounts payable (1,068) 60
Accrued expenses, royalties, compensation and benefits 1,921 344
Deferred revenue 2,555 339
-------- -------
Net cash used in operating activities (9,199) (1,836)
-------- -------
Cash flows from investing activities:
Additions to property and equipment (3,694) (1,759)
Additions to other assets - (589)
Maturity of short-term investments 22,835 16,200
Purchases of short-term investments (21,191) (1,815)
-------- -------
Net cash provided by (used in) investing activities ( 2,050) 12,037
-------- -------
Cash flows from financing activities:
Proceeds from exercise of stock options and stock purchase plan 931 2,810
Proceeds from common stock issuance - 995
Return of capital to shareholders - (8)
Proceeds from notes payable issuance - 295
Payments of notes payable (334) -
-------- -------
Net cash provided by financing activities 597 4,092
-------- -------
Effect of exchange rate changes on cash and cash equivalents (18) -
-------- -------
Net increase (decrease) in cash and cash equivalents (10,670) 14,293
-------- -------
Cash and cash equivalents, beginning of period 16,096 23,393
-------- -------
Cash and cash equivalents, end of period $ 5,426 $37,686
======== =======
</TABLE>
The accompany notes are an integral part
of the consolidated financial statements
4
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SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The financial statements included herein have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. The Company believes that the disclosures are adequate to make the
information presented not misleading. However, it is suggested that these
financial statements be read in conjunction with the Company's audited financial
statements for the year ended December 31, 1998, included in its 1998 Annual
Report on Form 10-K.
This financial information reflects, in the opinion of management, all
adjustments of a normal recurring nature necessary to present fairly the results
for the interim periods. Results of interim periods may not be indicative of
results for the full year.
In December 1998, the Company acquired Eventus Software, Inc. and Black and
White Software, Inc. Both acquisitions were accounted for using the pooling-of-
interest method and, accordingly, the historical consolidated financial
statements of the Company prior to the acquisitions presented herein have been
restated to include their financial position, results of operations and cash
flows.
2. NET INCOME (LOSS) PER COMMON SHARE
Options and warrants to purchase approximately 2,810,000 shares of common
stock outstanding were excluded from the calculation of diluted earnings per
share for the three and nine months ended September 30, 1999, because their
inclusion would be anti-dilutive. Options to purchase 82,000 and 227,000 shares
of common stock outstanding as of September 30, 1998 were excluded from the
calculation of diluted net income per share because the exercise price of those
options exceeded the average market price of common stock during the three and
nine months ended September 30, 1998, respectively.
5
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The following table reconciles the numerator and denominator of the basic
and diluted per share computations shown on the consolidated statement of
operations (in thousands, except per share data):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------- -------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic EPS
Numerator:
Net income (loss) $ (741) $ 448 $(12,236) $ 173
Denominator
Weighted common shares outstanding 9,046 8,763 9,016 8,538
Basic EPS $(0.08) $ 0.05 $ (1.36) $ 0.02
Diluted EPS
Numerator:
Net income (loss) $ (741) $ 448 $(12,236) $ 173
Denominator:
Weighted common shares outstanding 9,046 8,763 9,016 8,538
Weighted common stock equivalents - 783 - 799
------ ------ -------- ------
9,046 9,546 9,016 9,337
Diluted EPS $(0.08) $ 0.05 $ (1.36) $ 0.02
</TABLE>
3. NON-RECURRING AND OTHER CHARGES
During the second quarter of 1999, the Company restructured its product
development operations and delayed the introduction of the Eventus product,
SilkControl. These activities were aimed at reducing the Company's costs
associated with the development of that product and enhancing the Company's
sales force ability to focus on other products. The restructuring resulted in
the consolidation of four development labs into three and included the
termination of 15 employees associated with the development of the Eventus
product. Additionally during the second quarter of 1999, the Company shifted
its sales strategy away from creating and managing a large network of resellers
towards building deeper relationships with a few large system integrators. This
revised strategy resulted in the termination of seven of the Company's employees
who focused sales efforts on these channel resellers. The reduced headcount
associated with the shift in sales strategy has resulted in reduced operating
costs during the third quarter of 1999 as compared to the second quarter of
1999. The Company also terminated the employment of two senior vice presidents
during the second quarter of 1999, each of whom has subsequently been replaced.
Associated with all the events noted above, the Company recorded during the
second quarter of 1999 non-recurring and other charges of approximately $1.5
million, which related exclusively to severance and other employee-related
costs, including a noncash compensation charge of approximately $118,000. As of
September 30, 1999, the Company had made payments of approximately $990,000
6
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related to these costs, and the related restructuring accrual balance was
approximately $400,000.
During the first quarter of 1999, the Company executed a restructuring plan
to consolidate its marketing, product development and administrative operations
in order to achieve cost efficiencies through the elimination of redundant
functions. The Company realigned its marketing and product development
operations to redirect focus on its strongest product lines and better integrate
the efforts of certain product development teams. As a result, the Company
recognized a non-recurring charge of approximately $1.0 million during the first
quarter of 1999. The restructuring charge included approximately $830,000 for
severance and other employee-related costs for the termination of 10 employees
and approximately $190,000 for facility-related costs, including the accrual of
estimated lease obligations associated with the closure of excess office
facilities. As of September 30, 1999, the Company had made payments of
approximately $560,000 related to these costs, and the related restructuring
accrual balance was approximately $460,000.
4. COMMITMENTS AND CONTINGENCIES
The Company has committed to spend approximately $2.2 million in 1999 for a
management information system, which is currently being implemented. The $2.2
million commitment includes a $400,000 increase in the previously reported
commitment is due to additional requests and requirements from the Company
during the third quarter of 1999 which added consulting and other implementation
charges for custom programs, additional special reports, added software and
revised accounting and financial reports. This total committed amount consists
of approximately $800,000 for hardware, software and related maintenance and
approximately $1.4 million for consulting and implementation services. As of
September 30, 1999, the Company had paid approximately $1.7 million for this
project and currently expects to make additional cash payments of $0.5 million
in the aggregate during the fourth quarter of 1999 and the first quarter of
2000.
On April 27, 1999, a putative class action complaint was filed in the
United States District Court for the District of Massachusetts against the
Company, its Chief Executive Officer and a former Chief Financial Officer of the
Company, captioned Nathan Rice v. Segue Software, Inc., et al., Civil No 99-CV-
----------- ---------------------------
10891RGS. The class action complaint alleged that the defendants violated the
federal securities laws by making material misrepresentations and omissions in
certain public disclosures during the period beginning on October 13, 1998
through April 9, 1999, inclusive. The public disclosures relate to, among other
things, the Company's past and future financial performance and results. On May
3, 1999, another similar putative class action complaint was filed against the
Company, its Chief Executive Officer and a former Chief Financial Officer of the
Company in the United States District Court for the District of Massachusetts,
captioned Anthony Moumouris v. Segue Software, Inc., et al., Civil No. 99-CV-
----------------- ---------------------------
10933RGS. These cases were consolidated under the caption In Re Segue Software,
--------------------
Inc. Securities Litigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a
- --------------------------
consolidated amended complaint on September 27, 1999 alleging a putative class
period of July 14, 1998 through April 7, 1999, inclusive. The Company intends to
defend the claims vigorously. On November 8, 1999 each of the defendants filed a
motion to dismiss the amended
7
<PAGE>
complaint for failure to state a cause of action. The defendants expect that the
plaintiffs will file an opposition to the motions on or by December 8, 1999. It
is not possible to predict when the court will rule on the motions or whether
they will be granted in whole or in part. The Company believes the defense of
the claims could involve significant litigation-related expenses. The outcome of
these matters is uncertain and, as a result, at this time, the Company is not
able to quantify any related financial exposure. In the event that any of the
claims set forth in the class action complaints are determined or settled in a
manner adverse to the Company, such determination or settlements could adversely
affect the Company's financial position or results of operations in the period
in which the litigation is resolved. No costs have been accrued for this
Various other claims, charges and litigation have been asserted or commenced
against the Company arising from or related to contractual or employee
relations. Management does not believe these claims will have a material adverse
effect on the financial position or results of operations of the Company.
5. PROVISION FOR INCOME TAXES
The Company recorded a provision for foreign and state income taxes of
$41,000 and $114,000 for the three and nine months ended September 30, 1999,
respectively, and $57,000 and $113,000 for the three and nine months ended
September 30, 1998, respectively. There was no tax benefit recorded for losses
generated in the U.S. in any period due to the uncertainty of realizing such
benefits.
6. COMPREHENSIVE INCOME (LOSS)
Total comprehensive loss for the three and nine months ended September 30,
1999 was $775,000 and $12,271,000, respectively, and total comprehensive income
for the three and nine months ended September 30, 1998 was $410,000 and
$132,000, respectively. Total comprehensive income (loss) consists of net
income (loss) and the net changes in foreign currency translation adjustment.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly results of
operations expressed as a percentage of total revenue for the periods indicated:
<TABLE>
<CAPTION>
Percentage of Revenue for Percentage of Revenue for
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Software 66.1% 58.8% 62.3% 66.1%
Services 33.9 41.2 37.7 33.9
----- ----- ------ -----
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of software 4.1 7.2 5.1 7.5
Cost of services 16.0 16.8 20.3 13.3
----- ----- ------ -----
Total cost of revenue 20.1 24.0 25.4 20.8
Gross margin 79.9 76.0 74.6 79.2
Operating expenses:
Sales and marketing 54.5 47.3 65.6 49.3
Research and development 17.1 17.9 22.8 21.7
General and administrative 15.3 9.7 17.1 11.2
Non-recurring and other charges - - 7.5 -
----- ----- ------ -----
Total operating expenses 86.9 74.9 113.0 82.2
----- ----- ------ -----
Income (loss) from operations (7.0) 1.1 (38.4) (3.0)
Other income, net 1.5 3.4 2.2 4.0
----- ----- ------ -----
Income (loss) before provision for
income taxes (5.5) 4.5 (36.2) 1.0
Provision for income taxes 0.3 0.5 0.4 0.4
----- ----- ------ -----
Net income (loss) (5.8)% 4.0% (36.6)% 0.6%
===== ===== ====== =====
</TABLE>
REVENUE
Revenue from Software. Software revenue increased 27% to $8.4 million
during the third quarter of 1999 from $6.7 million in the third quarter of 1998.
For the nine months ended September 30, 1999, software revenue increased 6% to
$20.9 million from $19.6 million for the nine months ended September 30, 1998.
The increase during the third quarter of 1999 is attributable primarily to
increased sales force productivity, resulting in increased unit shipments and
greater market penetration into the "e-business" marketplace. International
revenue accounted for 11% and 12% of total software revenue
9
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for the three and nine months ended September 30, 1999, respectively, and 11%
and 13% of total software revenue for the three and nine months ended
September 30, 1998, respectively.
Revenue from Services. Service revenue decreased 7% to $4.3 million during
the third quarter of 1999 from $4.7 million in the third quarter of 1998. For
the nine months ended September 30, 1999, service revenue increased 26% to $12.6
million as compared to $10.0 million for the nine months ended September 30,
1998. Training and consulting revenue decreased 25% during the third quarter of
1999 as compared to the third quarter of 1998. The decrease in training and
consulting revenue during the third quarter of 1999 is primarily due to the
completion of year 2000 related consulting projects as compared to the same
period of 1998. For the nine months ended September 30, 1999, training and
consulting revenue increased 25% as compared to the nine months ended September
30, 1998. This increase is primarily due to the fact that more year 2000 related
projects were completed by the Company during the first nine months of 1999 as
compared to the same period of 1998. For the three and nine months ended
September 30, 1999 as compared to the three and nine months ended September 30,
1998, recognized maintenance revenue increased 16% and 26%, respectively. The
increase in recognized maintenance revenue was driven largely by incremental
additional software licenses sold over the past 12 months.
COST OF REVENUE
Cost of Software. Cost of software decreased 36% to $518,000 during the
third quarter of 1999 from $810,000 in the third quarter of 1998. For the nine
months ended September 30, 1999, cost of software decreased 23% to $1.7 million
as compared to $2.2 million for the nine months ended September 30, 1998. As a
percentage of software revenue, costs of software in the current quarter
decreased to 6% from 12% in the corresponding prior-year period and, for the
nine months ended September 30, 1999, decreased to 8% from 11% in the nine
months ended September 30, 1998. The decreases are mainly due to a reduction in
third party royalty expense.
Cost of Services. Cost of services increased 7% to $2.0 million during the
third quarter of 1999 from $1.9 million in the third quarter of 1998. For the
nine months ended September 30, 1999, cost of services increased 72% to $6.8
million from $4.0 million during the same period in 1998. As a percentage of
service revenue, costs in the third quarter of 1999 increased to 47% from 41% in
the corresponding prior year period. For the nine months ended September 30,
1999, costs of services as a percentage of service revenue increased to 54% from
39% during the corresponding period in 1998. The percentage increases are
largely due to the fact that the Company utilized more third party consultants
to assist in testing solution implementations for the third quarter of 1999 and
the nine months ended September 30, 1999, as compared to the utilization of
third party consultants for the third quarter of 1998 and nine months ended
September 30, 1998. The cost of third party consultants is generally higher
than the cost of internal resources. The increases are also due to start up
costs incurred in the first six months of 1999 associated with the staffing and
training for the Company's Northern Ireland technical support center, which
began operations in July 1999, as well as operating expenses of this support
center during the third quarter of 1999.
10
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OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses increased 30% to $7.0
million during the third quarter of 1999 from $5.3 million in the third quarter
of 1998. For the nine months ended September 30, 1999, sales and marketing
expenses increased 50% to $22.0 million as compared to $14.6 million for the
nine months ended September 30, 1998. The increases are primarily due to
increased headcount, higher commissions as a result of changes in compensation
plans and increased sales on which commissions are calculated and higher
facility costs. Additionally, in the 1999 periods the Company incurred higher
sales and marketing costs associated with marketing programs such as advertising
and trade shows.
Research and Development. Research and development expenses increased 7%
to $2.2 million during the third quarter of 1999 from $2.0 million in the third
quarter of 1998. For the nine months ended September 30, 1999, research and
development expenses increased 19% to $7.6 million as compared to $6.4 million
during the same period in 1998. The increases are due to increased facility
lease costs and higher compensation costs for both the Lexington and West Coast
development operations as well as increased headcount for the Company's Austria
research and development facility.
General and Administrative. General and administrative expenses increased
78% to $2.0 million during the third quarter of 1999 from $1.1 million in the
third quarter of 1998. For the nine months ended September 30, 1999, general
and administrative costs increased 72% to $5.7 million as compared to $3.3
million in the same period in the prior year. The increases are largely due to
increased headcount, increased facility costs and increased consulting, legal
and accounting expenses.
Non-Recurring and Other Charges. During the second quarter of 1999, the
Company restructured its product development operations and delayed the
introduction of the Eventus product, SilkControl. These activities were aimed at
reducing the Company's costs associated with the development of that product and
enhancing the Company's sales force ability to focus on other products. The
restructuring resulted in the consolidation of four development labs into three
and included the termination of 15 employees associated with the development of
the Eventus product. Additionally during the second quarter of 1999, the Company
shifted its sales strategy away from creating and managing a large network of
resellers towards building deeper relationships with a few large system
integrators. This revised strategy resulted in the termination of seven of the
Company's employees who focused sales efforts on these channel resellers. The
reduced headcount associated with the shift in sales strategy has resulted in
reduced operating costs during the third quarter of 1999 as compared to the
second quarter of 1999. The Company also terminated the employment of two senior
vice presidents during the second quarter of 1999, each of whom has subsequently
been replaced. Associated with all the events noted above, the Company recorded
during the second quarter of 1999 non-recurring and other charges of
approximately $1.5 million, which related exclusively to severance and other
employee-related costs, including a noncash compensation charge of approximately
$118,000. As of September 30, 1999, the Company had made payments of
approximately $990,000
11
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related to these costs, and the related restructuring accrual balance was
approximately $400,000.
During the first quarter of 1999, the Company executed a restructuring plan
to consolidate its marketing, product development and administrative operations
in order to achieve cost efficiencies through the elimination of redundant
functions. The Company realigned its marketing and product development
operations to redirect focus on its strongest product lines and better integrate
the efforts of certain product development teams. As a result, the Company
recognized a non-recurring charge of approximately $1.0 million during the first
quarter of 1999. The restructuring charge included approximately $830,000 for
severance and other employee-related costs for the termination of 10 employees
and approximately $190,000 for facility-related costs, including the accrual of
estimated lease obligations associated with the closure of excess office
facilities. As of September 30, 1999, the Company had made payments of
approximately $560,000 related to these costs, and the related restructuring
accrual balance was approximately $460,000.
OTHER INCOME, NET
Other income, net decreased 49% to $192,000 during the third quarter of
1999 from $377,000 in the third quarter of 1998. For the nine months ended
September 30, 1999, other income, net decreased 37% to $738,000 from $1.2
million during the first nine months of 1998. The decreases are largely due to
decreased interest income on lower balances of cash, cash equivalents and short-
term investments as a result of the utilization of cash to fund operations.
PROVISION FOR INCOME TAXES
The Company recorded a provision for foreign and state income taxes of
$41,000 and $114,000 for the three and nine months ended September 30, 1999,
respectively, and $57,000 and $113,000 for the three and nine months ended
September 30, 1998, respectively. There was no tax benefit recorded for losses
generated in the U. S. in any period due to the uncertainty of realizing such
benefits.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1999, the Company had cash, cash equivalents and short-
term investments totaling $21.1 million as compared to cash, cash equivalents
and short-term investments of $33.4 million as of December 31, 1998.
In the first nine months of 1999, the Company used $9.2 million for
operating activities, resulting from the net loss, increases in accounts
receivable and decreases in accounts payable, partially offset by increases in
accrued expenses and deferred revenue.
The Company used $2.1 million from investing activities in the first nine
months of 1999, mainly as a result of acquisitions of property and equipment,
partially offset by net maturities of short-term investments.
12
<PAGE>
The Company generated funds from financing activities of $597,000 in the
first nine months of 1999 related to the exercise of stock options and the
issuance of stock under the employee stock purchase plan, partially offset by
payments of notes payable.
The Company recognized non-recurring and other charges of approximately
$1.0 million during the first quarter of 1999 related to a restructuring plan.
The restructuring charge included approximately $830,000 for severance and other
employee-related costs of the terminated staff and approximately $190,000 for
facility-related costs. As of September 30, 1999, the Company has utilized
available cash, cash equivalents and investments to pay approximately $560,000
of these amounts and currently expects to make future cash payments of $210,000
in the remainder of 1999 and $250,000 in 2000. At the time of the restructuring
action, the Company expected to realize a reduction in recurring costs of
approximately $1.5 million annually as a result of the restructuring action.
However, there can be no assurance that these benefits will be realized.
The Company recognized non-recurring and other charges of approximately
$1.5 million during the second quarter of 1999 related to a restructuring plan
and the termination of two executive officers. This restructuring and other
charges includes approximately $0.2 million of noncash charges and $1.3 million
of cash payments for severance and other employee-related costs of terminated
staff. As of September 30, 1999, the Company has utilized available cash, cash
equivalents and investments to pay approximately $990,000 of this amount and
currently expects to make future cash payments of $210,000 in the remainder of
1999 and $190,000 in 2000. At the time of the restructuring action, the Company
expected to realize a reduction in recurring costs of approximately $2.0 million
annually as a result of this restructuring action. However, there can be no
assurance that these benefits will be realized.
The Company has committed to spend approximately $2.2 million in 1999 for a
management information system, which is currently being implemented. The $2.2
million commitment includes a $400,000 increase in the previously reported
commitment is due to additional requests and requirements from the Company which
added consulting and other implementation charges for custom programs,
additional special reports, added software and revised accounting and financial
reports. This total committed amount consists of approximately $800,000 for
hardware, software and related maintenance and approximately $1.4 million for
consulting and implementation services. As of September 30, 1999, the Company
had paid approximately $1.7 million for this project and currently expects to
make additional cash payments of $0.5 million in the aggregate over the fourth
quarter of 1999 and the first quarter of 2000.
The Company opened a technical support center in Northern Ireland during
July 1999, and expects to incur total infrastructure costs related to this
location of approximately $1.2 million. This expenditure will be partially
funded by a grant of approximately $175,000 awarded by the Northern Ireland
Industrial Development Board (IDB) of which $153,000 has been granted and paid
by IDB as of September 30, 1999. As of September 30, 1999, the Company had
completed and equipped one of the two floors of the rented facility and paid
approximately $0.7 million of these total costs and currently expects to make
additional cash payments of $0.1 million for this project during the fourth
quarter of
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1999 and early 2000. The remaining $0.4 million is reserved for future
expansion that is still under management's consideration.
In December 1999, approximately $2.6 million becomes due under the SQLBench
notes. These notes were issued in connection with the acquisition of SQLBench in
December 1997.
Additional long-term cash requirements, other than normal operating
expenses, are anticipated for the development of new software products and
enhancements of existing products, the potential opening of additional
international offices, and the possible acquisition of software products or
technologies complementary to the Company's business.
Assuming there is no significant change in the Company's business, the
Company believes that the existing cash, cash equivalents and short-term
investments as well as cash flows from operations will be sufficient to meet its
working capital requirements for at least the next twelve months.
YEAR 2000 COMPLIANCE
The year 2000 presents potential concerns for business and consumer
computing. The consequences of this issue may include systems failures and
business process interruption. It may also include additional business and
competitive differentiation. If the Company, its significant customers, or
suppliers fail to make necessary modifications and conversions on a timely
basis, the year 2000 issue could have a material adverse effect on the Company's
operations. There are two other related issues which could also lead to
incorrect calculations or failures: i) some systems' programming assigns special
meaning to certain dates, such as 9/9/99, and ii) the year 2000 is a leap year.
To address these year 2000 issues with its internal systems, including
information technology (IT) and non-IT systems, the Company initiated a program
designed to deal with the most critical systems, packaged software applications,
first. As of September 30, 1999, the Company had completed its year 2000
compliance testing for its internal software systems, including the new MIS
system. All of the Company's core business hardware and software systems have
been tested and are year 2000 compliant. The Company's internal desktop hardware
systems have been tested for year 2000 compliance and have been found to be
compliant. Additionally, the internal desktop software applications have been
tested and the Company has determined that these systems will need appropriate
"patches" applied as they are not currently year 2000 compliant. The Company
expects these upgrades to be completed during the fourth quarter of 1999. In
addition, the Company began work on various types of contingency planning to
address potential problem areas with internal systems, including a computer
disaster recovery module which will allow the Company to recover any of its
backups in the case of a disaster. Although the assessment is still underway,
management currently believes that all material systems will be compliant by the
year 2000 and that the cost to address the issues will not be more than $100,000
in total. However, this estimate does not include potential costs related to any
customer or other claims or the cost of internal software and hardware replaced
in the normal course of business. The total cost estimate is based on the
current assessment of the projects and
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is subject to change as the projects progress. The costs incurred to date
related to these programs are minimal.
The Company has also initiated formal communications with its significant
vendors, mainly of IT packaged applications, to determine the extent to which
the Company is vulnerable to those third parties' failure to remedy their own
year 2000 issues. The Company has received written assurances of year 2000
compliance from all significant vendors. Most of the vendors under existing
contracts with the Company are under no contractual obligation to provide such
information to the Company. The Company is taking steps with respect to new
vendor agreements to ensure that the vendors' products and internal systems are
year 2000 compliant. The Company does not believe it has any mission-critical
suppliers of products or services.
The Company also assesses the capability of its products to handle the year
2000. To assist customers in evaluating their year 2000 issues, the Company has
a description on its website which indicates the capability of Segue's products
to handle the year 2000. All Segue products are year 2000 compliant. However,
the assessment of whether a complete system will operate correctly depends on
the BIOS capability and software design and integration, and for many end-users
this will include BIOS and software provided by companies other than Segue.
The Company anticipates that substantial litigation may be brought against
vendors, including the Company, of all component products of systems that are
unable to properly manage data related to year 2000. The Company's agreements
with customers typically contain provisions designed to limit the Company's
liability for such claims. It is possible, however, that these measures will
not provide protection from liability claims, as a result of existing or future
federal, state or local laws or ordinances or unfavorable judicial decisions.
Any such claims, with or without merit, could result in a material adverse
effect on the Company's business, financial condition and results of operations,
including increased warranty costs, customer satisfaction issues and potential
lawsuits.
Based on currently available information, management does not believe that
the year 2000 matters discussed above related to internal systems or products
sold to customers will have a material adverse impact on the Company's financial
condition or overall trends in results of operations; however, it is uncertain
to what extent the Company may be affected by such matters. In addition, there
can be no assurance that the failure to ensure year 2000 capability by a
supplier or another third party would not have a material adverse effect on the
Company.
IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Statements made in this Quarterly Report on Form 10-Q include a number of
forward looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-
looking statements
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include, without limitation, statements containing the words "anticipates,"
"believes," "expects," "intends," "future" and words of similar import which
express management's belief, expectations or intentions regarding the future
performance of Segue. Segue's actual results could differ materially from those
set forth in the forward-looking statements. Certain factors that might cause
such differences are discussed in this Quarterly Report on Form 10-Q including,
without limitation, those discussed below.
Segue's quarterly results may fluctuate. Segue's quarterly revenue and
operating results are difficult to predict and may fluctuate significantly from
quarter to quarter. If Segue's quarterly revenue or operating results fall
below the expectations of investors or public market analysts, the price of its
common stock could fall substantially. Segue's quarterly revenue may fluctuate
significantly for several reasons, including: the timing of introductions of new
products or product enhancements by Segue or its competitors; personnel changes;
the size and timing of individual orders; software bugs or other product quality
problems; competition and pricing; customer order deferrals in anticipation of
new products or product enhancements; demand for Segue's products is difficult
to predict for reasons discussed below; changes in operating expenses; product
mix; and general economic conditions. A substantial portion of Segue's
operating expenses are related to personnel, facilities and marketing programs.
The level of spending for such expenses cannot be adjusted quickly and is based,
in significant part, on Segue's expectations of future revenues. If actual
revenue levels are below management's expectations, results of operations are
likely to be adversely affected. In addition, Segue does not typically
experience order backlog. Furthermore, Segue has often recognized a substantial
portion of its revenues in the last month of a quarter, with these revenues
frequently concentrated in the last weeks or days of a quarter. As a result,
product revenues in any quarter are substantially dependent on orders booked and
shipped in the latter part of that quarter, and revenues for any future quarter
are not predictable with any significant degree of accuracy. For these reasons,
Segue believes that period-to-period comparisons of its results of operations
are not necessarily meaningful and should not be relied upon as indications of
future performance.
Segue 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 $30.3 million as of September 30, 1999. Segue had net
income of $144,000 in 1996; a net loss of $11.5 million in 1997, which includes
a charge $9.1 million for purchased research and development in process and
$718,000 for severance charges; a net loss of $2.9 million in 1998, which
includes a charge of $1.5 million related to Segue's acquisitions of Eventus
Software and Black & White Software, and a charge of $667,000 related to write-
offs of an NRE fee and guaranteed royalties; and a net loss of $12.2 million for
the nine months ended September 30, 1999, which includes non-recurring and other
charges of approximately $2.5 million related to employee severance costs.
While Segue has experienced revenue growth in recent periods, continued growth
at the same rate may not be sustainable and may not necessarily indicative of
future operating results. Failure to sustain or increase profitability may
adversely affect the market price of Segue's common stock.
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Segue has recently shifted its focus from general software testing to
e-business testing. In 1997, Segue began to develop and acquire technology to
provide automated software testing for Web-enabled software applications,
including its acquisition of SQLBench in December 1997. These developments
allowed Segue to extend its testing capabilities beyond distributed
client/server applications with GUI front ends. In the second quarter of 1998,
Segue introduced "LiveQuality," an e-business scenario testing product. In the
fourth quarter of 1998, Segue acquired Eventus Software and Black & White
Software to acquire certain other technologies which Segue believed would help
expand its then current line of e-business testing products. Segue's shift from
a general software testing company to an e-business testing company during the
past year has resulted in significant changes in Segue's (i) organizational
structure, (ii) management personnel, (iii) product mix, and (iv) sales
approach. In addition, because e-business scenario testing is more complicated
than general software testing, Segue may experience issues with its product
quality. If Segue fails to effectively manage these changes, or make other
changes which may be needed in connection with its shift to an e-business
testing company, Segue's business, operating results and financial condition may
be materially adversely affected.
The development of a market for Segue's products is uncertain. The market
for automated software testing products is relatively new and undeveloped.
Marketing and sales techniques in the automated software testing marketplace, as
well as the bases for competition, are not well established. There can be no
assurance as to the extent that a significant market for automated software
testing products will develop or the extent to which our products will be
accepted in that market. Although Segue believes that the current trend toward
increased use of automated software testing will continue, a majority of
software testing is still carried out manually, and there can be no assurance
that the automated software testing market will enjoy continued growth.
The commercial market for products and services designed for use on the
Internet, Intranet and Extranet has only recently begun to develop. The success
of Segue's products focused on e-commerce and Internet applications will depend
on the growth of the market and on Segue's ability to continue to enhance its
products to work with all of the prevalent technologies driving Internet
applications. There can be no assurance that Segue will be able to effectively
adapt its products to the prevalent technologies being used on e-commerce
applications or to successfully compete in the market for Internet-related
products and services. As is typical for new and rapidly evolving industries,
demand for recently introduced products is highly uncertain.
Segue may have difficulty managing its growth. Segue has been experiencing
a period of rapid growth, including increases in the number of orders, customers
and employees. Segue's rapid growth has placed, and may continue to place,
strains on its management, operations and systems. To manage future growth
effectively, Segue must expand, improve and effectively utilize its operational,
management, marketing, sales and financial systems as necessitated by changes in
Segue's business. Segue is currently implementing a new management information
system and anticipates that such system will be completed by December 1999.
There can be no assurance that this system will be successfully and timely
implemented. Segue also opened its global technical support
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center in Northern Ireland in July 1999 which supports its LiveQuality E-
Business Management Solutions software. There can be no assurance that the
Northern Ireland support center will be able to effectively support Segue's
software products or that Segue will not have to increase training or incur
other additional costs with respect to the Northern Ireland support center.
Furthermore, the management information system and the Northern Ireland support
center have required, and will continue to require, significant management
attention and/or financial resources of Segue that Segue might otherwise
allocate to other activities. There can be no assurance that Segue will be able
to effectively manage such changes.
Segue has also significantly changed the executive management team and the
sales management team as well as changed the structure of its internal
organization for its e-business testing products. Segue consolidated the
positions of Senior Vice President of Research and Development and Senior Vice
President and General Manager of the executive management team and in the
quarter ended June 30, 1999 filled the newly created position of Senior Vice
President and General Manager of Product Development. Also during the second
quarter of 1999, Segue appointed a new Chief Financial Officer. There can be no
assurance that Segue will be able to effectively manage such changes.
Segue may be subject to risks associated with its recent acquisitions and
future acquisitions. In the fourth quarter of 1998, Segue acquired Eventus
Software and Black & White Software in two separate transactions. Segue's
product range and customer base have increased in the recent past due in part to
these acquisitions. These acquisitions provided Segue with technologies, which
it believed, would help expand its then current line of e-business testing
products. There can be no assurance that the integration of any or all of the
acquired technologies will be successful or will not result in difficulties,
which may absorb significant management attention.
In the future, Segue may acquire additional businesses or product lines.
The recently completed acquisitions, or any future acquisition, may not produce
the revenue, earnings or business synergies that Segue anticipated, and an
acquired product, service or technology might not perform as it expected. Prior
to completing an acquisition, it is difficult to determine if such benefits can
actually be realized. There can be no assurance that the integration of an
acquired company will be successful. The process of integrating acquired
companies into Segue's business may also result in unforeseen difficulties.
Unforeseen operating difficulties may absorb significant management attention,
which Segue might otherwise devote to its existing business. Also, the process
may require significant financial resources that Segue might otherwise allocate
to other activities, including the ongoing development or expansion of its
existing operations.
If Segue pursues a future acquisition, its management could spend a
significant amount of time and effort in identifying and completing the
acquisition. To pay for a future acquisition, Segue might use capital stock or
cash. Alternatively, Segue might borrow money from a bank or other lender. If
Segue uses capital stock as it has with its recent acquisitions, its
stockholders would experience dilution of their ownership interests. If Segue
uses cash or debt financing, its financial liquidity will be reduced.
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Segue has recently changed its sales approach and restructured its sales
teams. As part of the shift in its business to e-business testing, Segue
focuses its marketing and sales efforts with a solution sales approach. Segue's
direct sales force focuses on large enterprise-wide and strategic sales in an
effort to provide as many solutions as a particular client needs. To facilitate
the solution sales approach, Segue restructured its direct sales force into
teams of one strategic sales representative and one technical support engineer.
There can be no assurance that this sales approach will result in greater
revenues. Because its sales force focuses on making larger sales, Segue's
sales cycle may increase. Larger purchases will take longer than smaller sales
because customers will generally take more time to decide on whether to make
larger purchases. A longer sales cycle reduces Segue's ability to forecast
revenue levels. Any delay or loss in sales of its products could have a
material adverse effect on Segue's business, operating results and financial
condition, and could cause its operating results to vary significantly from
quarter to quarter.
Segue's performance will depend in part on the growth and commercial
acceptance of the Internet. Segue's future success will depend substantially
upon the widespread adoption of the Internet as a primary medium for commerce
and business applications. If the Internet does not become a viable and
substantial commercial medium, Segue's business, operating results and financial
condition will be materially adversely affected. The Internet has experienced,
and is expected to continue to experience, significant user and traffic growth,
which has, at times, caused user frustration with slow access and download
times. The Internet infrastructure may not be able to support the demands
placed on it by continued growth. Moreover, critical issues concerning the
commercial use of the Internet, such as security, reliability, cost,
accessibility and quality of service, remain unresolved and may negatively
affect the growth of Internet use or the attractiveness of commerce and business
communication on the Internet. In addition, the Internet could lose its
viability due to delays in the development or adoption of new standards and
protocols to handle increased activity or due to increased government regulation
and taxation of Internet commerce.
Segue faces significant competition from other software companies. The
market for software quality management tools is new, intensely competitive and
subject to rapid technological change. Segue expects competition to intensify
in the future. Segue currently encounters competition from a number of public
and private companies including Mercury Interactive Corporation, Rational
Software Corporation, Compuware Corporation and RSW Software (a subsidiary of
Teradyne Inc.). Many of Segue's current and potential competitors have longer
operating histories, greater name recognition, larger installed customer bases,
and significantly greater financial, technical and marketing resources than it
does and therefore may be able to respond more quickly than Segue can to new or
changing opportunities, technologies, standards or customer requirements or to
devote greater resources to the promotion and sale of their products than Segue.
Segue may also face increased competition from the recent consolidation of
several companies in the automated software quality market. An increase in
competition could result in price reductions and loss of market share. Such
competition and any resulting reduction
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in profitability could have a material adverse effect on Segue's business,
operating results and financial condition.
Segue's business could be adversely affected if its products contain errors.
Software products as complex as Segue's products may contain undetected errors
or "bugs," which result in product failures. The occurrence of errors could
result in loss of or delay in revenue, loss of market share, failure to achieve
market acceptance, diversion of development resources, injury to Segue's
reputation, or damage to its efforts to build brand awareness, any of which
could have a material adverse effect on Segue's business, operating results and
financial condition.
Segue's future success will depend on its ability to enhance existing
products and develop new products. To be competitive, Segue must develop and
introduce product enhancements and new products which increase its customers'
ability to test their systems. If Segue fails to develop and introduce new
products and enhancements successfully and on a timely basis, it could have a
material adverse effect on its business, operating results and financial
condition. The emerging nature of the automated software testing and e-commerce
testing markets requires that Segue continually improves the performance,
features and reliability of its products, particularly in response to
competitive offerings and evolving customer needs. Segue must also introduce
enhancements to existing products as quickly as possible and prior to the
introduction of competing products. Segue has acquired, and may in the future
acquire, technologies to provide it with the tools to introduce new products or
enhance current products. The success of such acquisitions will depend in part
on Segue's ability to effectively integrate the technologies.
Segue must hire and retain skilled personnel in a tight labor market.
Qualified personnel are in great demand throughout the software industry.
Segue's success depends in large part upon its ability to attract, train,
motivate and retain highly skilled employees, particularly sales and marketing
personnel, software engineers and other senior personnel. There is intense
competition for sales personnel in our business, and there can be no assurance
that Segue will be successful in attracting, integrating, motivating and
retaining new sales personnel. The failure of Segue to attract and retain the
highly skilled personnel that are integral to its direct sales, product
development, service and support teams may limit the rate at which Segue can
generate sales and develop new products or product enhancements. This could
have a material adverse effect on Segue's business, operating results and
financial condition.
Class action lawsuits have been filed against Segue which, if determined or
settled in a manner adverse to Segue, could adversely affect Segue's financial
condition. On or about April 27, 1999, a putative class action complaint was
filed in the United States District Court for the District of Massachusetts
against Segue, its Chief Executive Officer and a former Chief Financial Officer
of Segue, captioned Nathan Rice v. Segue Software, Inc., et al. Civil No. 99-CV-
---------- ----------------------------
10891RGS. The class action complaint alleged that the defendants violated the
federal securities laws by making material misrepresentations and omissions in
certain public disclosures during the period beginning on October 13, 1998
through April 9, 1999, inclusive. The public disclosures relate to, among other
things,
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Segue's past and future financial performance and results. On or about May 3,
1999, another similar putative class action complaint was filed against Segue,
its Chief Executive Officer and a former Chief Financial Officer of Segue in the
United States District Court for the District of Massachusetts, captioned
Anthony Moumouris v. Segue Software, Inc., et al., Civil No. 99-CV-10933RGS.
- ----------------- ----------------------------
These cases were consolidated under the caption In Re Segue Software, Inc.
--------------------------
Securities Litigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a
- ---------------------
consolidated amended complaint on September 27, 1999 alleging a putative class
period of July 14, 1998 through April 9, 1999, inclusive. Segue intends to
defend the claims vigorously. On November 8, 1999 each of the defendants filed a
motion to dismiss the amended complaint for failure to state a cause of action.
The defendants expect that the plaintiffs will file an opposition to the motions
on or by December 8, 1999. It is not possible to predict when the court will
rule on the motions or whether they will be granted in whole or in part.Segue
believes the defense of the claims could involve significant litigation-related
expenses. The outcome of these matters is uncertain and, as a result, at this
time Segue is not able to quantify any related financial exposure. In the event
that any of the claims set forth in the class action complaints are determined
or settled in a manner adverse to Segue, then such determination or settlements
could adversely affect Segue's financial position or results of operations in
the period in which the litigation is resolved.
Segue faces many risks associated with international business activities.
Segue derived approximately 16% of its total product sales from international
customers in fiscal year 1998 and 12% for the first nine months of 1999. The
international market for software products is highly competitive and Segue
expects to face substantial competition in this market from established and
emerging companies. Segue faces many risks associated with international
business activities including currency fluctuations, imposition of government
controls, export license requirements, restrictions on the export of critical
technology, political and economic instability, tailoring of products to local
requirements, trade restrictions, changes in tariffs and taxes, difficulties in
staffing and managing international operations, longer accounts receivable
payment cycles and the burdens of complying with a wide variety of foreign laws
and regulations. To the extent that Segue is unable to expand international
sales in a timely and cost-effective manner, its business could be materially
adversely affected.
Segue may be affected by unexpected Year 2000 problems. Many existing
computer systems and software products do not properly recognize dates after
December 31, 1999. This "Year 2000" problem could result in miscalculations,
data corruption, system failures or disruptions of operations. Segue is subject
to potential Year 2000 problems affecting its products, its internal systems and
the systems of its vendors and distributors, any of which could have a material
adverse effect on Segue's business, operating results and financial condition.
In addition, there can be no assurance that Year 2000 errors or defects will
not be discovered in Segue's internal software systems and, if such errors or
defects are discovered, there can be no assurance that the costs of making such
systems Year 2000 compliant will not be material.
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Year 2000 errors or defects in the internal systems maintained by Segue's
vendors or distributors could require Segue to incur significant unanticipated
expenses to remedy any problems or replace affected vendors and could reduce its
revenue from its indirect distribution channel.
Segue's new strategy of selling its products through a few large system
integrators may result in fewer sales and may adversely affect Segue's results
of operations. During the second quarter of 1999, Segue shifted its sales
strategy away from creating and managing a large network of resellers and
towards building deeper relationships with a few large system integrators.
There can be no assurance that this sales strategy will result in greater
revenues. (In general, these system integrators are not subject to minimum
sales requirements and may discontinue marketing and selling Segue's products
with little or no notice.) In addition, because Segue will be dependent on a
smaller number of integrators, the affect that any single integrator may have on
Segue will be greater than any single reseller under Segue's former strategy.
Accordingly, Segue is highly dependent on the services of the system integrators
and the loss of, or a significant reduction in sales volume through, any single
system integrator could have a material adverse effect on Segue.
Segue could be subject to product liability claims. In selling its
products, Segue relies primarily on "shrink wrap" licenses that contain, among
other things, provisions protecting against the unauthorized use, copying and
transfer of the licensed program and limiting its exposure to potential product
liability claims. However, these licenses are not signed by the licensees and
the provisions of these licenses, including the provisions limiting Segue's
exposure to product liability claims, may therefore be unenforceable under the
laws of certain jurisdictions. Segue's products may be used on applications
which are critical to the operations of its customers' businesses. Any failure
in a customer's applications could result in a claim for substantial damages
against Segue, regardless of its responsibility for such failure. Although
Segue maintains general liability insurance, including coverage for errors and
omissions, there can be no assurance that such coverage will continue to be
available on reasonable terms or will be available in amounts sufficient to
cover one or more large claims, or that the insurer will not disclaim coverage
as to any future claim.
Segue's success depends on its ability to protect its proprietary
technology. Segue's success depends to a significant degree upon the protection
of its software and other proprietary technology. The unauthorized reproduction
or other misappropriation of its proprietary technology could enable third
parties to benefit from its technology without paying Segue for it. This could
have a material adverse effect on Segue's business, operating results and
financial condition. Although Segue has taken steps to protect its proprietary
technology, they may be inadequate. Segue currently relies on a combination of
trademark, copyright and trade secret laws and contractual provisions to protect
its proprietary rights in its products. Segue presently has no registered
copyrights. Segue has a patent but there can be no assurance that the patent
would be upheld if challenged. Moreover, the laws of other countries in which
Segue markets its products may afford little or no effective protection of its
intellectual property. There can be no assurance that Segue's competitors will
not independently develop technologies that are
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substantially equivalent or superior to its technology. If Segue resorts to
legal proceedings to enforce its intellectual property rights, the proceedings
could be burdensome and expensive and could involve a high degree of risk. There
can be no assurance that third parties will not assert intellectual property
infringement claims against Segue. If Segue were to discover that any of its
products violated third party proprietary rights, there can be no assurance that
it would be able to obtain licenses on commercially reasonable terms to continue
offering the product without substantial reengineering or that any effort to
undertake such reengineering would be successful.
Any claim of infringement could cause Segue to incur substantial costs
defending against the claim, even if the claim is invalid, and could distract
its management from its business. Furthermore, a party making such a claim
could secure a judgment that requires Segue to pay substantial damages. A
judgment could also include an injunction or other court order that could
prevent Segue from selling its products. Any of these events could have a
material adverse effect on Segue's business, operating results and financial
condition.
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ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially from
those discussed in the forward-looking statements. The company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
Interest Rate Risk. The Company is exposed to market risk from changes in
interest rates primarily through its investing and borrowing activities. In
addition, the Company's ability to finance future acquisition transactions may
be impacted if the company is unable to obtain appropriate financing at
acceptable rates. The Company's investing strategy to manage interest rate
exposure is to invest in short-term, highly liquid investments. The Company
maintains a portfolio of highly liquid cash equivalents and short-term
investments (primarily in high-grade corporate commercial paper). At September
30, 1999, the fair value of the Company's short-term investments approximated
market value.
Foreign Currency Risk. The Company faces exposure to movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company does not
use derivative financial instruments or other financial instruments to hedge
foreign currency exposures or for trading. Historically, the Company's primary
exposures have been related to the operations of its foreign subsidiaries. In
1998, the net impact of foreign currency changes was not material. The
introduction of the Euro as a common currency for most members of the European
Monetary Union has taken place in the Company's fiscal year 1999. The Company
has not determined the impact, if any, that the Euro will have on foreign
currency and business exposure.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On or about April 27, 1999, a putative class action complaint was filed
in the United States District Court for the District of Massachusetts against
Segue, its Chief Executive Officer and a Former Chief Financial Officer of
Segue, captioned Nathan Rice v. Segue Software, Inc., et al. Civil No. 99-CV-
----------- ---------------------------
10891RGS. The class action complaint alleged the defendants violated the federal
securities laws by making material misrepresentations and omissions in certain
public disclosures during the period beginning on October 13, 1998 through
April 9, 1999, inclusive. The public disclosures relate to, among other things,
Segue's past and future financial performance and results. On or about May 3,
1999, another similar putative class action complaint was filed against Segue,
its Chief Executive Officer and a former Chief Financial Officer of Segue in the
United States District Court for the District of Massachusetts, captioned
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Anthony Moumouris v. Segue Software, Inc., et al., Civil No. 99-CV-10933RGS.
- ----------------- ----------------------------
These cases were consolidated under the caption In Re Segue Software, Inc.
--------------------------
Securities Litigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a
- ---------------------
consolidated amended complaint on September 27, 1999 alleging a putative class
period of July 14, 1998 through April 9, 1999, inclusive. Segue intends to
defend the claims vigorously. On November 8, 1999 each of the defendants filed a
motion to dismiss the amended complaint for failure to state a cause of action.
The defendants expect that the plaintiffs will file an opposition to the motions
on or by December 8, 1999. It is not possible to predict when the court will
rule on the motions or whether they will be granted in whole or in part. Segue
believes the defense of the claims could involve significant litigation-related
expenses. The outcome of these matters is uncertain and, as a result, at this
time Segue is not able to quantify any related financial exposure. In the event
that any of the claims set forth in the class action complaints are determined
or settled in a manner adverse to Segue, then such determination or settlements
could adversely affect Segue's financial position or results of operations in
the period in which the litigation is resolved.
Various other claims, charges and litigation have been asserted or
commenced against the Company arising from or related to contractual or employee
relations. Management does not believe these claims will have a material adverse
effect on the financial position or results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company completed the initial public offering (IPO) of its Common Stock
in April 1996. The IPO was made pursuant to a Registration Statement on
Form S-1, filed with the Securities and Exchange Commission pursuant to Rule
462(b) under the Securities Act of 1933 (Commission File No. 333-1488), which
was declared effective as of March 28, 1996. The IPO commenced on April 2, 1996
and terminated shortly thereafter after the sale into the public market of all
of the registered shares of Common Stock.
The 3,162,500 shares of Common Stock sold by the Company and selling
security holders in the IPO were offered for sale in the United States by a
syndicate of underwriters represented by Alex. Brown & Sons Incorporated, Adams,
Harkness & Hill, Inc., and Soundview Financial Group, Inc.
The Company registered an aggregate of 2,412,500 shares of Common Stock
(including 412,500 shares issued upon the exercise of the underwriters'
overallotment options) for sale in the IPO at a per share price of $18.00 for an
aggregate offering price of approximately $43.4 million. All of such shares
were registered for the Company's account. Selling security holders registered
an aggregate of 750,000 shares of Common Stock for sale in the IPO at a per
share price of $18.00 for an aggregate offering price of $13.5 million. All of
such shares were registered for the selling security holders' accounts. As
stated above, all of such shares were sold shortly after the commencement of the
offering.
25
<PAGE>
In connection with the IPO, the Company incurred the following expenses:
<TABLE>
<S> <C>
Underwriting discounts and commissions $3,039,750
Expenses paid to underwriters 10,999
Other direct expenses 847,281
----------
Total expenses $3,898,030
</TABLE>
After deducting the expenses set forth above, the Company received
approximately $39.5 million in net proceeds of the IPO. As of September 30,
1999, the Company had used $6.6 million for the purchase of property and
equipment, approximately $2.0 million for the repayment of indebtedness
including interest ($883,000 and $522,000 for principal and interest,
respectively, on the SQL Bench notes and approximately $395,000 and $303,000 on
Eventus and Black & White debts, respectively), $950,000 for guaranteed
royalties, $480,000 for a non-recurring engineering and initial license fee,
approximately $965,000 for employee severance payments, and approximately
$14.2 million for working capital. The remaining $14.2 million was invested in
temporary investments, mainly consisting of government agency paper and
commercial paper.
The expenses of the IPO do not include any payments made to directors,
officers, or persons owning 10 percent or more of the Common Stock of the
Company.
26
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended
September 30, 1999.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 12, 1999
SEGUE SOFTWARE, INC.
/s/ STEPHEN B. BUTLER
---------------------
Stephen B. Butler
Chief Executive Officer
/s/ DENNIS V. FAVERO
--------------------
Dennis V. Favero
Senior Vice President and Chief Financial Officer
28
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JUL-01-1999 JAN-01-1999
<PERIOD-END> SEP-30-1999 SEP-30-1999
<CASH> 5,426 0
<SECURITIES> 15,691 0
<RECEIVABLES> 12,053 0
<ALLOWANCES> 735 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 34,023 0
<PP&E> 10,765 0
<DEPRECIATION> 4,813 0
<TOTAL-ASSETS> 40,793 0
<CURRENT-LIABILITIES> 15,914 0
<BONDS> 0 0
0 0
0 0
<COMMON> 91 0
<OTHER-SE> 23,905 0
<TOTAL-LIABILITY-AND-EQUITY> 40,793 0
<SALES> 8,438 20,851
<TOTAL-REVENUES> 12,770 33,452
<CGS> 518 1,705
<TOTAL-COSTS> 2,562 8,506
<OTHER-EXPENSES> 11,100 37,806
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 72 212
<INCOME-PRETAX> (700) (12,122)
<INCOME-TAX> 41 114
<INCOME-CONTINUING> (741) (12,236)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (741) (12,236)
<EPS-BASIC> (0.08) (1.36)
<EPS-DILUTED> (0.08) (1.36)
</TABLE>
