<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[_] 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.)
1320 Centre Street, Newton Centre, Massachusetts 02159
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 796-1000
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
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 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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. [x]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant was approximately $87,948,602 as of March 10, 1998, based upon
the closing sale price of Common Stock reported for that date on the NASDAQ
National Market. Shares of Common Stock held by each officer and director and
by each person who owns 5% or more of the outstanding Common Stock have been
excluded because such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares of Registrant's Common Stock outstanding as of March
10, 1998 was 7,903,585.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A for Registrant's 1998 Annual Meeting of Stockholders to be held
on June 5, 1998, are incorporated by reference into Part III of this Annual
Report on Form 10-K/A.
<PAGE>
SEGUE SOFTWARE, INC.
FORM 10-K/A
TABLE OF CONTENTS
Page
PART I
Item 1. Business 2
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 12
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 8. Financial Statements and Supplementary Data 27
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 27
PART III
Item 10. Directors and Executive Officers of the Registrant 27
Item 11. Executive Compensation 27
Item 12. Security Ownership of Management and Certain Beneficial Owners 27
Item 13. Certain Relationships and Related Transactions 27
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 28
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1997 Form 10-K/A
THIS ANNUAL REPORT ON FORM 10-K/A AMENDS AND SUPERSEDES, TO THE EXTENT SET
FORTH HEREIN, THE REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1997 PREVIOUSLY FILED ON MARCH 31, 1998. AS MORE PARTICULARLY SET
FORTH BELOW, THE FOLLOWING FINANCIAL AND RELATED INFORMATION HAS BEEN UPDATED IN
CONNECTION WITH THE FILING OF THE RESTATED FINANCIAL STATEMENTS INCLUDED HEREIN.
Statements made or incorporated in this Form 10-K/A 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 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
Segue Software, Inc.'s (hereafter "Segue" or the "Company") future performance.
The Company's actual results could differ materially from those set forth in the
forward-looking statements. Certain factors that might cause such a difference
are discussed in the section entitled "Certain Factors Affecting Future
Operating Results" on page 21 of this Form 10-K/A.
PART I
ITEM 1. BUSINESS
GENERAL
Segue Software, Inc. is a leader in automated testing for software
reliability. The Company's products are used by quality assurance professionals
and software developers to improve software quality, reduce development costs
and shorten the time required to develop and deploy software applications. The
Company's products integrate test planning, creation, execution, management and
analysis to provide automated functionality and load testing of software
applications. The Company's products are used to test software applications
across various components of distributed, multi-platform client/server systems
as well as applications deployed on the World Wide Web.
During 1997, Segue introduced new technology to provide automated software
testing for Web-enabled software applications extending the Company's
distributed testing capabilities beyond distributed client/server applications
with GUI front ends. Segue also began to focus on load testing in 1997, through
an OEM/reseller arrangement with a third party software vendor. On December 30,
1997, the Company acquired both the third party software vendor and the
developer of the product, SQLBench International, Inc. and ARC - Dr. Ambichl &
Dr. Reindl Communication GmbH (formerly named ARC Dr. Ambichl & Dr. Reindl OEG),
hereafter referred to as "SQLBench". See Note B to the Consolidated Financial
Statements. These new product offerings formed the basis for a significant
refocus of the Company's marketing and sales initiatives beginning in the fourth
quarter of 1997.
In the fourth quarter of 1997, the Company began focusing its marketing and
sales efforts on the electronic commerce ("e-commerce") and Internet
applications market with a solution sales approach for its customers. The
Company believes that it can provide its customers with an automated testing
solution which can be of strategic value. This decision to refocus the
Company's marketing and sales efforts was based on the belief that this is a
fast-growing segment of the automated software testing market. The Company
introduced its cross-browser regression testing tool, SilkTest, in May 1997 to
address this market. The Company also believes that its Web load testing
product, SilkPerformer, introduced in September 1997, is positioned to model or
simulate load on Web-based applications for this market.
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In order to offer this testing solution consisting of products and
consulting, the Company reorganized its sales force structure beginning in the
fourth quarter of 1997. The Company formed an enterprise sales group consisting
of teams of one strategic sales representative and one technical support
engineer. This group focuses on e-commerce solution sales. At the same time, the
Company reconfigured its telesales force into a product sales group focused on
selling regression and load testing products primarily to the distributed
client/server market. This reorganization was accomplished under the direction
of a new domestic sales management team put in place in the fourth quarter of
1997.
The new sales focus and structure was launched under the direction of a new
Chief Executive Officer who joined the Company in September 1997 and was fueled
in large part by the evolution of the Company's regression testing products
addressing Web-based applications. This new focus also emphasizes the Company's
load testing product line.
Since these changes were implemented in the fourth quarter of 1997, the
Company does not have significant data to determine whether these initiatives
will be well received by its customers or whether the e-commerce market will
grow significantly.
Segue was incorporated in California in 1988 and reincorporated in Delaware
in March 1996.
INDUSTRY BACKGROUND
As businesses expand the use of technology to manage information and
processes, and as software has become a more important component in the delivery
of their products and services, consistent and effective operation of software
applications has become more critical to their success. These applications are
increasingly deployed in both client/server configurations and on the World Wide
Web. According to Brendan Conway of the Gartner Group, "Software, which
connects people to process, has become the blood supply to today's living
enterprise. If it becomes infected, so does the business process of the
organization." As client/server software is increasingly utilized to support
mission-critical applications, effective software quality management and testing
is required to avoid defects. As Web-based applications are increasingly being
used to support commerce, the up-time reliability and accuracy of those commerce
applications are critical to the success of those companies.
Unlike mainframe environments, where applications, operating systems and
hardware were designed by a single vendor as an integrated solution,
client/server systems and Web-based systems consist of component layers of
applications, middleware, operating systems, databases, browsers, servers,
processors and network technology designed separately by multiple vendors. For
example, in a client/server configuration, a Microsoft Windows95 client might
send requests to a router installed on a Microsoft NT server that distributes
them to an Oracle database located on a Sun Solaris server. There is a higher
probability for application instability or failure when the component layers of
client/server applications and Web-based applications are developed separately
by multiple vendors and integrated to form a business system.
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The transition to client/server environments has occurred in two phases. In
the first phase, client/server application logic exists on either the client or
the server. Typically the business logic is supported by the client and only the
data resides on the database server. In the second phase, referred to as
distributed client/server, application logic and business data are distributed
among multiple client, middleware and server layers. Now Web-based, e-commerce
applications are being added to the client/server environments, adding another
layer of complexity to the environments.
Distributed client/server computing and Web applications present enormous
challenges to quality assurance professionals and software developers.
Moreover, advances in client/server software development tools have enabled
rapid development of client/server applications. The complexity of distributed
client/server environments, and rapid application development, greatly increase
the likelihood that a combination of events will cause an application or system
to fail or produce unintended results ("bugs"). At the same time, competitive
pressures force software developers to compress development schedules in order
to shorten time to deployment.
To date, quality assurance professionals and software developers have
primarily used manual testing techniques to test software application functions
and features. Manual testing is slow, tedious and difficult to replicate in a
systematic manner, and is often performed at the end of the development process
when bugs are difficult and costly to correct. As a result, quality assurance
professionals and software developers have begun to invest in automated software
testing tools.
Traditional automated testing tools, which are designed for a specific
component on a particular platform, do not adequately address the complexities
of distributed client/server computing. First, they are not designed to
validate distributed application logic and data. Second, tests created by these
tools become obsolete when a component is replaced or upgraded. Third,
traditional automated testing tools are unable to recover when a bug is
encountered in the component being tested, meaning that truly unattended testing
in a distributed environment is impossible with such tools. Finally, they do
not deliver the capability to design, create, manage and reuse tests across
multiple platforms and system configurations, resulting in additional costs and
time spent on the software development and quality assurance processes.
In addition to automated testing tools, defect tracking and load testing
are important components of the automated testing solution. With integrated
defect tracking, the quality assurance department and the software development
organization can work more closely in the process of finding, tracking and
fixing software errors. By building load testing into the application testing
process early in the development cycle, the performance of the application in a
"real world" environment can be tested as well.
PRODUCTS
The Company's product family of software testing and quality management
tools can be divided into those that provide an automated testing solution for
Web-based applications (Silk) and those that provide an automated testing
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solution for distributed client/server applications (QualityWorks).
The Silk Product Family
The Silk product family includes SilkTest for end-to-end functional and
regression testing; SilkPerformer for robust load testing; QA Organizer for Web
site test planning and management; and Surf! for automatic link and Web-page
load testing. Available in a variety of Silk Editions, these tools test the
reliability of complex, cross-enterprise Web applications.
SilkTest
SilkTest is an automated functional and regression testing tool for end-to-
end testing of enterprise Web applications. SilkTest includes a recovery system
that supports unattended testing 7 days a week, 24 hours a day. SilkTest can run
across multiple platforms, technologies, browsers and environments.
SilkPerformer
SilkPerformer uses load testing technology to simulate real-world
conditions to help users predict capacity, scalability and performance problems
during their development process. SilkPerformer captures and simulates all
Internet protocols including HTTP, HTTPS, FTP, POP3 and SMTP, and playback at
varying connection speeds, from modem to T1.
Surf!
Surf! is an easy-to-use automatic Web site tester. Using pre-packaged
scripts and tests that Surf! provides, users can test the links in their Web
application, check the load time of each Web page, and drill down and report
back results.
The QualityWorks Product Family
QualityWorks combines testing tools to deliver an end-to-end testing
solution. QualityWorks includes QA Partner for end-to-end functional and
regression testing; QA Performer, for load testing; QA Organizer for test
planning and management; QA Radar for automated defect tracking; QA DBTester for
direct database access and verification; and GO! for automatic test generation.
Available in a variety of QualityWorks Editions, these tools together test the
reliability of complex, cross-enterprise applications.
QA Partner
QA Partner is an automated functional and regression testing tool for end-
to-end testing of cross-enterprise client/server applications. QA Partner
includes a recovery system that supports unattended testing 7 days a week, 24
hours a day. QA Partner runs across multiple platforms, technologies, and
environments.
QA Performer
QA Performer uses load testing technology to simulate real-world conditions
to help users predict capacity, scalability and performance problems during
their development process. QA Performer assists the user in modeling performance
improvements before incurring the cost of application rework. From database
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design through to deployment, QA Performer tests mission-critical client/server
applications under challenging conditions.
QA Organizer
QA Organizer is a fully-automated test planning and management tool. QA
Organizer automatically creates customized test plans for a particular
application and manages the testing process from a central point of control.
QA Radar
QA Radar automates the time-consuming process of tracking defects. Once
the bugs in an application are found, QA Radar automatically captures the bug
and recommends an action to correct the bug.
QA DBTester
QA DBTester directly accesses a database, using SQL calls, to verify
accurate database content. By providing test scripts with direct ODBC standard
access to over 35 databases, QA DBTester helps ensure that client/server
applications function with the associated database reliably before it deploys.
GO!
GO! is an easy-to-use automatic test generator. Using pre-packaged scripts
and tests that GO! provides, users can perform application operability testing,
including tests for tab orders, window detail, mnemonics, and property sets
without scripting.
SERVICES
The Company supplements all of its product offerings with training,
consulting and technical support services. The Company's services are designed
to promote a clear and consistent approach to automated testing and to
facilitate the penetration of the Company's products into a broader market. As
of February 28, 1998, these services were provided by 23 employees.
Training and Consulting. The Company offers training courses and consulting
services in support of its product families. The training courses are held
regionally in selected U.S. cities or at the customer site. The Company has two
principal objectives for its fee-based training courses and consulting services:
to produce the agreed-upon deliverables for the projects and to enhance the
customers' understanding of the Company's methodologies and techniques. The
Company has recently begun to offer e-commerce testing consulting services in
order to assist companies in a more rapid and successful adoption of regression
and load testing for Web-based applications.
Support Services. The Company offers annual maintenance contracts for an
annual fee to customers who have entered into license agreements for the use of
the Company's software products. The Company provides customer service and
support through its internal technical support organization. Support services
include the maintenance of the Company's software products in accordance with
specifications contained in the user's guide for such products and access to
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technical support personnel. This support includes technical support through the
Company's internal customer support group via phone, fax and e-mail
communications. Customers who are under an active software maintenance contract
are entitled to product upgrades and enhancements, when and if released. The
Company's distributors and some of its channel partners provide initial
telephone support to end-users.
SALES AND MARKETING
The Company sells its products through four channels: a direct sales force;
telesales representatives; a channel partner program; and international
distributors and resellers. The Company has made a significant investment in
sales and marketing in each of the last two years. As of February 28, 1998, the
Company's sales and marketing force consisted of 69 employees.
Direct Sales. The Company has historically relied principally on direct
sales of its products. The Company has recently structured its domestic direct
sales force into an enterprise sales group consisting of teams of one strategic
sales representative and one technical support engineer. As of February 28,
1998, the Company's direct sales force consisted of 33 employees. The Company
has nine sales offices throughout the United States and Canada and one sales
office in the United Kingdom. The Company intends to hire additional sales and
support personnel to broaden its direct selling and distribution capabilities.
Telesales. The Company recently separated its telesales representatives
into a product sales group selling principally to the distributed client/server
market. As of February 28, 1998, the Company's telesales force totaled six
employees.
Channel Partner Programs. In 1995, the Company established its Channel
Partner Programs, which aim to generate revenues from alternate channels. These
programs consist of the following: Value Added Resellers (VARs), Business
Integration Partners and Technology Integration Providers. Current partners
include Andersen Consulting, Interim Technology and INTERSOLV.
International Sales. In international markets, the Company utilizes
distributors in ten countries, which are supported by six members of the
Company's international sales organization. The Company derived approximately
11%, 8% and 7% of its total product sales from international customers in 1997,
1996 and 1995, respectively.
In support of its sales efforts, the Company conducts sales training
courses, targeted marketing programs, including direct mail, public relations,
advertising, seminars, trade shows and telemarketing, and ongoing customer and
third party communications programs. The Company also seeks to stimulate
interest in computer and software quality management tools through a public
relations program, speaking engagements, white papers, technical notes and other
publications. The Company has established a home page on the Internet's World
Wide Web, where potential customers can access information about the Company and
its products.
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BACKLOG
The time between order and delivery of the Company's products is generally
quite short. The number of orders, as well as the size of individual orders, can
vary substantially from month to month. Because of the short period between
order receipt and shipment of products, the Company typically does not have a
backlog of unfilled orders.
RESEARCH AND DEVELOPMENT
The Company has made substantial investments in research and product
development. The Company's research and development is conducted by project
teams consisting of development and quality assurance engineers and technical
writers. The Company uses many of its own products and methodologies in its
development process. The Company organizes development and quality assurance
schedules to optimize usage of automated tests by starting script development
very early in the development life cycle. The Company's research and
development staff originates, produces and tests many of the Company's prototype
products. The research and development department consults with the Company's
sales and marketing staff and utilizes the feedback from customer support and
training to ensure the satisfaction of its current customers. The Company also
licenses technology from vendors to be embedded in its product for resale or to
be resold as products by the Company.
The Company's research and development organization for regression testing
products is located at the Company headquarters in Newton Centre, MA. The
Company also has nine developers in Austria who are focused on the development
of load testing products. These employees joined the Company as part of the
acquisition of SQLBench. See Note B to the Consolidated Financial Statements.
Research and development expenses were $4.9 million in 1997, $3.8 million
in 1996 and $2.3 million in 1995. The staff grew to 51 employees as of February
28, 1998 from 35 as of February 28, 1997. The Company intends to continue making
significant investments in research and development to develop new products,
expand the capabilities of its Web application testing products and to
internationalize all of the Company's products.
COMPETITION
The market for software quality management tools is new, intensely
competitive, rapidly evolving and subject to rapid technological change. The
Company's competitors offer a variety of products and services to address this
market. The Company currently encounters direct competition from a number of
public and private companies such as Mercury Interactive Corporation, Rational
Software Corporation and Compuware Corporation. In addition, the possible
entrance of new competitors may intensify competition in the software quality
management market. Many of the Company's current and possible future
competitors have significantly greater financial, technical, marketing and other
resources than the Company, and many have well established relationships
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with current and potential customers of the Company. It is also possible that
alliances among competitors may emerge and rapidly acquire significant market
share. The Company also expects that competition will increase as a result of
software industry consolidations. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any of which would
materially adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the Company will be able to
compete effectively against current and future competitors.
The Company believes that the principal competitive factors affecting its
market include product features and functionalities, such as flexibility,
scalability, ease-of-integration, ease-of-implementation, ease-of-use, quality,
performance, price and total cost of ownership; customer service and support;
company reputation and financial viability; and effectiveness of sales and
marketing efforts. Although the Company believes that it currently competes
effectively with respect to such factors, there can be no assurance that the
Company will be able to maintain its competitive position against current and
potential competitors.
PROPRIETARY TECHNOLOGY
The Company primarily relies upon a combination of trademark, copyright and
trade secret laws and employee and third-party non-disclosure agreements to
protect its proprietary rights in its products. The Company has one patent, but
there can be no assurance that this patent would be upheld if challenged. There
can be no assurance that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to the
Company's technology. There can also be no assurance that the measures taken by
the Company to protect its proprietary rights will be adequate to prevent
misappropriation of the technology or independent development by others of
similar technology. In addition, the laws of various countries in which the
Company's products may be sold may not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
intellectual property infringement claims against the Company or that any such
claims will not require the Company to enter into royalty arrangements or result
in costly litigation. The Company is not aware of any patent infringement
charge or any violation of other proprietary rights claimed by any third party
relating to the Company or the Company's products. However, the computer
software market is characterized by frequent and substantial intellectual
property litigation. Intellectual property litigation is complex and expensive,
and the outcome of such litigation is difficult to predict. The Company
believes that, due to the rapid pace of technological innovation for software
quality management products, the Company's ability to establish and maintain a
position of technology leadership in the industry is dependent more upon the
skills of its development personnel than upon the legal protections afforded its
existing technology.
EMPLOYEES
As of February 28, 1998, the Company had 167 full-time employees, all but
13 of whom were based in the United States. These employees include 51 in
Research and Development, 69 in Sales and Marketing, 28 in Customer Support,
Training and Distribution, and 19 in Finance and Administration. The Company's
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employees are not represented by any collective bargaining organizations and the
Company has never experienced any work stoppages. The Company considers its
relations with its employees to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, their ages and their positions with
the Company as of March 10, 1998 are as follows:
NAME AGE POSITION
Stephen B. Butler 40 President, Chief Executive Officer and
Director
J. Jeffrey Bingenheimer 54 Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary
Jeannine A. Bartlett 37 Senior Vice President of Research and
Development
Stewart A. Bush 41 Senior Vice President of North American Sales
Anthony G. Kolish 38 Senior Vice President of Services
Alexander M. Levi 40 Senior Vice President of International
Operations
Michael D. Maggio 36 Senior Vice President of Marketing
Betsy R. Rudnick 47 Senior Vice President of Human Resources and
Administration
Mr. Butler joined the Company in September 1997 as Chief Executive Officer
and Director. Mr. Butler was elected to the office of President in January 1998.
Mr. Butler served as President and Chief Executive Officer at TriQuest Design
Automation from October 1995 until July 1997. Prior to that, Mr. Butler held
senior management positions at Quickturn Design Systems where he served as
Senior Vice President of Sales, Marketing and Support from May 1993 until July
1995, and as Vice President of Sales from July 1991 until May 1993.
Mr. Bingenheimer has served as Vice President, Chief Financial Officer and
Assistant Secretary of the Company since September 1995 and as Treasurer since
February 1996. Prior to joining the Company, Mr. Bingenheimer served as Vice
President of Finance and Administration and Treasurer of CenterLine Software,
Inc., a software company, from April 1991 to September 1995.
Ms. Bartlett joined the Company in June 1997. Ms. Bartlett has served as
Senior Vice President of Research and Development since February 1998. Ms.
Bartlett served as Vice President of Product Management from November 1997 until
February 1998 and as Director of Product Management from June 1997 until October
1997. Prior to joining the Company, Ms. Bartlett served as Director of
Marketing, Director of Software Development and Senior Marketing Manager from
November 1994 until June 1997 at Praxis International, Inc. Prior to that, Ms.
Bartlett served as Director of Business Development from September 1993 until
October 1994 at Marketpulse, a division of CCA.
Mr. Bush joined the Company in October 1997 as Senior Vice President of
North American Sales. Prior to that, Mr. Bush served in several roles at
Talarian Corporation from 1991 until he joined the Company; these roles included
Director of North American Sales, National Sales Manager of Messaging and
Director of Eastern Region Sales.
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Mr. Kolish joined the Company in September 1995 and has served in several
positions. Mr. Kolish has served as Senior Vice President of Services since
February 1998. Prior to that, Mr. Kolish served as Vice President of Services,
Director of Marketing Strategy and Director of Product Management. Prior to
joining the Company, Mr. Kolish served as Senior Systems Manager at Fidelity
Investments from January 1994 until August 1995.
Mr. Levi joined the Company in December 1997 as Senior Vice President of
International Operations. Prior to that, Mr. Levi served in a variety of roles
at Quickturn Design Systems, Inc. from February 1991 until he joined the
Company. Mr. Levi's most recent role at Quickturn Design Systems was that of
Vice President of Asia Pacific Operations, which he held from October 1996 until
he joined Segue. Other roles included Director of Asia Sales and Senior Account
Manager, New England Area.
Mr. Maggio joined the Company in October 1991 and has held several senior
management positions. Mr. Maggio has served as Senior Vice President of
Marketing since February 1998. Mr. Maggio served as Vice President of Business
Development from January 1995 until February 1998, as Director, Eastern Region
in the Company's sales organization from June 1993 to December 1994 and as Vice
President of Development from 1991 until 1993.
Ms. Rudnick has served as Senior Vice President, Human Resources and
Administration since January 1995. From August 1987 to January 1995, Ms.
Rudnick worked as an independent consultant to several software companies in the
areas of organizational development, human resource management and facilities
planning and leasing. Effective March 31, 1998, Ms. Rudnick has resigned from
the Company.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located in Newton Centre, MA, where
it leases approximately 22,750 square feet under a lease that expires in
November 1998. The Company's field sales and support operations occupy leased
facilities in eight locations throughout the United States and in two
locations in Canada and Europe. The Company also leases a research and
development facility, approximately 1,000 square feet, in Linz, Austria. The
facility in Newton Centre is being fully utilized. In the second quarter of
1998, the Company expects to enter into a lease agreement for a new headquarters
location and move into those new offices in Lexington, MA in the third quarter
of 1998. The Company will lease 40,500 square feet initially. See Note M to the
Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET PRICE FOR COMMON STOCK
The Company's Common Stock began trading publicly on March 28, 1996 on the
National Market Tier of the NASDAQ Stock Market under the symbol: SEGU. The
following table sets forth, for the periods indicated, the high and low closing
prices of the Common Stock as reported on the NASDAQ National Market System.
These prices do not include retail markups, markdowns, or commissions.
<TABLE>
<CAPTION>
Year ended December 31, 1997: High Low
------- -------
<S> <C> <C>
First Quarter $18.250 $ 7.500
Second Quarter $15.125 $ 8.625
Third Quarter $13.750 $ 7.625
Fourth Quarter $12.500 $ 7.750
Year ended December 31, 1996:
First Quarter (March 28, 1996 - March 31, 1996) $21.500 $21.000
Second Quarter $39.500 $21.250
Third Quarter $24.500 $ 9.875
Fourth Quarter $18.250 $12.000
</TABLE>
On March 10, 1998, the closing price reported on the NASDAQ National Market
System for the Common Stock was $13.875. The market price of the Company's
Common Stock has fluctuated significantly and is subject to significant
fluctuations in the future.
HOLDERS OF RECORD
As of March 10, 1998, there were approximately 94 holders of record of the
Company's Common Stock and 7,903,585 shares of Common Stock outstanding. The
Company estimates that as of March 10, 1998, there were approximately 1,800
beneficial stockholders.
DIVIDEND POLICY
The Company has never paid cash dividends on the Common Stock and does not
anticipate paying such dividends in the foreseeable future. The Company intends
to retain future earnings for use in the Company's business. The payment of any
future dividends will be determined by the Board of Directors in light of
conditions then existing, including the Company's financial condition and
requirements, future prospects, restrictions in financing agreements, business
conditions and other factors deemed relevant by the Board of Directors.
12
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
the Consolidated Financial Statements and the Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Annual Report on Form 10-K/A.
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------
1997 1996 1995 1994 1993
-------- --------- -------- -------- --------
(restated)
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue:
Software $15,783 $12,592 $ 8,312 $4,770 $2,173
Services 6,011 4,381 2,627 1,253 466
Royalties - - 129 335 770
------- ------- ------- ------ ------
Total revenue 21,794 16,973 11,068 6,358 3,409
Cost of revenue:
Cost of software 1,095 651 315 243 165
Cost of services 2,590 1,709 1,194 601 352
Cost of royalties - - 30 80 169
------- ------- ------- ------ ------
Total cost of revenue 3,685 2,360 1,539 924 686
Gross margin 18,109 14,613 9,529 5,434 2,723
Operating expenses:
Sales and marketing 11,872 8,500 5,378 2,546 925
Research and development 4,931 3,806 2,273 1,574 1,041
General and administrative 3,211 2,437 1,709 1,284 724
Non-recurring charges 835/(1)/ - 449 - -
------- ------- ------- ------ ------
Total operating expenses 20,849 14,743 9,809 5,404 2,690
------- ------- ------- ------ ------
Income (loss) from operations (2,740) (130) (280) 30 33
Litigation settlement - (744) - - -
Other income (expense), net 2,186 1,535 (23) (21) (34)
------- ------- ------- ------ ------
Income (loss) before provision
for income taxes (554) 661 (303) 9 (1)
Provision for income taxes 56 20 - - -
------- ------- ------- ------ ------
Net income (loss) $ (610) $ 641 $ (303) $ 9 $ (1)
======= ======= ======= ====== ======
Net income (loss) per common share -
basic $ (.08) $ .12 $ (.20) $ .01 $ -
======= ======= ======= ====== ======
Net income (loss) per common share -
diluted $ (.08) $ .09 $ (.20) $ - $ -
======= ======= ======= ====== ======
Weighted average common shares
outstanding - basic 7,337 5,364 1,552 1,528 1,395
------- ------- ------- ------ ------
Weighted average common shares
outstanding - diluted 7,337 7,689 1,552 4,002 1,395
------- ------- ------- ------ ------
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
Balance Sheet Data:
December 31,
1997 1996 1995 1994 1993
-------- ------- ------------- ------ ------
(restated) (in thousands)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $22,975 $ 7,112 $ 442 $ 711 $ 218
Working capital (deficit) 35,521 40,667 (57) 1,211 504
Total assets 55,523 47,631 4,496 3,810 1,991
Subordinated notes payable 4,415 - 654 654 654
Total stockholders' equity 45,229 42,707 1,305 1,546 613
</TABLE>
/(1)/Non-recurring charges in 1997 include a charge of $117,000 for purchased
research and development in process and $718,000 for severance charges.
There were no cash dividends declared per common share for any of the years
shown above.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Segue Software, Inc. is a leader in automated testing for software
reliability. The Company's products are used by quality assurance professionals
and software developers to improve software quality, reduce development costs
and shorten the time required to develop and deploy software applications. The
Company's products integrate test planning, creation, execution, management and
analysis to provide automated functionality and load testing of software
applications. The Company's products are used to test software applications
across various components of distributed, multi-platform client/server systems
as well as applications deployed on the World Wide Web.
During 1997, Segue introduced new technology to provide automated software
testing for Web-enabled software applications extending the Company's
distributed testing capabilities beyond distributed client/server applications
with GUI front ends. Segue also began to focus on load testing in 1997, through
an OEM/reseller arrangement with a third party software vendor. On December 30,
1997, the Company acquired both the third party software vendor and the
developer of the product, SQLBench International, Inc. and ARC - Dr. Ambichl &
Dr. Reindl Communication GmbH (formerly named ARC Dr. Ambichl & Dr. Reindl OEG),
hereafter referred to as "SQLBench". See Note B to the Consolidated Financial
Statements. These new product offerings formed the basis for a significant
refocus of the Company's marketing and sales initiatives beginning in the fourth
quarter of 1997.
The Company began focusing its marketing and sales efforts on the e-
commerce and Internet applications market with a solution sales approach for its
customers. By doing so, the Company believes it can provide its customers with
an automated testing solution which can be of strategic value.
The new sales focus was launched under the direction of a new Chief
Executive Officer who joined the Company in September 1997 and was fueled in
large part by the evolution of the Company's regression testing products to
address Web-based applications. This new focus also emphasizes the Company's
load testing product line.
RESTATEMENT RELATED TO ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
The accompanying consolidated financial statements as of and for the year
ended December 31, 1997 have been restated to reflect a change in the original
accounting for the amount and allocation of the purchase price related to the
Company's acquisition of SQLBench in December 1997.
In a letter dated September 9, 1998 to the American Institute of
Certified Public Accountants SEC Regulations Committee, the Securities and
Exchange Commission ("SEC") set forth its views on purchased in-process research
and development ("IPR&D"), taking issue with certain appraisal practices
employed in practice at the time. Subsequent to the issuance of the SEC letter,
the staff of the SEC has reviewed various filings of the Company and has
inquired regarding the methods used by the Company to value acquired IPR&D that
was written-off as of the acquisition date. As a result of this review, the
Company has modified the methods used to value acquired intangible assets in
connection with the SQLBench acquisition and has increased the total purchase
price from $10.1 million to $10.6 million. Under the revised accounting, the
value ascribed to the acquired IPR&D was reduced from $9.1 million to $0.1
million, the value assigned to acquired completed technology was increased from
$1.0 million to $3.0 million, and goodwill of $7.5 million was recorded. The
principal effects of this restatement on previously reported consolidated
financial statements as of and for the year ended December 31, 1997 are set
forth below (in thousands, except per share data). The restatement does not
affect previously reported net cash flows for any period.
<TABLE>
<CAPTION>
For the year ended
December 31, 1997
--------------------------
As
Previously As
Reported Restated
------------ -----------
<S> <C> <C>
Non-recurring charges $ 9,813 $ 835
Total operating expenses 29,827 20,849
Loss from operations (11,718) (2,740)
Loss before provision for income taxes (9,532) (554)
Net loss (9,588) (610)
Net loss per common share - basic and diluted (1.31) (0.08)
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1997
--------------------------
As
Previously As
Reported Restated
------------ -----------
<S> <C> <C>
Completed technology, net $ 1,006 $ 2,964
Goodwill, net - 7,528
Total assets 46,037 55,523
Additional paid-in capital 48,479 48,987
Accumulated deficit (12,707) (3,729)
Total stockholders' equity 35,743 45,229
</TABLE>
14
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of revenue represented by certain items reflected in the Company's consolidated
statements of operations:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1996 1995
------- ------ ------
(restated)
<S> <C> <C> <C>
Revenue:
Software 72.4% 74.2% 75.1%
Services 27.6 25.8 23.7
Royalties - - 1.2
------ ----- -----
Total revenue 100.0 100.0 100.0
Cost of revenue:
Cost of software 5.0 3.8 2.8
Cost of services 11.9 10.1 10.8
Cost of royalties - - 0.3
------ ----- -----
Total cost of revenue 16.9 13.9 13.9
Gross margin 83.1 86.1 86.1
Operating expenses:
Sales and marketing 54.5 50.1 48.6
Research and development 22.6 22.4 20.5
General and administrative 14.7 14.4 15.4
Non-recurring charges 3.8 - 4.1
------ ----- -----
Total operating expenses 95.6 86.9 88.6
------ ----- -----
Loss from operations (12.5) (0.8) (2.5)
Litigation settlement - (4.4) -
Other income (expense), net 10.0 9.1 (0.2)
------ ----- -----
Income (loss) before provision for income taxes (2.5) 3.9 (2.7)
Provision for income taxes 0.3 0.1 -
------ ----- -----
Net income (loss) (2.8)% 3.8% (2.7)%
====== ===== =====
</TABLE>
REVENUE
TOTAL REVENUE
Total revenue increased 28% to $21.8 million in 1997 and 53% to $17.0
million in 1996 from $11.1 million in 1995.
Total revenue primarily consists of software and services revenue. Software
revenue consists of revenue from the granting of perpetual licenses to use the
Company's products. Services revenue consists of revenue from maintenance,
training and consulting. The Company sells its licenses through its direct sales
force, telesales, international distributors and channel partners.
15
<PAGE>
REVENUE FROM SOFTWARE
Software revenue increased 25% to $15.8 million in 1997 and 51% to $12.6
million in 1996 from $8.3 million in 1995. The increases in software revenue
are primarily the result of increased unit shipments in each of the respective
periods. These increased unit shipments were due to an increase in the demand
for automated testing products; the introduction by the Company of new and
upgraded products; increased market acceptance of the families of products
including its Web application testing products and load testing products
introduced in 1997; and expansion of the Company's sales and marketing
activities.
In 1997, the Company introduced a Web application testing product,
SilkTest, and load testing products, SilkPerformer and QA Performer. Revenues
from these three new products represented 18%, 5% and 3% of total product
revenue, respectively.
The increase in unit shipments came largely through the direct domestic
channel. Revenue from the domestic indirect channel accounted for 8%, 5% and 5%
of total product revenue in 1997, 1996 and 1995, respectively. International
revenue accounted for 11%, 8% and 7% of total product revenue in 1997, 1996 and
1995, respectively.
In addition, the mix of software license revenue changed in 1997. Prior to
1997, the Company had no revenue from either the e-commerce testing or load
testing markets. Revenues from those markets totaled 23% and 8% of total
product revenue in 1997.
REVENUE FROM SERVICES
Services revenue increased 37% to $6.0 million in 1997 and 67% to $4.4
million in 1996 from $2.6 million in 1995. The increases in revenue from
services are principally the result of the increased volume of maintenance,
training and consulting services, primarily due to the expansion of the
installed base of users of the Company's products. Maintenance revenue increased
46% to $4.1 million in 1997 and 75% to $2.8 million in 1996 from $1.6 million in
1995. Training and consulting revenue increased 19% to $1.9 million in 1997 and
60% to $1.6 million in 1996 from $1.0 million in 1995.
COST OF REVENUE
COST OF SOFTWARE
Cost of software includes documentation reproduction costs, product
packaging, product media, employment costs for processing and distribution,
amortization of intangible assets and royalties due to third parties for their
software included in the Company's products or sold separately by the Company.
These costs increased 68% to $1,095,000 in 1997 and 107% to $651,000 in 1996
from $315,000 in 1995. As a percentage of software revenue, cost of software
16
<PAGE>
was 7% in 1997, 5% in 1996 and 4% in 1995. The increase in the cost of software
revenue in each period primarily reflects the increased volume of units sold.
The increase in the cost of software revenue in 1997 is also attributable to
royalty expense related to the sale of the Company's load testing products which
were licensed from a third party software provider until December 30, 1997 (see
Note J to the Consolidated Financial Statements).
COST OF SERVICES
Cost of services consists principally of employment-related costs for the
Company's customer support staff, which provides services under maintenance
contracts, and the Company's training and consulting staff, as well as the cost
of materials and facilities used in training customers. Cost of services
increased 52% to $2.6 million in 1997 and 43% to $1.7 million in 1996 from $1.2
million in 1995. As a percentage of services revenue, cost of services was 43%,
39% and 45% in 1997, 1996 and 1995, respectively. The increases in the cost of
services are largely the result of the increase in the number of employees in
both the training and consulting and technical support groups, from 18 employees
as of February 28, 1997 to 23 employees as of February 28, 1998. This increase
is also attributable to costs related to the delivery of training and consulting
services, such as travel and equipment rental. The Company expects to expand
its customer support, training and consulting capabilities in 1998.
OPERATING EXPENSES
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, commissions and
related costs of Company personnel and promotional marketing programs, including
advertising, brochures, direct mail programs and seminars. Sales and marketing
expenses increased 40% to $11.9 million in 1997 and 58% to $8.5 million in 1996
from $5.4 million in 1995. The principal reasons for the increases in sales and
marketing expenses in all periods were increases in the number of sales and
marketing personnel, increases in commissions as a result of higher revenue
levels and increases in promotional marketing programs. The staff grew to 69
employees as of February 28, 1998 from 52 as of February 28, 1997. Sales and
marketing expenses increased as a percentage of revenue to 55% in 1997 from 50%
in 1996 and 49% in 1995, respectively, as a result of significant increases in
the number of sales staff hired by the Company and in the Company's promotional
marketing programs. The sales organization was restructured in the fourth
quarter of 1997 to focus on the Company's e-commerce market initiative.
Historically, the Company's costs for the sales and marketing organization have
totaled between 40% and 50% of revenue on an annual basis. However, in 1997, as
noted above, the cost of the sales and marketing organization grew to 55% of
revenue. These increases are largely related to the restructuring of the sales
organization to focus on e-commerce solution selling and the hiring of a new
sales management team. The Company intends to continue this increase in
spending for sales and marketing in 1998, both internationally and domestically,
principally related to hiring additional sales personnel and the related travel,
training and commission costs.
17
<PAGE>
There can be no assurance that these increased expenditures or the re-
structuring of the sales organization will result in increased revenue or
improvement in the effectiveness of the sales organization.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of the employment-
related costs for engineering and technical personnel associated with developing
new products or enhancing existing products, for quality assurance personnel and
for product documentation specialists to provide user product documentation and
tutorials. To date, all of the Company's internal costs for research and
development have been charged to operations as incurred since the amount of
software development costs qualifying for capitalization has been insignificant.
Research and development expenses increased 30% to $4.9 million in 1997 and 67%
to $3.8 million in 1996 from $2.3 million in 1995. The increases are mainly
attributable to increases in the number of research and development employees.
The staff grew to 51 employees as of February 28, 1998 from 35 as of February
28, 1997. The Company intends to continue making significant investments in
research and development to develop new products, expand the capabilities of its
Web application testing products and to internationalize all of the Company's
products.
During 1997, the Company introduced several new products including SilkTest
(a regression testing product for Web applications), SilkPerformer (a load
testing product for Web applications) and QA Partner Blue (a Year 2000
regression testing product). Additionally, in January 1998, the Company further
enhanced its SilkTest product by adding support for the JAVA programming
language.
As a result of the acquisition of SQLBench on December 30, 1997, the
Company now has nine developers located in Austria who are focusing on the
development and enhancement of the Company's load testing products.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist principally of employment-
related costs for executive and administrative personnel, professional fees,
consulting fees, system support costs and other general corporate expenses.
General and administrative expenses increased 32% to $3.2 million in 1997 and
43% to $2.4 million in 1996 from $1.7 million in 1995. The increases in all
periods are attributable to increased employment of both executive and
administrative personnel and increases in professional fees, system support
costs and other general corporate expenses. The staff growth has occurred in
executive, finance and human resources and has been necessary to support the
growth of the Company. The Company anticipates that general and administrative
expenses will increase in 1998 due to the growth in management systems and
administrative infrastructure.
18
<PAGE>
NON-RECURRING CHARGES
In the fourth quarter of 1997, the Company recognized a charge of $117,000
related to the write-off of purchased research and development in process in
conjunction with the SQLBench acquisition and $718,000 consisting of severance
and accelerated vesting of options related to the resignation of the Company's
former President and Chief Executive Officer (see Note K to the Consolidated
Financial Statements). In-process research and development identified at the
acquisition date represented development projects in six areas that had not
reached technological feasibility and had no alternative future use. The values
of the in-process research and development projects were determined using a
risk-adjusted, discounted cash flow approach, reflecting each project's stage of
completion at the acquisition date. In those cash flow projections of in-process
technologies, the Company used discount rates ranging from 35% to 45%, as
compared to a discount rate of 20% used to value the completed technology
acquired in the transaction. The in-process research and development projects
were focused on the predictive and design aspects of load testing, which the
Company expected would allow users greater ability to perform load testing early
in the development phase instead of waiting until deployment. If proven to be
feasible, the in-process technologies were expected to provide improved load
testing tools for client/server and Internet environments.
The non-recurring charge in 1995 totaled $449,000 and consisted of
severance and the purchase of vested options for common stock granted to the
Company's President and Chief Executive Officer who had held that position from
1991 until June 30, 1995.
LITIGATION SETTLEMENT
On September 30, 1996, the Company entered into a definitive agreement with
a plaintiff to settle litigation brought against the Company and certain of its
current and former employees. The Company recorded a charge of $744,000 in the
third quarter of fiscal 1996 to cover the settlement and other expenses incurred
in connection therewith.
OTHER INCOME (EXPENSE), NET
Other income (expense), net is comprised primarily of interest income from
cash, cash equivalents and short-term investments. On April 2, 1996, the
Company completed an initial public offering of common stock and received net
proceeds of $39.5 million. As a result of the Company's receipt and investment
of the offering proceeds, other income has increased substantially over prior
periods. Prior to 1997, interest income was partially offset by interest
expense related to the Company's convertible debt. As of December 31, 1996, all
of the Company's convertible debt was converted into common stock of the
Company.
PROVISION FOR INCOME TAXES
The Company had a provision for income taxes of $56,000 and $20,000 in 1997
and 1996, respectively, principally for state taxes. There was no provision for
income taxes in 1995. As of December 31, 1997, the Company had federal net
operating loss carryforwards of approximately $4.5 million and state net
operating loss carryforwards of $1.8 million as well as $821,000 of federal tax
credit carryforwards available for income tax purposes. These carryforwards
generally expire in the years 1998 through 2012 and may be subject to annual
limitations as a result of changes in the Company's ownership. Management of
the Company has evaluated the positive and negative evidence impacting the
realizability of its deferred tax assets, which are comprised principally of net
operating loss carryforwards and tax credits. Based on the weight of the
available evidence, it is more likely than not that all of the deferred tax
assets will not be realized, and accordingly the deferred tax assets have been
fully reserved. Management re-evaluates the positive and negative evidence on a
quarterly basis.
19
<PAGE>
NET INCOME (LOSS)
For the year ended December 31, 1997, the Company had a net loss of
$610,000 compared with net income of $641,000 for the year ended December 31,
1996 and a net loss of $303,000 for the year ended December 31, 1995.
Net income for 1997, excluding the non-recurring charges, would have been
$225,000.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments decreased to $37.4
million as of December 31, 1997 from $41.2 million as of December 31, 1996. In
1996, cash, cash equivalents and short term investments increased from $442,000
as of December 31, 1995, primarily as a result of the funds raised in the
Company's initial public offering of common stock.
The Company generated $1.4 million and $2.1 million from operations in 1997
and 1996, respectively. In 1997, funds provided by operating activities were
primarily affected by the growth in accounts receivable. In 1996, funds provided
by operating activities were primarily the result of net income and growth in
accrued expenses and deferred revenue, partially offset by growth in accounts
receivable and other current assets.
The Company generated $13.6 million and utilized $35.4 million for
investing activities in 1997 and 1996, respectively. Funds generated in 1997
were largely the result of the maturity of short-term investments, partially
offset by $4.4 million related to the SQLBench acquisition and $1.3 million
related to capital expenditures for computer equipment, software and furniture.
The investing activities in 1996 involved the investment of the initial public
offering proceeds in short-term investments, generally in U.S. Government and
government agency securities, and the purchase of computer equipment, software
and furniture.
The Company generated funds from financing activities of $925,000 and $40.0
million in 1997 and 1996, respectively. In 1997, funds generated from financing
activities resulted from the exercise of stock options. In 1996, the Company
generated $39.5 million from its initial public offering of common stock and
$445,000 from the exercise of stock options.
In the second quarter of 1998, the Company expects to enter into a nine
year lease commitment for 40,500 to 67,500 square feet, effective August 1,
1998, at an annual rental rate of approximately $2.2 million. The lease expires
in October, 2007. The Company has the right to terminate the lease on September
30, 2004 for a fee of approximately $2.2 million.
Long-term cash requirements, other than normal operating expenses, are
anticipated for the development of new software products and enhancements of
existing products, the opening of additional international offices, and the
20
<PAGE>
possible acquisition of software products or technologies complementary to the
Company's business.
Assuming there is no significant change in the Company's business, the
Company believes that the existing cash and 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income". This statement requires that changes in comprehensive
income be shown in a financial statement that is displayed with the same
prominence as other financial statements. The statement is effective for annual
periods beginning after December 15, 1997, and the Company will adopt its
provisions in fiscal 1998. Reclassification for earlier periods is required for
comparative purposes. Management does not expect the statement to have a
material impact on the Company's financial disclosures.
In June 1997, the FASB issued SFAS No. 131 ("SFAS 131"), "Disclosure about
Segments of an Enterprise and Related Information", which changes the manner in
which public companies report information about their operating segments. SFAS
131, which is based on the management approach to segment reporting, establishes
requirements to report selected segment information quarterly and to report
entity-wide disclosures about products and services, major customers, and the
geographic locations in which the entity holds assets and reports revenue.
Management is currently evaluating the effects of this change on its reporting
of segment information. The Company will adopt SFAS 131 for its fiscal year
ending December 31, 1998.
In October 1997, Statement of Position 97-2, "Software Revenue Recognition"
("SOP 97-2"), was issued which provides guidance on applying generally accepted
accounting principles in recognizing revenue on software transactions. SOP 97-2
is effective for transactions entered into in fiscal years beginning after
December 15, 1997. The Company will adopt the guidelines of SOP 97-2 as of
January 1, 1998 and does not expect adoption to have a material impact on the
Company's financial results.
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
Statements made or incorporated in this Form 10-K/A 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 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 Company's future performance. The Company's actual results could differ
materially from those set forth in the forward-looking statements. Certain
factors that might cause such a difference are discussed below.
21
<PAGE>
Short Operating History; Accumulated Deficit.
The Company was founded in 1988 to provide software porting services to
independent software vendors. In 1992, the Company reorganized its business to
focus on the development and marketing of automated testing software for the
quality assurance market. The Company shipped its first automated testing
product, QA Partner, in the quarter ended March 31, 1993. Accordingly, the
Company has a limited operating history and, although the Company has
experienced growth in recent periods, continued growth at the same rate is not
sustainable and is not necessarily indicative of future operating results.
Losses have resulted in an accumulated deficit of approximately $3.7 million as
of December 31, 1997. The Company had a net loss of $303,000 in 1995, net income
of $641,000 in 1996 and a net loss of $610,000 in 1997. The limited operating
history of the Company makes the prediction of future results difficult and,
therefore, there can be no assurance that the Company will sustain revenue
growth or achieve profitability on a consistent basis.
Potential Fluctuations in Operating Results.
The Company may experience significant fluctuations in future quarterly
operating results, which may be caused by many factors, including: the timing of
introductions of new products or product enhancements by the Company 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; reduction in demand for automated software testing products;
changes in operating expenses; product mix; and general economic conditions. A
substantial portion of the Company'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 the
Company'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, the Company does not typically experience order backlog.
Furthermore, the Company 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, the
Company 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. Moreover, although the Company has not historically
experienced seasonal fluctuations in its revenue or results of operations, such
fluctuations are not uncommon in the software industry and may affect the
Company in the future.
Dependence on Principal Product.
To date, the Company has derived substantially all of its revenues from
licenses of QA Partner and related products and from fees for related services.
As a result, any factors adversely affecting the sales of QA Partner, such as
increased price competition or the introduction of technologically superior
products, could have a material adverse effect on the Company. The Company's
future financial performance will depend in significant part on its ability to
develop and introduce new releases of QA Partner with enhanced features and
functionalities and related products. In 1997, the Company introduced a Web
application testing product, SilkTest, and load testing products, SilkPerformer
and QA Performer. Revenues from these three new products represented 18%, 5% and
22
<PAGE>
3% of total product revenue, respectively. The Company has refocused its sales
and marketing organization on the sale of these new products with an emphasis on
the e-commerce market. There can be no assurance that these products will be
successfully developed or achieve market acceptance.
Emerging Market.
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 the
Company's products will be accepted in that market. Although the Company
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 the Company's products focused on e-commerce and Internet applications will
depend on the growth of the market and on the Company'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 the Company 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.
Management of Growth.
The Company has recently experienced a period of rapid growth, including
increases in the number of orders, customers and employees. Such growth has
placed, and may continue to place, strains on the Company's management,
operations and systems. The Company's ability to compete effectively will
depend, in part, upon its ability to expand, improve and effectively utilize its
operational, management, marketing, sales and financial systems as necessitated
by changes in the Company's business. Any failure by the Company's management to
effectively anticipate, implement and manage the changes required to sustain the
Company's growth could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company has
significantly changed the executive management team and the sales management
team under the direction of a new Chief Executive Officer. In conjunction with
these management changes, the Company has refocused its sales and marketing
approach to focus on e-commerce applications. There can be no assurance that the
Company will be able to effectively manage such change.
Management of Growth Through Acquisitions.
The Company's product range and customer base have increased in the recent
past due in part to acquisitions. The Company may acquire additional businesses
or product lines in the future. The probability of success of any acquisition
may be dependent upon the Company's ability to integrate the acquired business
or products successfully and to retain key personnel associated with the
acquisition. Failure to do so, or a material increase in the cost of
integration, could cause actual results to differ from those projected in
management's forward-looking statements.
23
<PAGE>
Year 2000 Compliance.
The Year 2000 compliance issue concerns the inability of computerized
information systems to accurately calculate, store or use a date after 1999.
This could result in a system failure or miscalculations causing disruptions of
operations.
The Company is in the process of conducting an assessment of its core
internal and external computer information systems and is taking the necessary
steps to understand the nature and extent of the work required to make its
systems, in those situations in which the Company is required to do so, Year
2000 compliant. These steps may require the Company to modify, upgrade or
replace some of its internal financial and operational systems. The total cost
of bringing all internal systems, equipment and operations into Year 2000
compliance has not been fully quantified. The Company continues to evaluate the
estimated costs associated with these compliance efforts. While these efforts
involve additional costs, the Company believes, based on available information,
that these costs will not have a material adverse effect on its business,
financial condition or results of operations. However, if these efforts are not
completed on time, or if the cost of updating or replacing the Company's
information systems exceeds the Company's current estimates, the Year 2000 issue
could have a material impact on the Company's ability to meets its financial and
reporting requirements and/or on its financial results. Further, no estimates
can be made as to any potential adverse impact resulting from the failure of
third-party service providers and vendors to prepare for the Year 2000. The
Company is attempting to identify those risks as well as to receive compliance
certificates from all third parties that have a material impact on the Company's
operations, but the cost and timing of third party Year 2000 compliance is not
within the Company's control and no assurances can be given with respect to the
cost or timing of such efforts or the potential effects of any failure to
comply.
Rapidly Changing Technology; New Products; Risk of Product Defects.
The market for computer software products is generally characterized by
rapidly changing technology and frequent new product introductions that can
render existing products obsolete or unmarketable. The Company believes that a
major factor in its future success will be its ability to develop and introduce
in a timely manner enhancements to its existing products and new products that
will gain market acceptance. If the Company is unable to introduce new products
and respond to industry changes on a timely basis, its business could be
materially adversely affected. Software products as complex as those offered by
the Company may contain undetected errors or failures when first introduced or
as new versions are released. Although the Company has not experienced material
adverse effects resulting from undetected errors in the past, there can be no
assurance that errors will not be found in new products after commencement of
commercial shipments, resulting in loss of or delay in market acceptance, which
could have a material adverse effect upon the Company's business, financial
condition and results of operations. Further, because the Company is in the
quality assurance business, any errors in its software could harm the Company's
reputation in the quality assurance software market and make it more difficult
for the Company to sell its products.
Competition.
The market for software quality management tools is new, intensely
competitive and subject to rapid technological change. The Company expects
competition to intensify in the future. The Company currently encounters direct
competition from a number of public and private companies including Mercury
Interactive Corporation, Rational Software Corporation and Compuware
24
<PAGE>
Corporation. Due to the expansion of the market for software quality management
tools, the Company may face competition from new entrants in the software
quality management industry, possibly including the Company's resellers or
current customers. There can be no assurance that the Company's current and
potential competitors will not develop software quality management tools that
may be more effective or achieve greater market acceptance than the Company's
current or future products or that the Company's technologies and products would
not be rendered obsolete by such developments. Many of the Company'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 the Company. The Company may also face increased
competition from the recent consolidation of several companies in the automated
software quality market. As a result, these competitors may be able to adapt
more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the promotion and sale of their
products than the Company. An increase in competition could result in price
reductions and loss of market share. Such competition and any resulting
reduction in profitability could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Key Personnel.
The Company's success depends upon its ability to attract and retain highly
skilled technical, managerial and sales personnel. Competition for such
qualified sales, marketing and software development personnel in the computer
industry in general, and the automated software testing industry in particular,
is intense. Future results will depend on the Company's ability to attract and
retain such personnel, and the failure to do so could have a material adverse
effect on the Company's ability to develop and market competitive products and
its ability to achieve projected operating results.
International Activities.
The Company derived approximately 11% of its total product sales from
international customers in 1997. The international market for software products
is highly competitive and the Company expects to face substantial competition in
this market from established and emerging companies. Risks inherent in the
Company's international business activities also include 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 the Company is
unable to expand international sales in a timely and cost-effective manner, the
Company's business could be materially adversely affected.
Development of Indirect Channels; Potential for Channel Conflict.
Although the Company has not historically sold significant amounts of its
products through indirect channels, the Company intends to continue to develop
channel sales as part of its growth strategy. In 1995, the Company established
its Channel Partner Program. The Company licenses its products to its channel
partners at a discount and such partners relicense the products to end-users.
The Company's agreements with its channel partners are non-exclusive and provide
the channel partners with 60-day price protection. Because the Company's channel
partners generally order the Company's products after they have received
purchase orders, there is no requirement that the Company repurchase any
25
<PAGE>
product. The Company selects its channel partners based on the partner's
financial viability, product expertise and market focus. In order for the
Company's strategy to broaden market penetration through its Channel Partner
Program to be successful, the Company must increase its unit sales to offset the
discount it is providing the channel partners. There can be no assurance that
the Company will succeed in the development of these channels. Moreover, selling
through indirect channels may limit the Company's contact with the end users of
its products. As a result, the Company's ability to accurately forecast sales,
evaluate customer satisfaction and recognize emerging customer requirements may
be hindered and its ability to develop and maintain customer goodwill may be
limited. In addition, the Company's strategy of marketing its products directly
to end users and indirectly through its channel program and through distributors
may result in distribution channel conflicts. Although the Company has attempted
to manage its distribution channels in a manner to avoid potential conflicts,
there can be no assurance that channel conflicts will not materially adversely
affect its relationships with existing channel partners or distributors or
adversely affect its ability to attract new channel partners and distributors.
In addition, there can be no assurance that the Company's resellers will be able
to effectively market the Company's products or that they will not commence the
sale of competitive products. In 1996, the Company entered into an OEM
arrangement with INTERSOLV whereby INTERSOLV has the right to resell QA Partner
and related products to its customers. The Company has no assurance that this
will be a successful sales channel for the Company's products or that it will
not result in significant channel conflict.
Product Liability.
In selling its products, the Company 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 the
Company's 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 the Company's exposure to product liability
claims, may therefore be unenforceable under the laws of certain jurisdictions.
Intellectual Property and Proprietary Rights.
The Company currently relies on a combination of trademark, copyright and
trade secret laws and contractual provisions to protect its proprietary rights
in its products. The Company presently has no registered copyrights. The Company
has a patent but there can be no assurance that the patent would be upheld if
challenged. There can be no assurance that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology. There can also be no assurance that the measures
taken by the Company to protect its proprietary rights will be adequate to
prevent misappropriation of the technology or independent development by others
of similar technology. In addition, the laws of various countries in which the
Company's products may be sold may not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
intellectual property infringement claims against the Company or that any such
claims will not require the Company to enter into royalty or cross-license
arrangements or result in costly litigation. In the event of litigation to
determine the validity of any third party claims, such litigation could result
in significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is determined
in favor of the Company.
26
<PAGE>
Stock Market Volatility.
Market prices for securities of software companies have generally been
volatile. In particular, the market price of the Company's common stock has been
and may continue to be subject to significant fluctuations as a result of
factors affecting the computer industry or the securities markets in general.
These factors include, but are not limited to, quarterly variations,
announcements of technological innovations by the Company or competitors,
announcements of mergers or acquisitions by the Company or competitors, changes
in prices by the Company or competitors, change in product mix, and change in
revenue or revenue growth rates for geographic areas or products.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements required pursuant to this Item 8 are presented
beginning on page F-1 of this Form 10-K/A.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 concerning the Company's officers
is incorporated by reference to the section of Part I of this Form 10-K entitled
"Item 1. Business - Executive Officers of the Registrant". The information
concerning the Company's directors required by this Item 10 is incorporated by
reference to the information under the heading, "Election of Directors -
Information Regarding the Nominees and Executive Officers" in the Company's 1998
Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to
the Company's 1998 Proxy Statement under the heading, "Compensation of Directors
and Executive Officers".
ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS
The information required by this Item 12 is incorporated by reference to
the Company's 1998 Proxy Statement under the heading, "Security Ownership of
Management and Certain Beneficial Owners".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
27
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. Financial Statements. The following financial statements of
Segue Software, Inc. are filed as a part of this report:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Table of Contents F-1
Report of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3
Consolidated Statements of Operations for the Years ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity for the Years
ended December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996 and 1995 F-6
Notes to Consolidated Financial Statements F-7
</TABLE>
2. Financial Statement Schedules. All schedules have been omitted
because they are not applicable or the required information is
shown in the financial statements or notes thereto.
3. Exhibits. The following is a complete list of Exhibits filed as
part of this Form 10-K/A.
<TABLE>
<CAPTION>
NUMBER DESCRIPTION OF EXHIBITS
- ------ ---------------------------------------------------------------
<S> <C>
*(3.1) Restated Certificate of Incorporation (Exhibit 3.2 of Registration Statement on Form S-1
(File No. 333-1488))
*(3.2) By-Laws (Exhibit 3.3 of Registration Statement on Form S-1 (File No. 333-1488))
*(4.1) Specimen Certificate representing the Common Stock (Exhibit 4.2 of Registration
Statement on Form S-1 (File No. 333-1488))
*(10.1) 1996 Amended and Restated Incentive and Non-Qualified Stock Option Plan
*(10.2) 1996 Employee Stock Purchase Plan
*(10.3) Preferred Stock Purchase and Sale Agreement, dated as of February 11, 1994, by and
between the Registrant and John J. Cullinane
</TABLE>
28
<PAGE>
<TABLE>
<S> <C>
*(10.4) Non-Qualified Stock Option Agreement, dated as of February 11, 1994,
by and between the Registrant and John J. Cullinane
*(10.5) Letter Agreement, dated as of April 14, 1994, by and between the
Registrant and John J. Cullinane
*(10.6) Employment Separation Agreement, dated as of June 30, 1995, by and
between the Registrant and Laurence R. Kepple
*(10.7) Form of Shareholder Rights Agreement, dated as of February 8, 1996,
entered into between the Registrant and certain of its stockholders
(Exhibit 10.9 of Registration Statement on Form S-1 (File No. 333-
1488))
*(10.8) Form of Indemnification Agreement between the Registrant and its
directors and officers (Exhibit 10.10 of Registration Statement on
Form S-1 (File No. 333-1488))
*(10.9) Lease, dated as of October 19, 1995, by and between the Registrant and
1330 Centre Street Associates Limited Partnership (Exhibit 10.11 of
Registration Statement on Form S-1 (File No. 333-1488))
(10.10) Agreement and Plan of Merger by and among the Registrant, SGE
Merger Corp. and SQLBench International, Inc. and the Stockholders of
SQLBench International, Inc. dated as of December 30, 1997
(10.11) Asset Purchase Agreement by and among the Registrant, ARC - Dr.
Ambichl & Dr. Reindl Communication GmbH and the Stockholders of ARC -
Dr. Ambichl & Dr. Reindl Communication GmbH dated as of December 30,
1997
(10.12) Segue Software, Inc. Special Termination and Vesting Plan adopted
February 5, 1997
(10.13) Letter Agreement, effective as of December 31, 1997, by and between
the Registrant and Elisabeth Elterman
(21.1) Subsidiaries of the Registrant
(23.1) Consent of PricewaterhouseCoopers LLP
(27.1) Restated Financial Data Schedule
(27.2) Restated Financial Data Schedule for the three and six months ended
June 30, 1997
(27.3) Restated Financial Data Schedule for the three months ended
March 31, 1997
(27.4) Restated Financial Data Schedule for the year ended December 31, 1996
</TABLE>
* All exhibits with an asterisk are incorporated by reference to identically
numbered exhibits (unless otherwise indicated) filed in response to Item 16(a),
"Exhibits", of the Registrant's Registration Statement on Form S-1, as amended
(File No. 333-1488), which was declared effective on March 28, 1996.
29
<PAGE>
(b) Reports on Form 8-K
On January 14, 1998, the Company filed a Report under Item 5 on Form 8-K.
On March 16, 1998, the Company filed an amendment to the Report.
30
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on this 27th day of March,
2000.
SEGUE SOFTWARE, INC.
By: /s/ STEPHEN B. BUTLER
----------------------
Stephen B. Butler, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Titles Date
- --------- ------ ----
<S> <C> <C>
/s/ STEPHEN B. BUTLER President, Chief Executive Officer March 27, 2000
- --------------------------- and Director (Principal Executive Officer)
Stephen B. Butler
/s/ DOUGLAS ZACCARO Chief Financial Officer March 27, 2000
- --------------------------- (Principal Financial Officer and
Douglas Zaccaro Principal Accounting Officer)
/s/ JAMES H. SIMONS Chairman of the Board March 27, 2000
- ---------------------------
James H. Simons
/s/ LEONARD E. BAUM Director March 27, 2000
- ---------------------------
Leonard E. Baum
/s/ JOHN R. LEVINE Director March 27, 2000
- ---------------------------
John R. Levine
/s/ HOWARD L. MORGAN Director March 27, 2000
- ---------------------------
Howard L. Morgan
/s/ JYOTI PRAKASH Director March 27, 2000
- ---------------------------
Jyoti Prakash
</TABLE>
31
<PAGE>
SEGUE SOFTWARE, INC.
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3
Consolidated Statements of Operations for the Years ended December 31,
1997, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity for the Years ended
December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows for the Years ended December 31,
1997, 1996 and 1995 F-6
Notes to Consolidated Financial Statements F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Segue Software, Inc.:
We have audited the accompanying consolidated balance sheets of Segue Software,
Inc. as of December 31, 1997 and 1996, and the related consolidated statements
of operations, stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Segue Software,
Inc. as of December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
February 5, 1998, except as to Note N
which is as of February 7, 2000
F-2
<PAGE>
SEGUE SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
December 31,
-----------
1997 1996
---- ----
(restated)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 22,975 $ 7,112
Short-term investments 14,385 34,092
Accounts receivable, net of allowances of $345 and $200 4,308 3,023
Other current assets 615 1,365
-------- --------
Total current assets 42,283 45,592
Property and equipment, net 2,252 1,960
Completed technology, net 2,964 -
Goodwill, net 7,528 -
Other assets 496 79
-------- --------
Total assets $ 55,523 $ 47,631
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 860 $ 474
Accrued compensation and benefits 1,127 885
Accrued expenses 1,268 642
Deferred revenue 2,477 1,876
Accrued royalties 147 1,047
Short-term subordinated notes payable 883 -
-------- --------
Total current liabilities 6,762 4,924
Subordinated notes payable 3,532 -
Commitments and contingencies (Note J)
Stockholders' equity:
Series A Preferred Stock, par value $.01 per share;
noncumulative; 4,000 shares authorized; no shares
issued and outstanding - -
Common Stock, par value $.01 per share; 30,000 shares
authorized; 7,630 and 7,196 shares issued and
outstanding 76 72
Additional paid-in capital 48,987 46,194
Unearned compensation (105) (440)
Accumulated deficit (3,729) (3,119)
-------- --------
Total stockholders' equity 45,229 42,707
-------- --------
Total liabilities and stockholders' equity $ 55,523 $ 47,631
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-3
<PAGE>
SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------
1997 1996 1995
---- ---- ----
(restated)
<S> <C> <C> <C>
Revenue:
Software $ 15,783 $ 12,592 $ 8,312
Services 6,011 4,381 2,627
Royalties - - 129
-------- -------- --------
Total revenue 21,794 16,973 11,068
Cost of revenue:
Cost of software 1,095 651 315
Cost of services 2,590 1,709 1,194
Cost of royalties - - 30
-------- -------- --------
Total cost of revenue 3,685 2,360 1,539
Gross margin 18,109 14,613 9,529
Operating expenses:
Sales and marketing 11,872 8,500 5,378
Research and development 4,931 3,806 2,273
General and administrative 3,211 2,437 1,709
Non-recurring charges 835 - 449
-------- -------- --------
Total operating expenses 20,849 14,743 9,809
-------- -------- --------
Loss from operations (2,740) (130) (280)
Litigation settlement - (744) -
Interest expense - (44) (57)
Interest income 2,186 1,579 34
-------- -------- --------
Income (loss) before provision for income taxes (554) 661 (303)
Provision for income taxes 56 20 -
-------- -------- --------
Net income (loss) $ (610) $ 641 $ (303)
======== ======== ========
Net income (loss) per common share - basic $ (.08) $ .12 $ (.20)
Net income (loss) per common share - diluted $ (.08) $ .09 $ (.20)
Weighted average common shares outstanding - basic 7,337 5,364 1,552
Weighted average common shares outstanding - diluted 7,337 7,689 1,552
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-4
<PAGE>
SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
Total
Series A Additional Unearned Accumulated stockholders'
Preferred Stock Common Stock paid-in capital compensation deficit equity
--------------- ------------ --------------- ------------ ------- ------
Shares Par value Shares Par value
------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 2,292 $ 4,338 1,527 $ 666 $ (3,457) $ 1,547
Issuance of common stock
under option plan 59 62 62
Net loss (303) (303)
------ -------- ------ ------- ---------- --------
Balance at December 31, 1995 2,292 4,338 1,586 728 (3,760) 1,306
Change in par value (4,315) (712) $ 5,027 -
Issuance of common stock
under option plan 125 1 127 1 1,017 $ (575) 444
Conversion of Series A
preferred stock to common
stock (2,417) (24) 2,416 24 -
Conversion of convertible
debt to common stock 654 7 647 654
Issuance of common stock,
net of issuance costs 2,413 24 39,503 39,527
Amortization of unearned
compensation 135 135
Net income 641 641
------ -------- ------ ------- --------- -------- ---------- --------
Balance at December 31, 1996 - - 7,196 72 46,194 (440) (3,119) 42,707
Issuance of common stock
under stock plans 290 3 1,446 1,449
Issuance of restricted
common stock 144 1 1,539 1,540
Stock options cancelled
and amortization of
unearned compensation (192) 335 143
Net loss (610) (610)
------ -------- ------ ------- --------- -------- ---------- --------
Balance at December 31, 1997 - $ - 7,630 $ 76 $ 48,987 $ (105) $ (3,729) $ 45,229
====== ======== ====== ======= ========= ======== ========== ========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-5
<PAGE>
SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
(restated)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (610) $ 641 $ (303)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Charge for purchased research and development in process 117 - -
Depreciation and amortization 1,242 655 382
Loss on disposal of property and equipment 4 16 35
Noncash compensation charges 666 135 -
Net changes in operating assets and liabilities, net of effects
from acquisitions:
Accounts receivable (1,346) (428) (548)
Other current assets 575 (369) (34)
Accounts payable 386 13 125
Accrued expenses, compensation and benefits 618 739 272
Accrued royalties (900) (72) 29
Deferred revenue 601 808 500
-------- ------- ------
Net cash provided by operating activities 1,353 2,138 458
-------- ------- ------
Cash flows from investing activities:
Additions to property and equipment (1,271) (1,414) (755)
(Increase) decrease in other assets (352) 66 (34)
Acquisition of businesses (4,499) - -
Sales (purchases) of short-term investments, net 19,707 (34,092) -
-------- ------- ------
Net cash provided by (used in) investing activities 13,585 (35,440) (789)
-------- ------- ------
Cash flows from financing activities:
Net proceeds from initial public offering of common stock - 39,527 -
Proceeds from exercise of stock options 925 445 62
-------- ------- ------
Net cash provided by financing activities 925 39,972 62
-------- ------- ------
Net cash increase (decrease) in cash and cash equivalents 15,863 6,670 (269)
Cash and cash equivalents at beginning of year 7,112 442 711
-------- ------- ------
Cash and cash equivalents at end of year $ 22,975 $ 7,112 $ 442
======== ======= ======
Supplemental disclosure of noncash financing transactions:
Conversion of convertible debt into common stock $ - $ 654 $ -
Issuance of subordinated notes payable $ 4,415 $ - $ -
Issuance of restricted common stock $ 1,540 $ - $ -
Supplemental disclosure:
Cash paid during the year for interest $ - $ 38 $ 57
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-6
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
Description of Business
The Company develops, markets and supports integrated software solutions
for the automated functionality and load testing and quality management of
client/server software applications. The Company also provides maintenance,
training and consulting services in support of its product offerings. The
Company operates in one industry segment and no customer accounted for 10% or
more of total revenue in 1997, 1996 or 1995.
Restatement of Financial Statements
The accompanying consolidated financial statements as of and for the year
ended December 31, 1997 have been restated to reflect a change in the original
accounting for the amount and allocation of the purchase price related to the
Company's acquisition of SQLBench in December 1997. See Note N.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany transactions and balances
have been eliminated in consolidation.
Revenue Recognition
Revenue from software license fees is recognized upon shipment and receipt
of a signed purchase order or contract. At the time the Company recognizes
revenue from the sale of software products, collection is probable, no
significant vendor obligations remain and the costs of insignificant support
obligations, if any, are accrued. Maintenance revenue associated with initial
product license contracts is recognized ratably over the initial term, which is
generally one year. Maintenance revenue for annual contracts is deferred and
recognized ratably over the term of agreement. Revenue from training and
consulting services is recognized as the related services are performed. Royalty
revenue is recognized based upon the sale of the related products.
The Company typically does not grant to its customers a contractual right
to return software products. When approved by management, however, the Company
has accepted returns of certain software products and has provided an allowance
for those specific products. The Company also provides reserves for customer
receivable balances which are considered potentially uncollectible. The
Company's allowances amounted to $345,000, $200,000 and $150,000 as of December
31, 1997, 1996 and 1995, respectively. The provision charged to general and
administrative expenses was $362,000, $489,000 and $249,000 in 1997, 1996 and
1995, respectively, and write-offs against the allowances were $217,000,
$439,000 and $139,000 in 1997, 1996 and 1995, respectively.
Deferred Revenue
Service revenue (maintenance, training and consulting) which is not yet
earned is included in deferred revenue.
F-7
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Research and Development and Software Development Costs
Research and development expenditures are charged to operations as
incurred. Software development costs subsequent to the establishment of
technological feasibility are capitalized and amortized to cost of software.
Based on the Company's product development process, technological feasibility is
established upon completion of a working model. Costs incurred by the Company
between completion of the working model and the point at which the product is
ready for general release have been insignificant.
Income Taxes
The Company uses the liability method of accounting for income taxes. Under
this method, deferred tax liabilities and assets are determined based on the
differences between the tax and financial reporting basis of assets and
liabilities and are measured using the tax rates and laws that will be in effect
when the differences are expected to reverse. The Company provides a valuation
allowance against net deferred tax assets if, based upon the available evidence,
it is more likely than not that some or all of the deferred tax assets will not
be realized.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents. Short-term investments
are those with maturities in excess of three months but less than one year. All
cash equivalents and short-term investments have been classified as available-
for-sale and are reported at fair value with unrealized gains and losses
included in stockholders' equity. For the years ended December 31, 1997 and
1996, unrealized gains and losses on available-for-sale securities were
insignificant.
Property and Equipment
Property and equipment are stated at cost. Expenditures for major
improvements which substantially increase the useful lives of assets are
capitalized. Repair and maintenance costs are expensed as incurred. Depreciation
is provided on a straight-line basis over the useful lives of the assets,
generally three to five years. Amortization of leasehold improvements is
computed on a straight-line basis over the remaining term of the lease.
Upon retirement or sale, the cost of the assets disposed and the related
accumulated depreciation and amortization are removed from the accounts and any
resulting gain or loss is included in the determination of net income.
Completed Technology and Goodwill
Completed technology is carried at cost less accumulated amortization,
which is being provided on a straight-line basis over a period of three years,
its estimated useful life (see Note B). Goodwill represents the excess of cost
over the fair value of the net assets of businesses acquired. Goodwill is
amortized using the straight-line method over five years.
F-8
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Long-lived assets to be held and used are recorded at cost. Management
reviews long-lived assets and the related intangible assets for impairment
whenever events or changes in circumstances indicate the carrying amount of such
assets may not be recoverable. Recoverability of these assets is determined by
comparing the forecasted undiscounted net cash flows of the operation to which
the assets relate, to the carrying amount including associated intangible assets
of such operation. In addition, the Company's evaluation considers non-financial
data such as market trends, product development cycles and changes in
management's market emphasis.
Concentration of Credit Risk
The Company invests its cash, cash equivalents and short-term investments
primarily in U.S. Government and government agency securities, investment-grade
commercial paper and money market accounts. The Company has established
guidelines relative to credit ratings, diversification and maturities that
maintain safety and liquidity. The Company has not experienced any losses on its
cash, cash equivalents and short-term investments to date.
The Company sells its products principally through a direct sales force
domestically and through distributors outside of the United States to customers
in a broad range of industries. The Company performs ongoing credit evaluations
of its customers but does not require collateral or other security to support
customer receivables. The Company maintains reserves for credit losses and such
losses have been within management's expectations.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.
Reclassification
Certain prior year amounts have been reclassified to conform to the current
year presentation.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation", allows companies to either account
for stock-based compensation under the provisions of SFAS 123 or under the
provisions of Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting
for Stock Issued to Employees", but requires pro forma disclosure in the notes
to the financial statements as if the measurement provisions of SFAS 123 had
been adopted. The Company has continued to account for its stock-based
F-9
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
compensation in accordance with the provisions of APB 25.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income". This statement requires that changes in comprehensive
income be shown in a financial statement that is displayed with the same
prominence as other financial statements. The statement is effective for annual
periods beginning after December 15, 1997, and the Company will adopt its
provisions in fiscal 1998. Reclassification for earlier periods is required for
comparative purposes. Management does not expect the statement to have a
material impact on the Company's financial disclosures.
In June 1997, the FASB issued SFAS No. 131 ("SFAS 131"), "Disclosure about
Segments of an Enterprise and Related Information", which changes the manner in
which public companies report information about their operating segments. SFAS
131, which is based on the management approach to segment reporting, establishes
requirements to report selected segment information quarterly and to report
entity-wide disclosures about products and services, major customers, and the
geographic locations in which the entity holds assets and reports revenue.
Management is currently evaluating the effects of this change on its reporting
of segment information. The Company will adopt SFAS 131 for its fiscal year
ending December 31, 1998.
In October 1997, Statement of Position 97-2, "Software Revenue Recognition"
("SOP 97-2"), was issued which provides guidance on applying generally accepted
accounting principles in recognizing revenue on software transactions. SOP 97-2
is effective for transactions entered into in fiscal years beginning after
December 15, 1997. The Company will adopt the guidelines of SOP 97-2 as of
January 1, 1998 and does not expect adoption to have a material impact on the
Company's financial results.
B. ACQUISITIONS:
On December 30, 1997, the Company acquired both SQLBench International,
Inc. and ARC - Dr. Ambichl & Dr. Reindl Communication GmbH (formerly named ARC
Dr. Ambichl & Dr. Reindl OEG), privately-held developers of Web-based load
testing technology (hereafter referred to as "SQLBench"). Since the acquisition
of each company was contingent upon both companies being acquired, the
transaction was accounted for as a single business combination using the
purchase method. The combined purchase had an aggregate consideration of
approximately $10.6 million, including transaction costs, and consisted of
approximately $4.4 million in cash paid from the Company's existing cash
balances, $4.4 million in subordinated notes payable and the issuance of 144,000
restricted shares of the Company's common stock with a fair value of $1.5
million. The purchase price was allocated $3.0 million to completed
technology, which is being amortized over three years; $0.1 million to purchased
research and development in process; and $7.5 million to goodwill, which is
being amortized over five years. The purchased research and development in
process had not reached technological feasibility, had no alternative future use
and was valued using expected future
F-10
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
cash flows, discounted for risks and uncertainties related to the target markets
and the completion of the products. Consequently, at the date of acquisition,
the $0.1 million allocated to purchased research and development in process was
recorded as a non-recurring charge.
Set forth below are unaudited pro forma combined results of operations of
the Company and SQLBench for the years ended December 31, 1997 and 1996 as if
the SQLBench acquisition had been completed at the beginning of each year
presented. The pro forma combined information set forth below is not necessarily
indicative of future results of operations or results of operations that would
have been reported for the periods indicated had the acquisition of SQLBench
been completed as of January 1, 1997 or 1996 (amounts in thousands, except per
share data).
<TABLE>
<CAPTION>
Year ended
December 31,
1997 1996
---- ----
(restated)
<S> <C> <C>
Net revenue $ 22,204 $17,317
Net loss $ (1,443) $ (240)
Net loss per share - basic $ (.19) $ (.04)
Net loss per share - diluted $ (.19) $ (.04)
</TABLE>
C. DEVELOPMENT CONTRACTS AND ROYALTY ARRANGEMENTS:
In 1991, the Company entered into a development agreement with Lotus
Development Corporation to develop and provide support for certain versions of a
product. The Company in turn subcontracted certain work to a third party to
assist in the development. Development was completed in 1992. The Company earns
royalties on sales of the product developed under this agreement. The Company
also must pay a certain percentage of the royalties received to the third party
who assisted with development. For the years ended December 31, 1997 and 1996,
there were no royalties earned pursuant to this agreement. During the year ended
December 31, 1995, the Company earned $101,000 pursuant to this agreement.
In addition, the Company participates in other royalty arrangements with
third parties and expenses such amounts as revenues from the related products
are recognized.
F-11
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
D. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Computer equipment $ 3,483 $ 2,466
Office equipment 63 67
Furniture and fixtures 460 343
Leasehold improvements 74 76
------- -------
4,080 2,952
Accumulated depreciation and amortization (1,828) (992)
------- -------
$ 2,252 $ 1,960
======= =======
</TABLE>
Depreciation and amortization of property and equipment amounted to
$996,000, $591,000, and $258,000 during the years ended December 31, 1997, 1996
and 1995, respectively.
E. SUBORDINATED NOTES PAYABLE:
In conjunction with the SQLBench acquisition, the Company issued $4.4
million of subordinated notes payable that bear interest at prime rate (8.5% at
December 31, 1997).
Subject to certain acceleration terms set forth below, the notes mature on
December 30, 2002. Interest is payable in arrears semi-annually beginning on
June 30, 1998 and on each December 31 and June 30 thereafter. If the holders of
the notes terminate employment with the Company prior to December 30, 2000, no
interest shall accrue with respect to any period following such termination. In
the event that the note holders are either (i) employed by the Company as of the
dates set forth below or (ii) terminated by the Company without cause or by
reason of death or permanent disability, payments under the notes shall be made
according to the following schedule (in thousands):
<TABLE>
<CAPTION>
Date Amount
---- ------
<S> <C>
December 30, 1998 $ 883
December 30, 1999 2,649
December 30, 2000 883
------
Total $4,415
</TABLE>
The Company's Convertible Subordinated Notes were converted into 654,200
shares of common stock during the year ended December 31, 1996 at $1.00 per
share.
F. STOCKHOLDERS' EQUITY:
Common Stock
In February 1996, the Board of Directors of the Company voted for the
following, which were approved by the stockholders on February 16, 1996: (i) the
reincorporation of the Company from a California corporation to a Delaware
corporation; (ii) an amendment of the Company's Certificate of Incorporation
F-12
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
to increase the number of authorized shares of common stock and preferred stock
to 30 million and 9 million shares, respectively; (iii) the designation of 4
million shares of such 9 million shares of preferred stock as Series A preferred
stock; (iv) the changing of the per share par value of the common stock and
preferred stock from no par value to $.01 par value; (v) the amendment and
restatement of the Company's 1989 Incentive and Non-Qualified Stock Option Plan,
pursuant to which, among other things, the number of shares of common stock
reserved for issuance pursuant to options granted pursuant to the plan was
increased to 2,450,000 shares, the name of the plan was changed to the 1996
Amended and Restated Incentive and Non-Qualified Stock Option Plan (the "Option
Plan"), and stock option grants to non-employee directors were authorized; and
(vi) the Employee Stock Purchase Plan, which permits eligible employees to
purchase common stock of the Company up to a maximum of 100,000 shares of common
stock.
In May 1997, the stockholders of the Company approved the increase of
550,000 shares of common stock reserved for issuance pursuant to options granted
pursuant to the Option Plan.
In April 1996, the Company consummated an initial public offering of
3,162,500 shares of the Company's common stock ($.01 par value) at an initial
public offering price of $18.00 per share. The total shares issued pursuant to
the initial public offering consisted of 2 million shares sold by the Company,
750,000 shares sold by selling shareholders, and an additional 412,500 shares
sold by the Company pursuant to the underwriters' over-allotment option.
Proceeds to the Company, net of underwriters' discount and associated costs of
$858,000, were approximately $39.5 million. Concurrent with the closing of the
offering, all outstanding shares of Series A preferred stock were converted into
common stock.
In February 1994, the Company sold 500,000 shares of Series A preferred
stock at a purchase price of $2.00 per share and received aggregate proceeds of
$1.0 million in cash. The Company paid $75,000 in related issuance costs. This
transaction included the sale of 375,000 shares of Series A preferred stock and
the issuance of a non-qualified stock option to purchase 125,000 shares of
Series A preferred stock exercisable at $2.00 per share, to an investor who
became a member of the Board of Directors. The option vested over three years
and provided that vesting of the option may be accelerated by the Board of
Directors or upon occurrence of certain events, including a public offering,
merger or liquidation. This option was exercised immediately prior to the
closing of the initial public offering. The Company had also entered into a
consulting agreement with this member of the Board of Directors. The Company
paid no amounts in 1997 or 1996. In 1995, the Company paid a total of $120,000.
In conjunction with the SQLBench acquisition, the Company issued
approximately 144,000 shares of unregistered restricted stock which by agreement
cannot be sold or otherwise disposed of for two years from the acquisition date.
F-13
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Stock Compensation Plans
As of December 31, 1997, the Company has two stock-based compensation plans
(the "Plans"). The Company applies APB 25 in accounting for the Plans. Had
compensation cost for the Company's Plans been determined based on the fair
value at the grant dates for awards under those Plans consistent with the
methodology of SFAS 123, the Company's net income (loss) and income (loss) per
share would have been adjusted to the pro forma amounts indicated below (in
thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
--------- ------- -------
(restated)
<S> <C> <C> <C> <C>
Net income (loss) As reported $ (610) $ 641 $(303)
Pro forma $( 2,733) $(511) $(387)
Income (loss) per common share -
basic As reported $ (.08) $ .12 $(.20)
Pro forma $ (.37) $(.10) $(.25)
Income (loss) per common share -
diluted As reported $ (.08) $ .09 $(.20)
Pro forma $ (.37) $(.10) $(.25)
</TABLE>
For the years ended December 31, 1997, 1996 and 1995, total compensation
cost recognized in pro forma loss for stock-based employee compensation awards
was $2,123,000, $1,152,000 and $84,000, respectively.
Since the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting compensation cost may not be
representative of that to be expected in future years.
Stock Option Plan
The Option Plan provides for the grant of common stock options, for which
there were 3 million shares of common stock reserved.
Incentive stock options (ISOs) may be granted to any officer or employee of
the Company. Nonqualified stock options may be granted to any officer, employee,
consultant, director or other agent of the Company. In the case of ISOs, the
exercise price shall be at least 100% (110% in certain cases) of the fair market
value of the common stock on the date of grant. Options become exercisable at
varying rates, generally over three or four years, as determined by the Board of
Directors.
F-14
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes option activity:
<TABLE>
<CAPTION>
Weighted average
Shares Exercise prices exercise prices
------ --------------- ---------------
<S> <C> <C> <C>
(in thousands)
Outstanding at December 31, 1994 1,016 $ 1.00 - $ 2.00 $ 1.44
Granted 826 2.00 - 3.50 2.39
Exercised (59) 1.00 - 2.00 1.06
Canceled (457) 1.00 - 3.50 1.79
-----
Outstanding at December 31, 1995 1,326 1.00 - 3.50 1.93
Granted 834 9.00 - 35.25 15.01
Exercised (127) 1.00 - 9.00 1.54
Canceled (183) 1.00 - 35.25 16.54
-----
Outstanding at December 31, 1996 1,850 1.00 - 22.25 6.43
Granted 1,177 8.50 - 18.00 10.64
Exercised (249) 1.00 - 11.25 2.33
Canceled (377) 1.00 - 16.63 10.25
-----
Outstanding at December 31, 1997 2,401 $ 1.00 - $22.25 $ 8.32
=====
</TABLE>
Subject to certain exceptions defined under the Option Plan, options expire
10 years from the date of grant. As of December 31, 1997, 1996 and 1995, options
to purchase 877,000, 628,000 and 415,000 shares, respectively, were exercisable
with a weighted average exercise price of $4.88, $2.51 and $1.43 per share,
respectively.
The weighted average fair value of the stock options granted during 1997,
1996 and 1995 was $5.78, $7.30 and $.68 per share, respectively. For the
computation in accordance with SFAS 123, the fair value of each stock option
grant is estimated on the date of grant using the Black-Scholes option pricing
model with the following weighted average assumptions used for grants in 1997,
1996 and 1995, respectively: risk-free interest rate of 6.1%, 5.9% and 7.1%;
dividend yield of 0%; expected life of five years; and expected volatility of
60%, 47% and 0%.
For various price ranges, weighted average information for options
outstanding at December 31, 1997 were as follows:
<TABLE>
<CAPTION>
Outstanding Options Exercisable Options
------------------------------------------- -----------------------------
Weighted
Range of per average Weighted Weighted
share exercise remaining life average average exercise
prices Shares (in years) exercise price Shares price
------ ------ -------- -------------- ------ -----
<S> <C> <C> <C> <C> <C>
$ 1.00 - $ 3.50 826,775 6.34 $ 1.98 647,675 $ 1.81
8.50 - 9.00 546,924 9.27 8.96 80,784 9.00
9.25 - 10.63 370,500 8.60 9.84 12,000 9.50
10.75 - 14.00 438,438 9.19 12.69 76,938 13.44
14.75 - 22.25 218,000 8.67 19.37 59,375 20.72
--------- -------
$ 1.00 - $22.25 2,400,637 8.09 $ 8.32 876,772 $ 4.88
</TABLE>
F-15
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Employee Stock Purchase Plan
On February 12, 1996, the Company established the Segue Software, Inc. 1996
Employee Stock Purchase Plan, under which eligible employees may purchase shares
of the Company's common stock through payroll deductions. The shares can be
purchased for 85% of the lower of the beginning or ending fair market value of
each six-month segment within the offering period. Purchases are limited to 10%
of an employee's annual compensation. A total of 100,000 shares of the
Company's common stock are reserved for issuance under the stock purchase plan,
of which approximately 37,000 shares have been issued as of December 31, 1997.
No shares had been issued as of December 31, 1996.
For the computation in accordance with SFAS 123, the fair value of the
employees' purchase rights is estimated using the Black-Scholes model with the
following assumptions for 1997 and 1996: risk-free interest rate of 5.3% and
5.4%; dividend yield of 0%; expected life of six months; and expected volatility
of 60%.
G. NET INCOME (LOSS) PER SHARE:
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share". Under the new
standard, primary and fully diluted earnings per share were replaced with basic
and diluted earnings per share. All net income (loss) per common share amounts
have been restated to conform to the requirements of SFAS 128.
F-16
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table sets forth the computation of basic and diluted
earnings (loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
--------- ------ -------
(restated)
<S> <C> <C> <C>
Net income (loss) $ (610) $ 641 $ (303)
Plus income impact of assumed conversions
Interest on convertible debt to shareholders, net of tax - 27 -
------- ------ ------
Net income (loss) plus assumed conversions (610) 668 (303)
Weighted average shares used in net income (loss) per share -
basic 7,337 5,364 1,552
Effect of dilutive securities:
Employee and director stock options - 1,164 -
Preferred stock - 614 -
Convertible debt to stockholders - 547 -
------- ------ ------
Dilutive potential common shares - 2,325 -
------- ------ ------
Weighted average shares used in net income (loss) per
common share - diluted 7,337 7,689 1,552
======= ====== ======
Net income (loss) per common share - basic $ (.08) $ .12 $ (.20)
======= ====== ======
Net income (loss) per common share - diluted $ (.08) $ .09 $ (.20)
======= ====== ======
</TABLE>
Options to purchase 584,000 weighted average shares of common stock at an
average exercise price of $8.32 per share were outstanding for the year ended
December 31, 1997, but were not included in the calculation of diluted net loss
per common share because their inclusion would have been antidilutive. Options
to purchase 24,000 weighted average shares of common stock at an average
exercise price of $21.44 were outstanding for the year ended December 31, 1996,
but were not included in the calculation of diluted net income per common share
because the options' exercise prices were greater than the average market price
of the common shares for the period. Options to purchase 1.2 million weighted
average shares of common stock at an average exercise price of $1.72 per share
were outstanding for the year ended December 31, 1995, but were not included in
the calculation of diluted net loss per common share because their inclusion
would have been antidilutive.
H. EMPLOYEE SAVINGS PLAN:
On November 1, 1990, the Company established the Segue Software, Inc.
401(k) Plan, under which all employees may make contributions to their
respective participant accounts. The Company may, at its discretion, make
matching contributions on behalf of its employees. Employees must have completed
two years of service to be eligible for the Company's contributions. No matching
contributions were made during the years ended December 31, 1997, 1996 and 1995.
I. INCOME TAXES:
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. As of December 31, the
F-17
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
components of the net deferred tax asset are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
(restated)
<S> <C> <C>
Gross deferred tax assets
- -------------------------
Federal and state net operating
loss carryforwards $ 1,619 $ 1,004
Acquired intangible assets 46 0
Accrued and deferred compensation 160 43
Research and development credits 1,047 764
Other 368 183
------- -------
Total assets $ 3,240 $ 1,994
------- -------
Gross deferred tax liability
- ----------------------------
Fixed assets $ (47) $ (83)
------- -------
Total liability (47) (83)
------- -------
Valuation allowance (3,193) (1,911)
------- -------
Net deferred tax asset $ 0 $ 0
======= =======
</TABLE>
The Company had a provision for income taxes of $56,000 and $20,000 in 1997
and 1996, respectively, principally for state taxes. There was no provision for
income taxes in 1995. As of December 31, 1997, the Company had federal net
operating loss carryforwards of approximately $4.5 million and state net
operating loss carryforwards of $1.8 million, of which $3,119,000 relates to
deductions attributable to the exercise of non-qualified stock options and
employees' disposition of stock acquired through incentive stock options, as
well as $821,000 of federal tax credit carryforwards available for income tax
purposes. These carryforwards generally expire in the years 1998 through 2012
and may be subject to annual limitations as a result of changes in the Company's
ownership. Management of the Company has evaluated the positive and negative
evidence impacting the realizability of its deferred tax assets, which are
comprised principally of net operating loss carryforwards and tax credits. Based
on the weight of the available evidence, it is more likely than not that all of
the deferred tax assets will not be realized, and accordingly the deferred tax
assets have been fully reserved. Management re-evaluates the positive and
negative evidence on a quarterly basis.
F-18
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
J. COMMITMENTS AND CONTINGENCIES:
Lease Commitments
The Company leases facilities for its headquarters in Massachusetts under
non-cancelable operating leases that expire in 1998. The Company also leases
certain U.S. and foreign sales offices and certain equipment under various
leases with lease terms ranging from month-to-month up to three years. Certain
of these leases contain renewal options. The agreements generally require the
payment of utilities, real estate taxes, insurance and repairs. Future minimum
payments under the facilities and equipment leases with non-cancelable terms are
as follows as of December 31, 1997 (in thousands):
<TABLE>
<S> <C>
1998 $558
1999 95
2000 19
----
$672
====
</TABLE>
Rent expense for the years ended December 31, 1997, 1996 and 1995 amounted
to $680,000, $585,000 and $263,000, respectively.
Royalty Commitments
In November 1996, the Company entered into an agreement with a vendor who
licensed specific software to the Company for purposes of marketing and
distribution. Under the terms of the agreement, the Company was required to pay
$1.0 million in royalties by December 31, 1997. As of December 31, 1996, the
Company had paid $100,000 and recorded a minimum royalty commitment of $900,000.
Royalty expense was recognized based upon the sale of the related product. As
of December 31, 1997, the Company had paid $800,000 in total and recognized
royalty expense of $170,000 related to the royalty agreement. In December 1997,
the Company acquired the vendor (see Note B) with the existing royalty agreement
being terminated. The remaining prepaid royalty of $630,000 was refunded to the
Company in conjunction with the acquisition.
K. NON-RECURRING CHARGES:
In the fourth quarter of 1997, the Company recognized a charge of $117,000
related to the write-off of purchased research and development in process in
conjunction with the SQLBench acquisition and $718,000 consisting of severance
and accelerated vesting of options related to the resignation of the Company's
former President and Chief Executive Officer. The charge of $718,000 consisted
of $195,000 in severance and $523,000 in accelerated vesting of options for
common stock.
For the year ended December 31, 1995, severance charges reflect costs
incurred pursuant to an employment separation agreement dated as of June 30,
1995 between the Company and its former Chief Executive Officer.
F-19
<PAGE>
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
L. LITIGATION SETTLEMENT:
On September 30, 1996, the Company entered into a definitive agreement with
a plaintiff, a software company located in Cambridge, MA, to settle litigation
brought against the Company and certain of its current and former employees. The
Company recorded a charge of $744,000 during the third quarter of 1996 to cover
the settlement and other expenses incurred in connection therewith.
M. SUBSEQUENT EVENT:
In the second quarter of 1998, the Company expects to enter into a nine-
year lease commitment for 40,500 to 67,500 square feet, effective August 1,
1998, at an annual rental rate of approximately $2.2 million. The lease expires
in October, 2007. The Company has the right to terminate the lease on September
30, 2004 for a fee of approximately $2.2 million.
N. RESTATEMENT RELATED TO ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
The accompanying consolidated financial statements as of and for the year
ended December 31, 1997 have been restated to reflect a change in the original
accounting for the amount and allocation of the purchase price related to the
Company's acquisition of SQLBench in December 1997.
In a letter dated September 9, 1998 to the American Institute of Certified
Public Accountants SEC Regulations Committee, the Securities and Exchange
Commission ("SEC") set forth its views on purchased in-process research and
development ("IPR&D"), taking issue with certain appraisal practices employed in
practice at the time. Subsequent to the issuance of the SEC letter, the staff
of the SEC has reviewed various filings of the Company and has inquired
regarding the methods used by the Company to value acquired IPR&D that was
written-off as of the acquisition date. As a result of this review, the Company
has modified the methods used to value acquired intangible assets in connection
with the SQLBench acquisition and has increased the total purchase price from
$10.1 million to $10.6 million. Under the revised accounting, the value
ascribed to the acquired IPR&D was reduced from $9.1 million to $0.1 million,
the value assigned to acquired completed technology was increased from $1.0
million to $3.0 million, and goodwill of $7.5 million was recorded. The
principal effects of this restatement on previously reported consolidated
financial statements as of and for the year ended December 31, 1997 are set
forth below (in thousands, except per share data). The restatement does not
affect previously reported net cash flows for any period.
<TABLE>
<CAPTION>
For the year ended
December 31, 1997
------------------
As
Previously As
Reported Reported
---------- --------
<S> <C> <C>
Non-recurring charges $ 9,813 $ 835
Total operating expenses 29,827 20,849
Loss from operations (11,718) (2,740)
Loss before provisions for
income taxes (9,532) (554)
Net loss (9,588) (610)
Net loss per common share -
basic and diluted (1.31) (0.08)
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1997
-----------------------
As
Previously As
Reported Reported
---------- --------
<S> <C> <C>
Completed technology, net $ 1,006 $ 2,964
Goodwill, net - 7,528
Total assets 46,037 55,523
Additional paid-in capital 48,479 48,987
Accumulated deficit (12,707) (3,729)
Total stockholders' equity 35,743 45,229
</TABLE>
F-20
<PAGE>
Exhibit 23.1
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the registration
statement on Form S-8 (No. 333-09393) of Segue Software, Inc. of our report
dated February 5, 1998, except as to Note N which is as of February 7, 2000,
relating to the consolidated financial statements, which appears in this Annual
Report on Form 10-K/A for the year ended December 31, 1997.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 27, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 22,975
<SECURITIES> 14,385
<RECEIVABLES> 4,653
<ALLOWANCES> 345
<INVENTORY> 107
<CURRENT-ASSETS> 42,283
<PP&E> 4,080
<DEPRECIATION> 1,828
<TOTAL-ASSETS> 55,523
<CURRENT-LIABILITIES> 6,762
<BONDS> 0
0
0
<COMMON> 76
<OTHER-SE> 45,153
<TOTAL-LIABILITY-AND-EQUITY> 55,523
<SALES> 15,783
<TOTAL-REVENUES> 21,794
<CGS> 1,095
<TOTAL-COSTS> 3,685
<OTHER-EXPENSES> 20,849
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (554)
<INCOME-TAX> 56
<INCOME-CONTINUING> (610)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (610)
<EPS-BASIC> (0.08)
<EPS-DILUTED> (0.08)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 7,111,690
<SECURITIES> 34,091,859
<RECEIVABLES> 3,022,468
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 45,591,152
<PP&E> 1,960,178
<DEPRECIATION> 591,000
<TOTAL-ASSETS> 47,630,668
<CURRENT-LIABILITIES> 4,923,693
<BONDS> 0
0
0
<COMMON> 71,959
<OTHER-SE> 42,635,016
<TOTAL-LIABILITY-AND-EQUITY> 47,630,668
<SALES> 16,972,867
<TOTAL-REVENUES> 16,972,867
<CGS> 2,250,678
<TOTAL-COSTS> 14,852,094
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 43,952
<INCOME-PRETAX> 661,347
<INCOME-TAX> 20,000
<INCOME-CONTINUING> 641,347
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 641,347
<EPS-BASIC> .12
<EPS-DILUTED> .09
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ITEM 1 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 6,216
<SECURITIES> 34,730
<RECEIVABLES> 4,041
<ALLOWANCES> 240
<INVENTORY> 61
<CURRENT-ASSETS> 46,314
<PP&E> 3,316
<DEPRECIATION> 1,194
<TOTAL-ASSETS> 48,511
<CURRENT-LIABILITIES> 4,771
<BONDS> 0
0
0
<COMMON> 73
<OTHER-SE> 43,667
<TOTAL-LIABILITY-AND-EQUITY> 48,511
<SALES> 5,401
<TOTAL-REVENUES> 5,401
<CGS> 199
<TOTAL-COSTS> 743
<OTHER-EXPENSES> 4,446
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 746
<INCOME-TAX> 48
<INCOME-CONTINUING> 698
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 698
<EPS-BASIC> .10
<EPS-DILUTED> .09
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> APR-01-1997 JAN-01-1997
<PERIOD-END> JUN-30-1997 JUN-30-1997
<CASH> 7,433 0
<SECURITIES> 33,159 0
<RECEIVABLES> 4,436 0
<ALLOWANCES> 240 0
<INVENTORY> 138 0
<CURRENT-ASSETS> 46,770 0
<PP&E> 3,956 0
<DEPRECIATION> 1,442 0
<TOTAL-ASSETS> 49,335 0
<CURRENT-LIABILITIES> 5,282 0
<BONDS> 0 0
0 0
0 0
<COMMON> 74 0
<OTHER-SE> 43,999 0
<TOTAL-LIABILITY-AND-EQUITY> 49,335 0
<SALES> 5,352 10,753
<TOTAL-REVENUES> 5,352 10,753
<CGS> 188 387
<TOTAL-COSTS> 865 1,608
<OTHER-EXPENSES> 4,894 9,340
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 139 885
<INCOME-TAX> 8 56
<INCOME-CONTINUING> 131 829
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 131 829
<EPS-BASIC> .02 .11
<EPS-DILUTED> .02 .10
</TABLE>
