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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(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, 1999
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.)
201 Spring Street,
Lexington, Massachusetts 02421
(Address of principal executive offices)
Registrant's telephone number, including area code: (781) 402-1000
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. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $100,982,515 as of March 15, 2000, 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 15,
2000 was 9,347,576.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A for Registrant's 2000 Annual Meeting of Stockholders to be held
on June 23, 2000, are incorporated by reference into Part III of this Annual
Report on Form 10-K.
SEGUE SOFTWARE, INC.
FORM 10-K
TABLE OF CONTENTS
Page
PART I
Item 1. Business 2
Item 2. Properties 8
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 9
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 27
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 28
Item 11. Executive Compensation 28
Item 12. Security Ownership of Certain Beneficial Owners and Management 28
Item 13. Certain Relationships and Related Transactions 28
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 29
This Form 10-K contains 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 future performance of Segue Software,
Inc. and its subsidiaries (hereafter, collectively, "we", "us", "our", "Segue"
or the "Company"). 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 this form 10-K under the caption
"Certain Factors Affecting Future Operating Results" and else where in this Form
10-K.
PART I
ITEM 1. BUSINESS
GENERAL
Segue develops, markets and supports software products, and provides
related professional services for the management and testing of electronic
business ("eBusiness") applications. The Company was incorporated in California
in 1988 and reincorporated in Delaware in March 1996. Our products are used by
webmasters, quality assurance professionals and software developers to improve
software quality, reduce development costs, manage the vast and growing number
of application components and shorten the time required to develop and deploy
these mission-critical applications. Our products provide a solution designed to
deliver automated functional, load testing and monitoring of applications
deployed on the World Wide Web. These solutions enable our customers to reliably
deploy and operate business-to-business (B2B) and business-to-consumer (B2C) web
sites. Reliability solutions, such as ours, are critical components of the
eBusiness infrastructure that is developing rapidly on a global basis. Segue's
eBusiness software revenue was 96%, 61%, and 33% of total software revenue for
the years ended December 31, 1999, 1998 and 1997, respectively. Our
client/server products, Segue's original product line, represented 4%, 39% and
67% of total software revenue for the years ended December 31, 1999, 1998 and
1997, respectively.
During 1997, Segue introduced new technology to provide automated
software testing for web-enabled software applications, extending our
distributed testing capabilities beyond distributed client/server applications
with GUI front ends. We also began to focus on load testing through an
OEM/reseller arrangement with a third party software vendor. On December 30,
1997, we 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 2 to the Consolidated Financial Statements).
The acquired load testing product, SilkPerformer, provides web developers and
testers the ability to determine the scalability of their web applications.
SilkPerformer revenue has grown rapidly from its introduction in the fourth
quarter of 1997 and represented approximately 50% of license revenue in the
fourth quarter of 1999.
In the second quarter of 1998, Segue introduced "LiveQuality," an
eBusiness scenario testing solution, and continued our strategic transition from
general software testing to the more specialized world of eBusiness testing. In
May 1999 we decided to brand all of our eBusiness products under the Silk brand
and renamed the LiveQuality product to be "SilkRealizer."
In December 1998 Segue acquired Eventus Software, Inc. ("Eventus")
which we anticipated would provide our business with content management and
workflow tools for eBusiness application development teams. Our plan was to
integrate our web testing tools with Eventus' Control product to produce a
single integrated product for rapid web application deployment. In addition, we
planned on selling the Control product under the name SilkControl as a
standalone product or as a sales bundle with other Segue web testing tools. In
May 1999 we revised our plans, deciding to delay the introduction of the Eventus
product, SilkControl. In addition, we are still evaluating our integration plans
for Control to determine how best to use the underlying technology of the
Control product.
2
During the first quarter of 1999, Segue began to execute a
restructuring plan to consolidate our marketing, product development and
administrative operations in order to achieve cost efficiencies through the
elimination of redundant functions. We realigned our marketing and product
development operations to redirect our focus to our strongest product lines and
better integrate the efforts of our product development teams. We recognized a
one-time pre-tax charge of approximately $1.0 million during the first quarter
of 1999 related to this restructuring plan. The restructuring charge included
approximately $830,000 for severance and other employee-related costs of the
terminated staff and approximately $190,000 for facility-related costs,
including the accrual of estimated lease obligations associated with the closure
of excess office facilities.
In the second quarter of 1999, Segue introduced the first versions of
SilkPilot, SilkMeter and SilkObserver. These tools came from our acquisition in
December 1998 of Black & White Software, Inc. ("B&W"), providing our business
with tools that specifically assist engineers in the testing of complex logic
associated with eBusiness servers. These tools help engineers detect software
bugs, monitor and diagnose performance, and meter transactions in servers that
deploy complex distributed Common Object Request Broker Architecture (CORBA)
object technology. License sales from these tools in 1999 were approximately
$400,000.
In addition, during the second quarter of 1999, we restructured our
product development operations and delayed the introduction of the Eventus
product, SilkControl. These activities were aimed at reducing our costs
associated with the development of that product and enhancing our sales force
ability to focus on other products. The restructuring resulted in the
consolidation of four development labs into three and included the termination
of fifteen employees associated with the development of the Eventus product.
Additionally, during the second quarter of 1999, Segue shifted its sales
strategy away from creating and managing a large network of resellers towards
building deeper relationships with a few large system integrators. This revised
strategy resulted in the termination of seven of our employees who focused sales
efforts on these channel resellers. Segue also terminated the employment of two
senior vice presidents during the second quarter of 1999, each of whom has
subsequently been replaced. Associated with all the events noted above, we
recorded during the second quarter of 1999 non-recurring and other charges of
approximately $1.5 million, of which $1.0 million relates exclusively to
severance and other employee-related costs associated with a restructuring, and
$481,000 (including a noncash compensation charge of approximately $118,000)
which relates to severance of two senior vice presidents. Further, beginning in
the second quarter of 1999, we implemented an ongoing program of extensive
training of our own sales and marketing organization for all existing and newly
acquired products.
In the third quarter of 1999 Segue introduced the eConfidence Solutions
packages called eConfidence Functionality, eConfidence Performance and
eConfidence Production that bundle our quality assurance tools with our
consulting services that range from a few weeks to several months.
We are focused on building up our eBusiness expertise through our
consulting services and then training the information technology consulting
industry to deliver these services based on Segue products. We believe that
consultants represent an important source of indirect channel revenue for the
future and that product education is a critical element for our success. As part
of this program, in October 1999, Segue published a book for consultants "Gain
eConfidence - The eBusiness Reliability Survival Guide." In addition, in
November 1999 we created eConfidence University, a certification school for
industry consultants that uses our book as its text. We trained 100 consultants
in the fourth quarter of 1999 from partnerships we have formed with several
consulting firms including USWeb/CKS, Arthur Andersen LLP, IBM Global Services
and PricewaterhouseCoopers LLP.
INDUSTRY BACKGROUND
Companies worldwide are rapidly implementing eBusiness applications
that customers can access twenty-four hours a day, seven days a week. 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 products
and services, consistent and effective operation of software applications has
become more critical to these businesses' success. While the real-time
communication prompted by eBusiness has created constant access to a company's
services and products, it also brings with it constant exposure. This exposure
is forcing companies to re-think the stability of their systems, as the cost of
an unexpected shutdown could cripple even the strongest of organizations.
3
Unlike mainframe environments, where applications, operating systems
and hardware are designed by a single vendor as an integrated solution, or
traditional client/server systems, where application development follows a
process of specify, design, develop, test and release, web-based systems are
developed across many different functional areas in an organization, are
designed in component fashion and are continuously being assembled, validated
and deployed based on market conditions. In addition, 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 Web-based configuration, a browser might
access a Netscape Web server that then sends requests to a router installed on a
Microsoft NT server that distributes the requests 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 Web-based applications are
developed separately by multiple vendors and integrated to form a business
system.
Web applications present enormous challenges to webmasters, quality
assurance professionals and software developers. These challenges include
integrating the efforts of many diverse contributors, managing a large and
growing number of varied application components and keeping applications
up-to-date with changing content while simultaneously maintaining system
reliability and accuracy.
Traditional automated functional and regression testing tools, which
are designed for a specific component on a particular platform, do not
adequately address the complexities of distributed 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 functional and regression 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 using such
tools. Finally, they do not deliver the capability to design, create, manage and
re-use tests across multiple platforms and system configurations, thereby
resulting in additional costs and time spent on the software development and
quality assurance processes.
As businesses move mission-critical applications to the Internet to
give customers greater access to such applications, they will need to test and
measure the true capacity and scalability of web applications in order to avoid
shutdowns, delays and other problems, and provide quality service. Such tests
should help users determine whether (i) web applications scale with anticipated
Internet volume, (ii) such applications can operate with little or no downtime,
and (iii) new content can be deployed quickly and reliably. 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
before the application is deployed and exposed to real customers.
PRODUCTS
Segue provides a full suite of products and services, known as our Silk
Product Line, designed to help companies create, monitor and deploy more
reliable B2B and B2C web applications. In addition, we continue to support our
legacy client/server automated testing tools.
eBUSINESS MANAGEMENT SYSTEM PRODUCTS
SILKRADAR is a defect-tracking product used to track and manage errors in
software projects that provides the ability to associate test scenarios and
known defects with each component.
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 is a test
planning and management tool, that creates customized test plans for particular
applications and manages the testing process from a central point of control.
SilkTest also 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, SilkTest helps ensure that client/server applications
function with the associated database reliably before they deploy. SilkTest can
run across multiple platforms, technologies, browsers and environments.
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 Web and application
server protocols including HTTP, HTTPS, FTP, POP3, LDAP, SMTP and IIOP at
varying connection speeds from 14.4 kbs through ISDN, T1 and other high-speed
connections.
4
SILKPILOT provides object-level transaction validation for debugging and testing
of objects in a CORBA-based distributed environment.
SILKREALIZER models the effects on business processes under real-world
conditions such as unpredictable user loads, rapid content change or
event-triggered volume.
SILKMETER manages the deployment and authorized usage of distributed objects for
the purpose of monitoring and billing.
SILKOBSERVER offers diagnostic and trace mechanisms for the effective monitoring
of communications between distributed application objects. SilkObserver monitors
and tracks individual and group transactions and verifies travel time,
transaction accuracy and resource utilization.
SILKMONITOR is for 24x7 monitoring and reporting of web, applications and
database servers.
CLIENT/SERVER TESTING PRODUCTS
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.
SERVICES
We supplement our product offerings with training, consulting and
technical support services. Segue's services are designed to promote a clear and
consistent approach to our solutions and facilitate the penetration of our
products into a broader market. As of March 13, 2000, these services were
provided by approximately 69 employees.
Training and Consulting. We offer training courses and consulting services,
performed by Segue employees and third party consultants, in support of our
products. Our training courses are held regionally in selected U.S. cities or at
the customer site. We have two principal objectives for our fee-based training
courses and consulting services; (i) to produce the agreed-upon deliverables for
the projects, and (ii) to enhance our customers' understanding of our
methodologies and techniques.
Support Services. We offer fee based annual maintenance contracts to customers
who have entered into license agreements for the use of Segue software
products. We provide customer service and support through our internal technical
support organization. Support services include the maintenance of our software
products in accordance with specifications contained in the user's guide for
such products and access to technical support personnel. This support includes
technical support through our internal customer support group via phone, fax and
e-mail communications. Our distributors and some of our channel partners provide
initial telephone support to end-users. We currently provide these services from
our Lexington, Massachusetts facility and from our global technical support
center in Belfast, Northern Ireland.
SALES AND MARKETING
Segue sells its products through four channels (1) a direct sales
force, (2) telesales representatives, (3) a business partner program, and (4)
international distributors and resellers. We have made a significant investment
in sales and marketing in each of the last three years. As of March 13, 2000,
our sales and marketing force consisted of approximately 137 employees.
Direct Sales. In the fourth quarter of 1999, Segue continued focusing its sales
and marketing efforts on the eBusiness and Internet applications market with a
multi-level sales organization. We have structured our sales force into four
sales organizations (1) a field-deployed sales force, (2) a telesales
organization, (3) a field-deployed system integrator sales force, and (4) a
Business Development sales organization responsible for development and
management of new
5
business partners. Each sales organization above has sales people that are
assigned sales quotas and technical sales engineers. We have thirteen sales
offices in North America, one sales office in the United Kingdom and three sales
offices in Germany. We have embarked on a significant sales force expansion
beginning in January 2000 in the United States and Europe. As of March 13, 2000,
our direct sales force consisted of approximately 69 employees.
Telesales. Segue's telesales organization responds to incoming inquiries
generated by our advertising and marketing activities. Telesales representatives
also initiate calls to existing customers, offering them new products. As of
March 13, 2000, our telesales force totaled approximately 29 employees.
Business System Integrator Partner Programs. We have established an indirect
sales program of value added resellers and system integrators including
USWeb/CKS, Arthur Andersen LLP, PricewaterhouseCoopers LLP and IBM Global
Services. In early 1999, we implemented a comprehensive Global Business Partner
program to target top resellers, system integrators and consulting partners,
resulting in recent partnership agreements with Netscape, IONA and Computer
Associates. As of March 13, 2000, our internal business sales force totaled
approximately 16 employees.
International Sales. In international markets, we have direct sales offices in
United Kingdom and Germany and distributors in Sweden, Finland, Norway, Denmark,
Spain, Italy and Australia. Our international sales force is approximately 16
employees. Segue derived approximately 12%, 16%, and 10% of its total software
revenue from international customers in 1999, 1998 and 1997, respectively.
In support of our sales efforts, we conduct sales training courses,
targeted marketing programs, including direct mail, public relations,
advertising, seminars, trade shows, telemarketing and ongoing customer and third
party communications programs. We also seek to stimulate interest in our
products through a public relations program, speaking engagements, white papers,
technical notes and other publications. We have a home page on the Internet's
World Wide Web, where potential customers can access information about us and
our products.
BACKLOG
The time between order and delivery of Segue's products is generally
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, we typically do not have a backlog of unfilled
orders.
RESEARCH AND DEVELOPMENT
Segue has made substantial investments in research and product
development. Our research and development is conducted by project teams
consisting of development and quality assurance engineers, technical writers and
product managers. We use many of our own products and methodologies in our
development process. Segue organizes development and quality assurance schedules
to optimize usage of automated tests by starting script development very early
in the development life cycle. Our research and development staff originates,
produces and tests many of our prototype products. The research and development
department consults with our sales and marketing staff and utilizes the feedback
from customer support and training to ensure the satisfaction of our current
customers. We also license technology from vendors to be embedded in our product
for resale or to be resold as Segue products.
Segue's primary research and development group is located at our
corporate headquarters in Lexington, Massachusetts. We also have development
operations in Austria and Northern California. The majority of the Northern
California employees joined the Company as part of the December 1998 acquisition
of Black & White. As of March 13, 2000, we had approximately 80 employees in
research and development. We intend to continue making significant investments
in research and development to develop new products, expand the capabilities of
our web application testing products and "internationalize" Segue products.
6
COMPETITION
The market for software quality management tools is new, intensely
competitive, rapidly evolving and subject to rapid technological change. Segue's
competitors offer a variety of products and services to address this market. We
currently encounter 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 our
current and possible future competitors have significantly greater financial,
technical, marketing and other resources than we have, and many have well
established relationships with our current and potential customers. It is also
possible that alliances among competitors may emerge and rapidly acquire
significant market share. We also expect that competition will increase as a
result of software industry consolidations or increased web usage. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which could materially adversely affect our business,
operating results and financial condition. There can be no assurance that Segue
will be able to compete effectively against current and future competitors.
Segue 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 we believe that Segue currently competes effectively
with respect to such factors, there can be no assurance that we will be able to
maintain our competitive position against current and potential competitors.
PROPRIETARY TECHNOLOGY
Segue primarily relies upon a combination of patents, trademarks,
copyrights and trade secret laws and employee and third-party non-disclosure
agreements to protect its proprietary rights in its products. We have two issued
patents and currently have submitted one more patent application that is under
evaluation by the United States Patent and Trademark Office. However, there can
be no assurance that these patents would be upheld if challenged. There can be
no assurance that our competitors will not independently develop technologies
that are substantially equivalent or superior to our technology. There can also
be no assurance that the measures taken to protect our 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 our products may be sold may not protect our 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 Segue or that any such claims
will not require us to enter into royalty arrangements or result in costly
litigation. We are not aware of any patent infringement charge or any violation
of other proprietary rights claimed by any third party relating to Segue or the
Segue 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. We believe that due to the rapid pace of technological
innovation for software quality management products, our ability to establish
and maintain a position of technology leadership in the industry is dependent
more upon the skills of our development personnel than upon the legal
protections afforded our existing technology.
EMPLOYEES
As of March 13, 2000, Segue had approximately 336 full-time employees
with 80 in research and development, 137 in sales and marketing, 69 in services,
and 50 in operations, finance and administration. Our employees are not
represented by any collective bargaining organizations and Segue has never
experienced any work stoppages. We consider our relations with our employees to
be good.
7
ITEM 2. PROPERTIES
Segue's corporate headquarters are located in Lexington, Massachusetts,
where the Company leases 67,500 square feet of office space under a lease that
expires in October 2007. On July 1, 1999, we fulfilled our commitment to lease
an additional 15,000 square feet at this corporate location. With this
additional space, we believe that we now have adequate expansion space for the
growth in operations at the headquarters location for the foreseeable future.
In November of 1999, Segue entered into a five year lease for 15,600
square feet of office space in Los Gatos, California. This site was established
as our Western Headquarters. The new space allowed us to consolidate two
California locations which housed the Campbell, California product development
lab and the Los Gatos based Western Regional Sales operation. The consolidation
of these two offices was implemented in February 2000. As a result of this
action, the Campbell, California lease terminated upon expiration in January
2000. The prior Los Gatos sales office will be subleased through the remainder
of the term (through March 31, 2003); the sublease agreement was executed on
March 24, 2000.
In February 2000, the Company entered into a five year lease for a
branch sales office consisting of approximately 3,200 square feet in San
Francisco, California. This office will replace another larger office in San
Francisco that we had acquired as part of the Eventus acquisition in December
1998. The lease for our existing office terminates in April 2000.
In addition, to the office locations outlined above, we have field
sales and support operations in ten other locations throughout the United States
and in six locations in Canada and Europe. Remote product development facilities
are located in Los Gatos, California and Linz, Austria. With the expansion of
our headquarters location in Lexington, Massachusetts and our Western
Headquarters in Los Gatos, California, we believe that our current facilities
are sufficient for current operations and for operations in the foreseeable
future.
ITEM 3. LEGAL PROCEEDINGS
On or about April 27, 1999, a putative class action complaint was filed
in the United States District Court for the District of Massachusetts against
Segue, its Chief Executive Officer and a former Chief Financial Officer of
Segue, captioned Nathan Rice v. Segue Software, Inc., et al., Civil No.
99-CV-10891RGS. The class action complaint alleged the defendants violated the
federal securities laws by making material misrepresentations and omissions in
certain public disclosures during the period beginning on October 13, 1998
through April 9, 1999, inclusive. The public disclosures relate to, among other
things, Segue's past and future financial performance and results. On or about
May 3, 1999, another similar putative class action complaint was filed against
Segue, its Chief Executive Officer and a former Chief Financial Officer of Segue
in the United States District Court for the District of Massachusetts, captioned
Anthony Moumouris v. Segue Software, Inc., et al., Civil No. 99-CV-10933RGS.
These cases were consolidated under the caption In Re Segue Software, Inc.
Securities Litigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a
consolidated amended complaint on September 27, 1999 alleging a putative class
period of July 14, 1998 through April 9, 1999, inclusive. The complaints sought
an unspecified amount of damages. Segue intends to defend the claims vigorously.
On November 8, 1999 each of the defendants filed a motion to dismiss the amended
complaint for failure to state a cause of action. The plaintiffs have opposed
the motions to dismiss on various grounds. The court heard arguments on the
motions on March 15, 2000, but has not yet rendered a decision on the motions.
It is not possible to predict when the court will rule on the motions or whether
they will be granted in whole or in part. Segue believes the defense of the
claims could involve significant litigation-related expenses. The outcome of
these matters is uncertain and, as a result, at this time Segue is not able to
quantify any related financial exposure. In the event that any of the claims set
forth in the class action complaints are determined or settled in a manner
adverse to Segue, then such determination or settlements could adversely affect
Segue's financial position or results of operations in the period in which the
litigation is resolved.
Various other claims, charges and litigation have been asserted or
commenced against the Company arising from or related to contractual or employee
relations. Management does not believe these claims will have a material adverse
effect on the financial position or results of operations of the Company.
8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET PRICE FOR COMMON STOCK
The following table sets forth, for the periods indicated, the high and
low closing prices of our Common Stock as reported on the Nasdaq National Market
System. Our Common Stock is traded under the Nasdaq symbol: SEGU. These prices
do not include retail markups, markdowns, or commissions.
YEAR ENDED DECEMBER 31, 1999: HIGH LOW
----------------------------- ---- ---
First Quarter $23.313 $8.813
Second Quarter $9.625 $4.438
Third Quarter $12.563 $7.000
Fourth Quarter $25.875 $9.875
YEAR ENDED DECEMBER 31, 1998: HIGH LOW
----------------------------- ---- ---
First Quarter $15.000 $9.875
Second Quarter $16.063 $12.250
Third Quarter $18.875 $13.875
Fourth Quarter $24.625 $12.750
On March 15, 2000, the closing price reported on the Nasdaq National
Market System for the Common Stock was $15.50. The market price of our Common
Stock has fluctuated significantly and is subject to significant fluctuations in
the future.
HOLDERS OF RECORD
As of March 15, 2000, there were approximately 104 holders of record of
the Common Stock and 9,347,576 shares of Common Stock outstanding. We estimate
that as of March 15, 2000, there were approximately 2,308 beneficial
stockholders.
DIVIDEND POLICY
We have never paid cash dividends on our Common Stock and do not
anticipate paying such dividends in the foreseeable future. The current policy
of our Board of Directors is 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.
1998 SALES OF UNREGISTERED SECURITIES
On December 3, 1998, the Company issued an aggregate of 312,990 shares
of Common Stock to the then current stockholders of Eventus in connection with
acquisition of all the capital stock of Eventus. We issued the shares of Common
Stock to the then current stockholders of Eventus in a private placement in
reliance on Rule 506 of Regulation D promulgated under the Securities Act of
1933 ("Regulation D").
On December 31, 1998, the Company issued an aggregate of 224,809 shares
of Common Stock to the stockholder of Black and White (referred to as B&W) in
connection with our acquisition of all the capital stock of B&W. We issued the
shares of Common Stock to the stockholder of B&W in a private placement in
reliance on Rule 506 of Regulation D.
9
USE OF PROCEEDS FROM REGISTERED SECURITIES
We completed our initial public offering ("IPO") of Segue Common Stock
in April 1996. The IPO was made pursuant to a Registration Statement on Form
S-1, filed with the Securities and Exchange Commission pursuant to Rule 462(b)
under the Securities Act of 1933 (Commission File No. 333-1488), which was
declared effective as of March 28, 1996. The IPO commenced on April 2, 1996 and
terminated shortly thereafter after the sale into the public market of all of
the registered shares of Common Stock.
The 3,162,500 shares of Common Stock sold by the Company and selling
security holders in our IPO were offered for sale in the United States by a
syndicate of underwriters represented by Alex. Brown & Sons Incorporated; Adams,
Harkness & Hill, Inc. and Soundview Financial Group, Inc.
We registered an aggregate of 2,412,500 shares of Common Stock
(including 412,500 shares issued upon the exercise of the underwriters'
overallotment options) for sale in the IPO at a per share price of $18.00 for an
aggregate offering price of approximately $43.4 million. All of such shares were
registered for the Company's account. Selling security holders registered an
aggregate of 750,000 shares of Common Stock for sale in the IPO at a per share
price of $18.00 for an aggregate offering price of $13.5 million. All of such
shares were registered for the selling security holders' accounts. As stated
above, all of such shares were sold shortly after the commencement of the
offering.
After deducting the expenses of $3.9 million, we received approximately
$39.5 million in net proceeds of the IPO.
Through the period ended December 31, 1999, we used approximately $7.2
million for the purchase of property and equipment, approximately $4.75 million
for repayment of indebtedness including interest ($3.4 million and $645,000, for
principal and interest, respectively, on the SQLBench notes and approximately
$395,000 and $334,000 on Eventus and B&W debt, respectively), $950,000 for
guaranteed royalties, $480,000 for a non-recurring engineering and initial
license fee, approximately $1.3 million for employee severance payments, and
approximately $14.6 million for working capital. The remaining $10.2 million was
invested in temporary investments, mainly consisting of government agency paper
and commercial paper.
No payments from the net offering proceeds of the IPO were made to
directors, officers, or persons owning 10 percent or more of the Common Stock of
the Company.
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 Form 10-K.
All financial data below has been restated to give retroactive effect
to the Company's December 1998 acquisitions of Eventus and B&W, using the
pooling-of-interests method of accounting.
10
STATEMENT OF OPERATIONS DATA: Year Ended December 31,
1999 1998 1997 1996 1995
--------- -------- -------- -------- --------
(in thousands, except per share data)
Revenue:
Software $ 29,448 $ 26,249 $ 19,662 $ 16,551 $ 11,544
Services 16,973 14,599 7,977 5,411 2,627
Royalties -- -- -- -- 129
--------- -------- -------- -------- --------
Total revenue 46,421 40,848 27,639 21,962 14,300
Cost of revenue:
Cost of software 2,762 (5) 4,291 3,673 2,807 1,537
Cost of services 8,942 6,119 2,641 1,721 1,194
Cost of royalties -- -- -- -- 30
--------- -------- -------- -------- --------
Total cost of revenue 11,704 10,410 6,314 4,528 2,761
Gross margin 34,717 30,438 21,325 17,434 11,539
Operating expenses :
Sales and marketing 29,461 20,764 14,071 10,073 6,710
Research and development 10,224 8,571 7,084 5,043 2,781
General and administrative 7,757 4,500 3,933 2,950 1,709
Amortization of goodwill 1,506 1,506 -- -- --
Non-recurring and other charges (1) 2,499 (2) 1,531 (3) 835 -- (4) 449
--------- -------- -------- -------- --------
Total operating expenses 51,447 36,872 25,923 18,066 11,649
--------- -------- -------- -------- --------
Loss from operations (16,730) (6,434) (4,598) (632) (110)
Litigation settlement -- -- -- (744) --
Other income (expense), net 956 1,521 2,155 1,540 (23)
--------- -------- -------- -------- --------
Income (loss) before provision for income taxes (15,774) (4,913) (2,443) 164 (133)
Provision for income taxes 174 140 56 20 3
--------- -------- -------- -------- --------
Net income (loss) $ (15,948) $ (5,053) $ (2,499) $ 144 $ (136)
========= ======== ======== ======== ========
Net income (loss) per share - basic $ (1.76) $ (0.59) $ (0.32) $ 0.03 $ (0.08)
Net income (loss) per share - diluted $ (1.76) $ (0.59) $ (0.32) $ 0.02 $ (0.08)
Weighted average shares outstanding - basic 9,041 8,626 7,761 5,639 1,777
Weighted average shares outstanding - diluted 9,041 8,626 7,761 7,980 1,777
December 31,
1999 1998 1997 1996 1995
--------- -------- -------- -------- --------
BALANCE SHEET DATA: (in thousands)
Cash and cash equivalents $ 7,429 $ 16,096 $ 23,393 $ 7,541 $ 588
Working capital (deficit) 17,668 30,904 33,693 40,308 (56)
Total assets 45,566 56,279 57,167 49,983 5,352
Long-term obligations -- 883 3,777 245 --
Total stockholders' equity 29,184 42,541 43,452 42,353 1,370
(1) Non-recurring and other charges in 1999 represent $2.3 million of servance
and other employee-related costs and $190,000 of facility-related costs
associated with the first and second quarter restructuring actions and the
costs related to the termination of two senior vice presidents of the
Company.
(2) Non-recurring and other charges in 1998 represent $1.5 million of
transaction costs associated with the acquisitions of Eventus Software,
Inc. and Black & White Software, Inc.
(3) Non-recurring and other charges in 1997 include a charge o f $117,000 for
purchased research and development in process and $718,000 for severance
charges.
(4) Non-recurring and other charges in 1995 represent severance cost pursuant
to an employment separation agreement.
(5) Cost of software in 1998 includes $667,000 associated with the write-off of
a non-recurring fee and prepaid royalties.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Segue develops, markets and supports software products and provides
related professional services, for the management and testing of eBusiness
applications. Our products are used by webmasters, quality assurance
professionals and software developers to improve software quality, reduce
development costs, manage the vast and growing number of application components
and shorten the time required to develop and deploy these mission-critical
applications. Our products provide a solution designed to assemble, model,
deploy, monitor and analyze electronic commerce ("e-commerce") systems as well
as to provide automated functional and load testing of applications deployed on
the World Wide Web and on client/server systems.
In December 1998, Segue acquired Eventus Software, Inc. ("Eventus") and
Black & White Software, Inc. ("B&W") in two separate transactions. Founded in
September 1996 and based in California, Eventus' principal product managed the
assembly and deployment of web applications. Eventus had approximately 20
employees at the time of the acquisition. We acquired Eventus to expand our
product offerings to include end-to-end enterprise web content management.
Founded in 1992, B&W's business included a wide range of products, internally
and externally developed, for application development and productivity
enhancement, including tools for creating object-oriented client/server
applications and building applications with dynamic graphics and visual
animation for graphical user interfaces. B&W had approximately 40 employees at
the time of the acquisition. During 1998, B&W began to focus its efforts on
products that diagnose and monitor communications between distributed
application objects. We acquired B&W to expand our product offerings to include
delivering comprehensive management, monitoring and testing of object level
transactions for eBusiness applications using the Common Object Request Broker
Architecture (CORBA) as well as to expand our customer base. Both acquisitions
were accounted for using the pooling-of-interests method and, accordingly, our
historical consolidated financial statements prior to the acquisitions presented
herein have been restated to include the financial position, results of
operations and cash flows of Eventus and B&W (see Note 2 to the Consolidated
Financial Statements).
In 1997, Segue began to focus on load testing through an OEM/reseller
arrangement with a third party software vendor. On December 30, 1997, we
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." The acquisition was accounted for using the purchase method and,
accordingly, the operating results of SQLBench are included in our consolidated
financial statements since the date of acquisition.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage of total revenue represented by certain items reflected in the
Company's consolidated statements of operations:
12
Year ended December 31,
1999 1998 1997
------- ------- -------
Revenue:
Software 63.4% 64.3% 71.1%
Services 36.6 35.7 28.9
------- ------- -------
Total revenue 100.0 100.0 100.0
Cost of revenue:
Cost of software 5.9 10.5 13.3
Cost of services 19.3 15.0 9.6
------- ------- -------
Total cost of revenue 25.2 25.5 22.8
Gross margin 74.8 74.5 77.1
Operating expenses:
Sales and marketing 63.5 50.8 50.9
Research and development 22.0 21.0 25.6
General and administrative 16.7 11.0 14.2
Amortization of goodwill 3.2 3.7 --
Non-recurring and other charges 5.4 3.8 3.0
------- ------- -------
Total operating expenses 110.8 90.3 93.7
------- ------- -------
Loss from operations (36.0) (15.8) (16.6)
Interest income 2.7 4.8 7.9
Interest expense (0.7) (1.1) (0.1)
------- ------- -------
Loss be fore provision for income taxes (34.0) (12.1) (8.8)
Provision for income taxes 0.4 0.3 0.2
------- ------- -------
Net loss (34.4)% (12.4)% (9.0)%
------- ------- -------
13
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
SOFTWARE REVENUE
Software revenue consists of revenue from the granting of perpetual
licenses to use Segue's products. We sell our licenses through our direct sales
force, telesales, international distributors and business partners. Software
revenue increased 12% to $29.4 million in 1999 from $26.2 million in 1998. The
increase is primarily the result of increased sales force productivity,
resulting in increased unit shipments and greater market penetration into the
eBusiness marketplace. These increased unit shipments were due to continued
demand for Segue products from existing customers and due to first-time buyers;
the introduction of new and upgraded products; and increased market acceptance
of the families of products including web application testing and load testing
products. International product sales accounted for 12% and 16% of total Segue's
product sales in 1999 and 1998, respectively. The slightly decreased
international sales were primarily due to the shifting of sales strategy from
distributor to direct sales.
Total e-commerce software revenue represented 96% and 61% of total
software revenue in 1999 and 1998, respectively. Segue client/server products,
our historical core product line, represented 4% and 39% of the total software
revenue for the years ended December 31, 1999 and 1998, respectively. The
increase in e-commerce software revenue from year to year was due to our
increased focus on the e-commerce testing market and the introduction of our new
and enhanced Silk family products such as SilkMonitor, SilkObserver and
SilkPilot.
The rate of continued software revenue growth depends upon our ability
to successfully generate and fill current software license orders, attract and
retain skilled personnel and deliver timely new products and enhancements.
Performance could also be affected by the market acceptance of our new products:
SilkPilot, SilkMeter and SilkObserver.
SERVICES REVENUE
Services revenue consists of revenue from maintenance, training and
consulting. Services revenue increased 16% to $17 million in 1999 from $14.6
million in 1998. The increase in service revenue is a result of the growth in
our installed customer base and the increased training and consulting services
performed for those customers. Maintenance revenue increased 24% to $8.9 million
in 1999 compared to $7.2 million in 1998. Training and consulting revenue
increased 9% to $8.1 million in 1999 compared to $7.4 million in 1998.
The moderate increase in training and consulting revenue is primarily
due to fact that we completed more year 2000 related projects during 1999 as
compared to 1998. The increase in recognized maintenance revenue was driven
largely by incremental additional software licenses sold over the past 12
months.
COST OF SOFTWARE
Cost of software includes documentation, product packaging, product
media, employment costs for processing and distribution, amortization of
capitalized technology and royalties due to third parties. These costs
decreased 36% to $2.8 million, or 9% of software revenue, in 1999 compared to
$4.3 million, or 16% of software revenue, in 1998. The amortization of the
completed technology included in cost of software for 1999 and 1998 was $987,000
and $988,000, respectively.
The decrease in cost of software is partly due to the 1998 non-
recurring charge of $667,000 to write-off of an NRE fee and prepaid royalties.
There were no similar charges in 1999. See discussion of 1998 compared to 1997
below. In addition, cost of software is lower in 1999 as a result of Segue's
continuing effort to increase sales of non-royalty-bearing products and
eliminate sales of royalty bearing products.
14
In December 1998, we entered into a five-year agreement with a vendor
which provides for future royalty payments to the vendor of 10% of net revenues
achieved on sales of Segue products to the vendor's customer base. Under the
terms of the agreement, we paid a guaranteed, non-refundable minimum royalty of
$650,000 in December 1998. As of December 31, 1999, other current assets
included approximately $220,000 and other long-term assets included
approximately $210,000 related to the guaranteed royalties. Future royalty
expense will be recognized as cost of software based upon qualified sales of the
Segue's products. To the extent that revenue from related products does not
support the guaranteed royalties described above, we could be required to
accelerate amortization of these prepaid royalties. The amortization of the
prepaid royalties may cause the cost of software to increase as a percentage of
revenue in the future.
COST OF SERVICES
Cost of services consists principally of salaries and benefits for our
customer technical support staff, which provides services under maintenance
contracts, and for our training and consulting staff, as well as third party
consulting fees and the cost of materials and facilities used in training
customers. Cost of services increased 46% to $8.9 million, or 53% of services
revenue, in 1999 compared to $6.1 million, or 42% of services revenue, in 1998.
The increase in cost of services is primarily due to our utilization of
third party consultants to assist in testing solution implementations. The cost
of third party consultants is generally higher than the cost of internal
resources. The increases in amount and as a percentage of service revenue are
also the result of start up costs incurred in the first six months of 1999
associated with the staffing and training for our Northern Ireland technical
support center, which began operations in July 1999, as well as the operating
expenses of this support center during 1999. Headcount in the training and
consulting and technical support groups increased 45% from December 31, 1998 to
December 31, 1999. We expect to continue to hire employees in the services group
in order to generate and support worldwide services revenue and to provide
ongoing quality customer support to our increasing installed base of customers.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries and
benefits, commissions, travel costs and promotional marketing programs.
Marketing programs include advertising, direct mail programs, seminars and trade
shows. Sales and marketing expenses increased 42% to $29.5 million, or 63% of
total revenue, in 1999 compared to $20.8 million, or 51% of total revenue, in
1998. The principal reasons for the absolute dollar increase in sales and
marketing expenses were increased headcount, increases in commissions as a
result of higher revenue levels, higher commission rates used in commission
plans and increases in related travel costs.
15
Segue expects to continue the growth of its worldwide sales and
marketing organization during 2000. The continued growth depends upon our
ability to attract and retain highly skilled technical, managerial and sales
personnel. There can be no assurance that related increased expenditures would
result in increased revenue or improvement in the effectiveness of our sales
organization.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries and
benefits and facility costs. To date, all of Segue's internal costs for research
and development have been charged to operations as incurred since amounts of
software development costs qualifying for capitalization have been
insignificant. Research and development expenses increased 19% to $10.2 million,
or 22% of total revenue, in 1999 compared to $8.6 million, or 21% of total
revenue, in 1998. The increase in absolute dollars in research and development
expenses is mainly attributable to the increased headcount.
Segue intends to continue to make significant investments in research
and development to develop new products and to expand the capabilities of its
web application testing products.
During 1999, Segue introduced several new products, including
SilkMonitor, which provides monitoring and reporting of web, application and
database servers; SilkPilot, a CORBA-based distributed object testing product;
and SilkObserver which provides object monitoring and diagnostic capabilities
for eBusiness applications.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of salaries and
benefits for executive, finance, information technology, human resource and
administrative personnel, professional fees, system support costs and other
general corporate expenses. General and administrative expenses increased 72% to
$7.8 million, or 17% of total revenue, in 1999 compared to $4.5 million, or 11%
of total revenue, in 1998. The increase in absolute dollars in general and
administrative expenses is partly attributable to increased headcount and
related bonuses, increased facility costs for our new office location in
Lexington, Massachusetts from August 1998 and increased consulting, legal and
accounting expenses. We anticipate that general and administrative expenses will
increase in 2000 to support our expanding business.
AMORTIZATION OF GOODWILL
Goodwill results from Segue's acquisition of SQLBench in December 1997
and is being amortized on a straight-line basis over five years. In 1999,
amortization expenses remained the same as in 1998 at $1.5 million, which
represents 3.2 % of total revenue in 1999, as compared to 3.7% in 1998.
NON-RECURRING AND OTHER CHARGES
During the second quarter of 1999, we restructured our product
development operations and delayed the introduction of the Eventus product,
SilkControl. These activities were aimed at reducing our costs associated with
the development of that product and enhancing our sales force's ability to focus
on other products. The restructuring resulted in the consolidation of four
development labs into three and included the termination of fifteen employees
associated with the development of the Eventus product. Additionally, during the
second quarter of 1999 we shifted our sales strategy away from creating and
managing a large network of resellers towards building deeper relationships with
a few large system integrators. This revised strategy resulted in the
termination of seven employees who focused sales efforts on these channel
resellers. We also terminated the employment of two senior vice presidents
during the second quarter of 1999, each of whom has subsequently been replaced.
Associated with all the events noted above, Segue recorded during the second
quarter of 1999 non-recurring and other charges of approximately $1.5 million,
of which $1.0 million relates exclusively to severance and other employee-
related costs associated with a restructuring, and $481,000 (including a noncash
compensation charge of approximately $118,000), which relates to severance of
two senior vice presidents. As of December 31, 1999, we had made payments of
approximately $882,000 related to the restructuring costs, and the related
restructuring accrual balance was approximately $131,000.
16
During the first quarter of 1999, we executed a restructuring plan to
consolidate our marketing, product development and administrative operations in
order to achieve cost efficiencies through the elimination of redundant
functions. We realigned our marketing and product development operations to
redirect our focus to our strongest product lines and better integrate the
efforts of our product development teams. As a result, Segue recognized a
non-recurring charge of approximately $1.0 million during the first quarter of
1999. This restructuring charge included approximately $830,000 for severance
and other employee-related costs for the termination of ten employees and
approximately $190,000 for facility-related costs, including the accrual of
estimated lease obligations associated with the closure of excess office
facilities. As of December 31, 1999, we had made payments of approximately
$700,000 related to these costs, and the related restructuring accrual balance
was approximately $300,000. At the time of the restructuring action, we expected
to realize a reduction in recurring costs of approximately $1.5 million annually
as a result of the restructuring action. However, there can be no assurance that
these benefits will be realized.
In the fourth quarter of 1998, the Company recorded a charge of $1.5
million related to the Eventus and B&W acquisitions (see Note 10 to the
Consolidated Financial Statements). This charge consisted primarily of
investment banking, legal, accounting and other professional fees and related
costs.
OTHER INCOME (EXPENSE)
Interest income from cash, cash equivalents and short-term investments
amounted to $1.2 million and $2.0 million for the years ended December 31, 1999
and 1998, respectively. The decrease in interest income is related to the
decrease in the average amount of invested funds.
Interest expense amounted to $289,000 and $449,000 for the years ended
December 31, 1999 and 1998, respectively.
PROVISION FOR INCOME TAXES
Segue recorded a provision for foreign and state income taxes of
$174,000 and $140,000 for the years ended December 31, 1999 and 1998,
respectively. There was no tax benefit for losses generated in the U.S. during
1999 and 1998 due to the uncertainty of realizing such benefits.
Management has evaluated the positive and negative evidence impacting
the realizability of its deferred tax assets. 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.
17
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
SOFTWARE REVENUE
Software revenue increased 34% to $26.2 million in 1998 compared to
$19.7 million in 1997. The increase is primarily the result of increased unit
shipments, particularly resulting from the direct domestic sales force. These
increased unit shipments were due to continued demand for products from existing
customers and due to first-time buyers; the introduction of new and upgraded
products; increased market acceptance of the families of products including Web
application testing and load testing products introduced in 1997 and the
expansion of our worldwide direct sales force. International product sales
accounted for 16% and 10% of total product sales in 1998 and 1997, respectively,
and increased for the factors noted above.
Our mix of software revenue changed from 1997 to 1998. Total e-commerce
software revenue represented 61% and 33% of total software revenue in 1998 and
1997, respectively. Our client/server products, our historical core product
line, represented 39% and 67% of total software revenue for the years ended
December 31, 1998 and 1997, respectively. The increase in e-commerce software
revenue was due to the introduction in May 1997 and September 1997,
respectively, of SilkTest and SilkPerformer, which target the e-commerce testing
markets. The Silk product family in total represented 54% and 19% of total
software revenue in 1998 and 1997, respectively. During 1998, Eventus
intentionally curtailed selling certain of its royalty-bearing products which
targeted the e-commerce testing market in order to concentrate its efforts on
developing and selling new products. Consequently, e-commerce software revenue
in 1998 consisted primarily of the Silk product family. QA Performer and
SilkPerformer which target the load testing markets, in total represented 25%
and 7% of total software revenue in 1998 and 1997, respectively.
The rate of continued software revenue growth depends upon our ability
to successfully generate and fill current software license orders, attract and
retain skilled personnel and deliver timely new products and enhancements.
Performance could also be affected by the efforts to integrate Eventus' and
B&W's operations with those of the Company; the success of those integration
efforts; and market acceptance of the new products: SilkControl, SilkPilot and
SilkRealizer.
SERVICES REVENUE
Services revenue increased 83% to $14.6 million in 1998 compared to
$8.0 million in 1997. The increase in service revenue is a result of the growth
in the Company's installed customer base and the increased training and
consulting services performed for these customers. Maintenance revenue increased
28% to $7.2 million in 1998 compared to $5.7 million in 1997. Training and
consulting revenue increased 218% to $7.4 million in 1998 compared to $2.3
million in 1997.
The increase in training and consulting revenue is also due to the
introduction in the second quarter of 1998 of LiveQuality scenario testing
solutions, which consist of a combination of software product and consulting
services. Moreover, one customer accounted for approximately 10% of training and
consulting revenue in 1998.
COST OF SOFTWARE
Cost of software increased 17% to $4.3 million, or 16% of software
revenue, in 1998 compared to $3.7 million, or 19% of software revenue, in 1997.
The increase in cost of software in 1998 is due principally to (1) the
amortization and write-off of the NRE fee and prepaid royalties totaling $0.9
million discussed below and (2) the amortization of $1.0 million for completed
technology resulting from the December 1997 acquisition of SQLBench, offset by
lower recurring royalty expenses of $1.3 million, resulting from the Company's
intentional reduction in sales of royalty-bearing products during 1998, and by
the cost of upgrading the installed base with new versions of various products.
18
In March 1998 we entered into an agreement with a vendor whereby the
vender licensed to us specific software for purposes of marketing and
distribution. Under the terms of this agreement, as amended in October 1998,
Segue (i) paid $780,000 in 1998 which represented a non-refundable NRE and
initial license fee of $480,000 and guaranteed royalties of $300,000,
(ii) committed to spend $200,000 on defined marketing activities during the
initial 18-month term and each subsequent one year term of the agreement, and
(iii) agreed to make guaranteed, annual royalty payments beginning October 1,
1999 of $300,000 for each one year term of the agreement. This agreement was
terminated in June 1999.
Through December 31, 1998, the NRE fee was being amortized into cost of
software revenue on a straight-line basis over its estimated life of two years
and the royalty expense was being recognized as cost of software based on sales
of the related products. For the year ended December 31, 1998, amortization
expense and royalty expense related to this agreement were approximately
$180,000 and $10,000, respectively.
As permitted under the agreement, Segue management decided in the first
quarter of 1999 to cease selling the licensed product, due to the fact that the
license was generating minimal sales and that management had determined to focus
efforts on the EBMS products. Consequently, the Company wrote-off the remaining
balances of $300,000 for the NRE fee and approximately $290,000 for the prepaid
royalties as cost of software as of December 31, 1998. As of that date
additional prepaid royalties of $77,000 were also written off.
In December 1998, we entered into a five-year agreement with a vendor
which provides for future royalty payments to the vendor of 10% of net revenues
achieved on sales of Segue products to the vendor's customer base. Under the
terms of the agreement, we paid a guaranteed, non-refundable minimum royalty of
$650,000 in December 1998. As of December 31, 1998, other current assets
included approximately $220,000 and other long-term assets included
approximately $430,000 related to the guaranteed royalties.
COST OF SERVICES
Cost of services increased 132% to $6.1 million, or 42% of services
revenue, in 1998 compared to $2.6 million, or 33% of services revenue, in 1997.
The increase in cost of services is primarily due to the utilization of
third party consultants to assist in LiveQuality scenario testing solutions. The
cost of third party consultants is generally higher than the cost of internal
resources. The increases in amount and as a percentage of service revenue are
also the result of increased investment in personnel needed to support the
increased demand for training and consulting services. Headcount in the training
and consulting and technical support groups increased 56% from December 31, 1997
to December 31, 1998.
SALES AND MARKETING
Sales and marketing expenses increased 48% to $20.8 million, or 51% of
total revenue, in 1998 compared to $14.1 million, or 51% of total revenue, in
1997. The principal reasons for the absolute dollar increase in sales and
marketing expenses were increased headcount, increases in commissions as a
result of higher revenue levels and increases in related travel costs.
RESEARCH AND DEVELOPMENT
Research and development expenses increased 21% to $8.6 million, or 21%
of total revenue, in 1998 compared to $7.1 million, or 26% of total revenue, in
1997. The increase in absolute dollars in research and development expenses is
mainly attributable to the operations of the Austria facility, which was only
reflected in the Company's operating results from the beginning of 1998.
Additionally, the increase is due to increased headcount. Research and
development headcount, including that of the Austrian facility, increased
approximately 10% from December 31, 1997 to December 31, 1998. The decrease in
research and development as a percentage of total
19
revenue is primarily due to the increase in total revenue. During 1998, Segue
introduced several new products including SilkControl which is a web content
management product and Eventus' principal product, SilkPilot, a CORBA-based
distributed object testing product and a B&W product; and SilkRealizer which is
for scenario testing and modeling. Subsequently in May 1999 management decided
not to continue selling SilkControl.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 14% to $4.5 million, or
11% of total revenue, in 1998 compared to $3.9 million, or 14% of total revenue,
in 1997. The increase in absolute dollars in general and administrative expenses
is attributable to increased headcount and related recruitment fees. General and
administrative headcount increased 28% from December 31, 1997 to December 31,
1998. The decrease as a percentage of total revenue is primarily due to the
increase in total revenue.
AMORTIZATION OF GOODWILL
Goodwill resulted from Segue's acquisition of SQLBench in December 1997
and is being amortized on a straight-line basis over five years. Amortization
expense increased to $1.5 million, or 3.7% of total revenue, compared to zero in
1997.
NON-RECURRING AND OTHER CHARGES
In the fourth quarter of 1998, the Company recorded a charge of
$1.5 million related to the Eventus and B&W acquisitions (see Note 10 to the
Consolidated Financial Statements). This charge consisted primarily of
investment banking, legal, accounting and other professional fees.
In the fourth quarter of 1997, Segue recorded a charge of $117,000
related to the write-off of purchased research and development in process in
conjunction with the SQLBench acquisition. 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, we 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 we expected would allow
users greater ability to perform load testing early in the development phase
instead of waiting until deployment. The in-process technologies were expected
to provide improved load testing tools for client/server and Internet
environments.
In addition to the $117,000 charge for acquired in-process technologies
discussed above, we recorded in the fourth quarter of 1997 a charge of $718,000,
consisting of severance and accelerated vesting of options related to the
resignation of the Company's former President and Chief Executive Officer.
OTHER INCOME (EXPENSE), NET
Other income, net decreased 29% to $1.5 million in 1998 compared to
$2.2 million in 1997 mainly due to interest expense associated with the issuance
of notes in December 1997 related to the SQLBench acquisition. In addition, the
decrease is partly attributable to lower interest income caused by lower levels
of investments.
PROVISION FOR INCOME TAXES
The Company recorded a provision for foreign and state income taxes of
$140,000 and $56,000 for the years ended December 31, 1998 and 1997,
respectively. There was no tax benefit for losses generated in the U.S. during
1998 and 1997 due to the uncertainty of realizing such benefits.
20
Segue management evaluated the positive and negative evidence
impacting the realizability of its deferred tax assets. Based on the weight of
the available evidence, it was more likely than not that all of the deferred tax
assets will not be realized, and accordingly the deferred tax assets as of
December 31, 1998 were fully reserved.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1999, our principal sources of liquidity included
cash, cash equivalents and short-term investments totaling $20.7 million.
Our operating activities utilized cash of $8.0 million in 1999,
compared to $3.7 million in 1998. Cash utilized in 1999 primarily reflects net
loss adjusted for depreciation of fixed assets and amortization of in-process
research and development in connection with the SQLBench acquisition, as well as
the change in accounts receivable as a result of our revenue growth and change
in accounts payable, offset by increased accrued expenses and deferred revenue.
Our investing activities utilized cash of $3.0 million in 1999 compared
to $7.2 million in 1998. We purchased $4.3 million of property and equipment in
1999 compared to $2.7 million in 1998. The large increase consists primarily of
a new management information system (ERP) implemented in 1999 as well as the
infrastructure costs related to the opening of a technical support center in
Northern Ireland during 1999. The increase in property and equipment was largely
offset by net maturities of short-term investment. Additionally in 1999, we made
payments of $2.6 million on acquisition related notes payable. Most of the cash
used in investing activities was offset by net maturities of short-term
investments.
Our financing activities provided cash of $2.3 million and $3.7 million
in 1999 and 1998, respectively, primarily due to the issuance of common stock
upon the exercise of stock options. However, in 1999, the proceeds from stock
options were offset by the payment of notes payable.
In August 1998, we moved our corporate headquarters to Lexington,
Massachusetts, under a lease which expires in October 2007. The annual rental
rate is approximately $2.1 million. We have the right to terminate the lease on
September 30, 2004 for a fee of approximately $2.2 million.
We recognized a one-time pre-tax charge of approximately $1.0 million
during the first quarter of 1999 related to a restructuring plan. The
restructuring charge included approximately $830,000 for severance and other
employee-related costs of the terminated staff and approximately $190,000 for
facility-related costs, including the accrual of estimated lease obligations
associated with the closure of excess office facilities. As of December 31,
1999, we have utilized available cash, cash equivalents and investments to make
payments of approximately $700,000 related to these costs, and the related
restructuring accrual balance was approximately $300,000. We expect to pay the
remaining balance in 2000. At the time of the restructuring action, we expected
to realize a reduction in recurring costs of approximately $1.5 million annually
as a result of the restructuring action. However, there can be no assurance that
these benefits will be realized.
We recognized non-recurring and other charges of approximately $1.5
million during the second quarter of 1999 of which $1.0 million related to a
restructuring plan and $481,000 related to the severance of two executive
officers. These restructuring and other charges includes approximately $118,000
of noncash charges and $1.3 million of cash payments for severance and other
employee-related costs of terminated staff. As of December 31, 1999, we have
utilized available cash, cash equivalents and investments to pay approximately
$1.3 million of this amount, of which $882,000 was related to the restructuring.
21
We currently expect to make future cash payments of the remaining
balance of $200,000, of which $131,000 is related to the restructuring, in 2000.
At the time of the restructuring action, we expected to realize a reduction in
recurring costs of approximately $2.0 million annually as a result of this
restructuring action. However, there can be no assurance that these benefits
will be realized.
During 1999, Segue implemented a new management information system
(ERP) for the cost of $2.2 million that consists of approximately $800,000 for
hardware, software and related maintenance and approximately $1.4 million for
implementation services. As of December 31, 1999, we had paid approximately
$1.9 million for this project and expect to pay the remaining $300,000 in 2000.
Segue opened a technical support center in Northern Ireland during July
1999. We expect to incur total infrastructure costs related to this location of
approximately $1.2 million. This expenditure will be partially funded by a grant
of approximately $300,000 awarded by the Northern Ireland Industrial Development
Board (IDB) of which $261,000 has been granted and paid by IDB as of December
31, 1999. As of December 31, 1999, we had completed and equipped one of the two
floors of the rented facility and paid approximately $700,000 of these total
costs, and we expect to make additional cash payments of $100,000 for this
project in 2000. The remaining $400,000 is reserved for future expansion that is
still under management's consideration.
In December 1999, we paid approximately $2.6 million for the repayment
of SQLBench notes. These notes were issued in connection with the acquisition of
SQLBench in December 1997. We expect to make the final note payment of
approximately $900,000 in December 2000.
Additional long-term cash requirements, other than normal operating
expenses, are anticipated for the development of new software products and
enhancements of existing products, the potential opening of additional
international offices, and the possible acquisition of software products or
technologies complementary to our business. Assuming there is no significant
change in our business, we believe that the existing cash, cash equivalents and
short-term investments as well as cash flows from operations will be sufficient
to meet our working capital requirements for at least the next twelve months.
YEAR 2000 COMPLIANCE
The year 2000 presents potential concerns for business and consumer
computing. The consequences of this issue may include systems failures and
business process interruption. It may also include additional business and
competitive differentiation. If we, our significant customers, or our suppliers
fail to make necessary modifications and conversions on a timely basis, the year
2000 issue could have a material adverse effect on our operations. There are two
other related issues which could also lead to incorrect calculations or
failures: i) some systems' programming assigns special meaning to certain dates,
such as 9/9/99, and ii) the year 2000 is a leap year. To address these year 2000
issues with our internal systems, including information technology (IT) and
non-IT systems, Segue implemented a program designed to deal with the most
critical systems, packaged software applications, first. As of September 30,
1999, we had completed our year 2000 compliance testing for our internal
software systems, including the new MIS system. All of the Company's core
business hardware and software systems have been tested and are year 2000
compliant. The Company's internal desktop hardware systems were tested for year
2000 compliance and were found to be compliant. Additionally, the internal
desktop software applications were tested and the Company determined that these
systems needed appropriate "patches" which were applied to bring these systems
into year 2000 compliance. The Company completed these upgrades during the
fourth quarter of 1999. In addition, the Company implemented various types of
contingency planning to address potential problem areas with internal systems,
including a computer disaster recovery module which would allow the Company to
recover any of its backups in the case of a disaster. All of our material
systems were year 2000 compliant.
We also initiated formal communications with our significant vendors,
mainly of IT packaged applications, to determine the extent to which we would be
vulnerable to those third parties' failure to remedy their own year 2000 issues.
We received written assurances of year 2000 compliance from all significant
vendors. Most of the vendors under existing contracts with Segue are under no
contractual obligation to provide such information to us. We are taking steps
with respect to new vendor agreements to ensure that the vendors' products and
internal systems are year 2000 compliant.
22
Through March 29, 2000, our operations appear to be fully functioning
with regard to year 2000 matters and we have not experienced any significant
issues associated with the year 2000 problem discussed above. Costs associated
with modifications Segue made to make our systems year 2000 compliant were
immaterial and we do not expect to incur additional material costs related to
year 2000 issues. There can be no assurance, however, that a failure by another
company's system to be year 2000 compliant would not have a material adverse
affect on our business, operating results and financial condition.
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
Statements made or incorporated into this Form 10-K 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 our future performance. Segue'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 and else where in this form
10-K.
Our quarterly results may fluctuate. Segue's quarterly revenue and operating
results are difficult to predict and may fluctuate significantly from quarter to
quarter. If our quarterly revenue or operating results fall below the
expectations of investors or public market analysts, the price of our common
stock could fall substantially. Our quarterly revenue may fluctuate
significantly for several reasons, including: the timing of introductions of our
new products or product enhancements by those of our 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; difficulty in predicting
the size and timing of customer orders and the demand for Segue products
generally; changes in operating expenses; whether we are able to successfully
expand our sales and marketing program mix of our product and services sold; and
general economic conditions. A substantial portion of our 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 expectations of future revenues. If actual revenue levels are below
management's expectations, results of operations are likely to be adversely
affected. In addition, Segue does not typically experience order backlog.
Furthermore, Segue has often recognized a substantial portion of its revenues in
the last month of a quarter, with these revenues frequently concentrated in the
last weeks or days of a quarter. As a result, product revenues in any quarter
are substantially dependent on orders booked and shipped in the latter part of
that quarter, and revenues for any future quarter are not predictable with any
significant degree of accuracy. For these reasons, we believe that
period-to-period comparisons of our results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
We may not be profitable in the future. Since Segue began operations, it has
generally experienced losses. Losses have resulted in an accumulated deficit of
approximately $27.2 million as of December 31, 1999. Segue had a net loss of
$2.5 million in 1997, which includes a charge of $117,000 for purchased research
and development in process and $718,000 for severance charges; a net loss of
$5.1 million in 1998, which includes a charge of $1.5 million related to the
Eventus and B&W acquisitions, a charge of $667,000 related to the write-offs of
an NRE fee and guaranteed royalties and $2.5 million for the amortization of
goodwill and completed technology related to the SQLBench acquisition; and a net
loss of $15.9 million in 1999 which includes $2.0 million for restructuring
costs, $481,000 for severance of senior executives, and $2.5 million for the
amortization goodwill and completed technology related to the SQLBench
acquisition. While we have experienced revenue growth in recent periods,
continued growth at the same rate may not be sustainable and is not necessarily
indicative of future operating results. Failure to sustain or increase
profitability may adversely affect the market price of Common Stock.
The development of a market for Segue products is uncertain. The market for
automated software testing products is relatively new and undeveloped. Marketing
and sales techniques in the automated software testing marketplace, as well as
the bases for competition, are not well established. There can be no assurance
as to the extent that a significant market for automated software testing
products will develop or the extent to which Segue products will be accepted in
that market. Although we believe 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.
23
The success of Segue products focused on e-commerce and Internet
applications will depend on our ability to stay current and continue to enhance
our products to work with all of the prevalent technologies driving Internet
applications. There can be no assurance that we will be able to effectively
adapt our products to the prevalent technologies used on e-commerce applications
or to successfully compete in the market for Internet-related products and
services. As is typical for new and rapidly evolving industries, demand for
recently introduced products is highly uncertain.
We may have difficulty managing recent changes. Segue has been experiencing a
period of rapid growth, including increases in the number of orders and changes
in customers and personnel. This rapid growth has placed, and may continue to
place, strains on our management, product offerings, services, operations and
systems. To manage future growth effectively, we must expand, improve and
effectively utilize our operational, management, marketing, sales and financial
systems as necessitated by changes in our business. We have completed the
implementation of a new management information system and opened a Technical
Support Center in Northern Ireland in 1999, both of which could be disruptive.
Additionally, as part in the restructuring plan of the first and second quarter
of 1999, we have significantly changed our sales management team and
consolidated the position of Senior Vice President of Research and Development
with the position of Senior Vice President and General Manager of the executive
management team. In conjunction with these management changes, we have also
changed the structure of our internal organization by adding product divisions
which relate to our eBusiness testing products. We have also refocused our sales
and marketing approach to focus on e-commerce applications. There can be no
assurance that we will be able to effectively manage such changes and such
changes are likely to be disruptive.
We may be subject to risks associated with our past acquisitions and future
acquisitions. In the fourth quarter of 1998, Segue acquired Eventus Software,
Inc. and Black & White Software, Inc. in two separate transactions. Our product
range and customer base have increased in the recent past due in part to these
acquisitions. These acquisitions provided us with technologies to expand our
current line of eBusiness testing products. There can be no assurance that the
integration of all of the acquired technologies will be successful or will not
result in unforeseen difficulties, which may absorb significant management
attention.
In the future, Segue may acquire additional businesses or product
lines. The recently completed acquisitions, or any future acquisition, may not
produce the revenue, earnings or business synergies that we had anticipated, and
an acquired product, service or technology might not perform as expected. Prior
to completing an acquisition, however, it is difficult to determine if such
benefits can actually be realized. The process of integrating acquired companies
into our existing business may also result in unforeseen difficulties.
Unforeseen operating difficulties may absorb significant management attention,
which we might otherwise devote to our existing business. Also, the process may
require significant financial resources that we might otherwise allocate to
other activities, including the ongoing development or expansion of our existing
operations. If Segue pursues a future acquisition, our management could spend a
significant amount of time and effort in identifying and completing the
acquisition. To pay for a future acquisition, we might use capital stock or
cash. Alternatively, we might borrow money from a bank or other lender. If we
use capital stock as we did with our past acquisitions, our stockholders would
experience dilution of their ownership interests. If we use cash or debt
financing, our financial liquidity will be reduced.
We may not be able to continue expansion of our sales force. We distribute our
product and services primarily through our direct sales force. Our ability to
continue to increase revenues in future periods will depend in large part on our
ability to expand our direct sales force and provide a high level of technical
consulting, training and customer support. We are in the process of hiring
additional sales and support personnel to broaden our direct selling and
distribution capabilities. We can not assure that we can build and train our
sales force to satisfactorily meet increased revenue goals.
Segue faces significant competition from other software companies. The market
for software quality management tools is new, intensely competitive and subject
to rapid technological change. We expect competition to intensify in the future.
Segue currently encounters competition from a number of public and private
companies, including Mercury Interactive Corporation, Rational Software
Corporation and Compuware Corporation. Many of our current and potential
competitors have longer operating histories, greater name recognition, larger
installed customer bases, and significantly greater financial, technical and
marketing resources than we do and, therefore, may be able to respond more
quickly to new or changing opportunities, technologies, standards or customer
requirements or may be able to devote greater resources to the promotion and
sale of their products than we can. An increase in competition could result in
price reductions and loss of market share. We may not be able to respond quickly
enough to competitive product offerings to be able to compete successfully in
the future. Such competition and any resulting reduction in profitability could
have a material adverse effect on our business, operating results and financial
condition.
24
Segue's business could be adversely affected if its products contain
errors. Software products as complex as ours may contain undetected errors or
"bugs" which result in product failures. The occurrence of errors could result
in loss of or delay in revenue, loss of market share, failure to achieve market
acceptance, diversion of development resources, injury to our reputation, or
damage to our efforts to build brand awareness, any of which could have a
material adverse effect on our business, operating results and financial
condition.
Segue's future success will depend on our ability to respond rapidly and
effectively to technological and other changes. The nature of the automated
software testing and eBusiness testing markets in which we compete is
characterized by rapidly changing technology, rapidly evolving customer needs
and desires, changes in industry standards and practices and frequent releases
of new product or enhancements by competitors. To be competitive, Segue must
develop and introduce product enhancements and new products that address the
increasingly sophisticated and varied needs of our existing and potential
customers. Failure to develop and introduce new products and enhancements
successfully and on a timely basis, could have a material adverse effect on our
business, operating results and financial condition. The emerging nature of the
automated software testing and e-commerce testing markets requires that Segue
continually improve the performance, features and reliability of its products,
particularly in response to competitive offerings and evolving customer needs.
We must also introduce enhancements to existing products as quickly as possible
and prior to the introduction of competing products. The development of
technologies that result in new products or enhancements requires significant
expenditures and utilization of resources. We may not be successful in
developing such technologies or may not be able to keep pace with technological
developments. We have acquired, and may in the future acquire, technologies to
provide us with the tools to introduce new products or to enhance current
products. The success of such acquisitions will depend in part on our ability to
effectively integrate the technologies.
Certain lawsuits have been filed against Segue which, if determined or settled
in a manner adverse to Segue, could adversely affect Segue's financial
condition. On or about April 27, 1999, a putative class action complaint was
filed in the United States District Court for the District of Massachusetts
against Segue, its Chief Executive Officer and a Former Chief Financial Officer
of Segue, captioned Nathan Rice v Segue Software, Inc. et al. Civil No. 99-CV-
----------- --------------------------
1089-IRGS. The class action complaint alleged the defendants violated the
federal securities laws by making material misrepresentations and omissions in
certain public disclosures during the period beginning on October 13, 1998
through April 9, 1999, inclusive. The public disclosures relate to, among other
things, Segue's past and future financial performance and results. On or about
May 3, 1999, another similar putative class action complaint was filed against
Segue, its Chief Executive Officer and a former Chief Financial Officer of Segue
in the United States District Court for the District of Massachusetts, captioned
Anthony Moumouris v Segue Software, Inc., et al., Civil No. 99-CV-10933RGS.
- ----------------- ---------------------------
These cases were consolidated under the caption In Re: Segue Software Inc.
--------------------------
Securities Litigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a
- ---------------------
consolidated amended complaint on September 27, 1999 alleging a putative class
period of July 14, 1998 through April 9, 1999, inclusive. Segue intends to
defend the claims vigorously. On November 8, 1999 each of the defendants filed a
motion to dismiss the amended complaint for failure to state a cause of action.
The plaintiffs have opposed the motions to dismiss on various grounds. The court
heard arguments on the motions on March 15, 2000, but has not yet rendered a
decision on the motions. It is not possible to predict when the court will rule
on the motions or whether they will be granted in whole or in part. Segue
believes the defense of the claims could involve significant litigation-related
expenses. The outcome of these matters is uncertain and, as a result, at this
time Segue is not able to quantify any related financial exposure. In the event
that any of the claims set forth in the class action complaints are determined
or settled in a manner adverse to Segue, then such determination or settlements
could adversely affect Segue's financial position or results of operations in
the period in which the litigation is resolved.
Various other claims, charges and litigation have been asserted or
commenced against the Company arising from or related to contractual or employee
relations. While management does not believe these claims will have a material
adverse effect on the financial position or results of operations of the
Company, we cannot assure you that an adverse resolution of one or more of these
cases would not have a material adverse affect on the Company's financial
condition or results of operations.
Segue must hire and retain skilled personnel in a tight labor market. Qualified
personnel are in great demand throughout the software industry. Our success
depends in large part upon our ability to attract, train, motivate and retain
highly skilled employees, particularly sales and marketing personnel, software
engineers and other senior personnel. There is intense competition for sales
personnel and software engineers in our business, and there can be no assurance
that Segue will be successful in attracting, integrating, motivating and
retaining new sales personnel and software engineers. The failure to attract and
retain the highly skilled personnel that are integral to our direct sales,
product development, service and support teams may limit the rate at which we
can generate sales and develop new products or product enhancements. This could
have a material adverse effect on our business, operating results and financial
condition.
We have completed the shift in our focus from general software testing to
eBusiness testing. In 1997, we began to develop and acquire technology to
provide automated software testing for Web-enabled software applications,
including the acquisition of SQLBench in December 1997. These developments
allowed us to extend our testing capabilities beyond distributed client/server
applications with GUI front ends. In the second quarter of 1998, Segue
introduced "LiveQuality," an eBusiness scenario testing solution. In the fourth
quarter of 1998, we acquired Eventus Software, Inc. and Black & White Software,
Inc. We anticipated that these acquisitions would provide us with other
technologies to expand our current line of eBusiness testing products. Segue
continued to develop and introduce other eBusiness products in 1999, including
our eConfidence Solution packages called eConfidence Functionality, eConfidence
Performance and eConfidence Production. Our shift from a general software
testing company to an eBusiness testing company has resulted in significant
changes in our (i) organizational structure, (ii) management personnel, (iii)
product mix, and (iv) sales approach. These changes have required and continue
to require significant management attention and have been and may continue to be
disruptive. We are reviewing the changes made in the past year and may make
additional changes to affect our shift. If we fail to effectively manage these
changes, or make other changes that may be needed in connection with our shift
to an eBusiness testing company, business, operating results and financial
condition may be materially adversely affected.
We face many risks associated with international business activities. Segue
derived approximately 12% of its total product sales from international
customers in 1999. The international market for software products is highly
competitive and we expect to face substantial competition in this market from
established and emerging companies. Segue faces many risks associated with
international business activities including currency fluctuations, imposition of
government controls, export license requirements, restrictions on the export of
critical technology, political and economic instability, tailoring of products
to local requirements, trade restrictions, changes in tariffs and taxes,
difficulties in staffing and managing international operations, longer accounts
receivable payment cycles and the burdens of complying with a wide variety of
foreign laws and regulations. To the extent we are unable to expand
international sales in a timely and cost-effective manner, our business could be
materially adversely affected.
25
Our business operations may be affected by unexpected year 2000 problems.
Although to date we have not experienced any material problems attributable to
the year 2000 problem with respect to our software products and internal
systems, it is possible that our current products could contain undetected
errors or defects associated with year 2000 date functions that may result in
material costs or liabilities to us in the future. Moreover, our software
directly and indirectly interacts with a large number of third party hardware
and software systems, each of which may contain or introduce undetected errors
or defects. We are unable to predict to what extent our business may be affected
if our software or the systems that operate in conjunction with our software
experience a material year 2000 related failure. Any year 2000 defect in our
products or the software and hardware systems with which our products operate,
as well as any year 2000 errors caused by older non-current products that were
not upgraded by our customers, could expose us to litigation that could require
us to incur significant costs in defending the litigation or expose us to the
risk of significant damages. The risks of this litigation may be particularly
acute due to the mission-critical applications for which our products are used.
Segue may be subject to risks associated with its business partner program.
Although Segue has not historically sold significant amounts of its products
through indirect channels, we intend to continue to develop system integrator
sales as part of our business strategy. There can be no assurance that our
efforts will result in an increase in revenues. Furthermore, we may be
subject to certain distinct risks associated with system integrator sales. Our
current business partners may not be able to effectively sell or continue to
effectively sell our products or new products. We may not be able recruit
additional or replacement business partners if any of our current business
partners terminate their relationship with us. Segue licenses its products to
business partners at a discount and such partners re-license the products to
end-users. Our agreements with our business partners are non-exclusive and
provide the business partners with 60-day price protection. Because our business
partners generally order products after they have received purchase orders,
there is no requirement that we repurchase any product. We typically do not
grant our business partners a contractual right to return software products.
When approved by management, however, we have accepted returns of certain
software products and have provided an allowance for the specified products.
Segue selects its business partners based on the partner's financial viability,
product expertise and market focus. In order for our strategy to broaden market
penetration through our business partner program to be successful, we must
increase our unit sales to offset the discount we are providing to our business
partners. There can be no assurance that we will succeed in the development of
these programs. Moreover, selling through indirect channels may limit our
contact with the end users of our products. As a result, our ability to
accurately forecast sales, evaluate customer satisfaction and recognize emerging
customer requirements may be hindered and our ability to develop and maintain
customer goodwill may be limited. Furthermore, our existing or future business
partners may choose to devote greater resources to marketing and supporting the
products of other companies. In addition, Segue will need to resolve potential
conflicts among its sales force and business partners.
Segue could be subject to product liability claims. In selling its products,
Segue relies primarily on "shrink wrap" licenses that contain, among other
things, provisions protecting against the unauthorized use, copying and transfer
of the licensed program and limiting Segue'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 Segue's
exposure to product liability claims, may therefore be unenforceable under the
laws of certain jurisdictions. Segue products may be used on applications that
are critical to the operations of its customers' businesses. Any failure in a
customer's application could result in a claim against Segue for substantial
damages, regardless of our responsibility for such failure. Although we maintain
general liability insurance, including coverage for errors and omissions, there
can be no assurance that such coverage will continue to be available on
reasonable terms or will be available in amounts sufficient to cover one or more
large claims, or that the insurer will not disclaim coverage as to any future
claim.
Segue's success depends on our ability to protect our proprietary technology.
Segue's success depends to a significant degree upon the protection of our
software and other proprietary technology. The unauthorized reproduction or
other misappropriation of our proprietary technology could enable third parties
to benefit from Segue's technology without paying us for it. This could have a
material adverse effect on our business, operating results and financial
condition. Although we have taken steps to protect our proprietary technology,
these efforts may be inadequate. We currently rely on a combination of
trademark, copyright and trade secret laws and contractual provisions to protect
our proprietary rights in our products. Currently, we have two issued patents
and one additional application for patent filed with the United States Patent
and Trademark Office. There can be no assurance that these patents would be
upheld if challenged. Moreover, the laws of other countries in which we market
our products may afford little or no effective protection of our intellectual
property. There can be no assurance that our competitors will not independently
develop
26
technologies that are substantially equivalent or superior to our technology. If
we resort to legal proceedings to enforce our intellectual property rights, the
proceedings could be burdensome and expensive and could involve a high degree of
risk. There can be no assurance that third parties will not assert intellectual
property infringement claims against Segue. If we were to discover that any of
Segue products violated third party proprietary rights, there can be no
assurance that we would be able to obtain licenses on commercially reasonable
terms to continue offering the product without substantial reengineering or that
any effort to undertake such reengineering would be successful.
Any claim of infringement could cause Segue to incur substantial costs
defending against the claim, even if the claim is invalid, and could distract
management resources from our business. Furthermore, a party making such a claim
could secure a judgment that requires us to pay substantial damages. A judgment
could also include an injunction or other court order that could prevent us from
selling our products. Any of these events could have a material adverse effect
on our business, operating results and financial condition.
ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially from
those discussed in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
Derivative Financial Instruments, Other Financial Instruments and
Derivative Commodity Instruments - The Company does not invest in derivative
financial instruments, other financial instruments or derivative commodity
instruments for which fair value disclosure would be required under SFAS No.
107. All of the Company's investments are in investment grade securities with
high credit ratings of relative short duration that trade in highly liquid
markets and approximate fair value on the Company's books at December 31, 1999.
Accordingly, the Company has no quantitative information concerning the market
risk of participating in such investments.
Primary Market Risk Exposure - The Company's primary market risk
exposure is in the area of interest rate risk. The Company's investment
portfolio of cash equivalents is subject to interest rate fluctuations, but the
Company believes this risk is immaterial due to the short-term nature of these
investments. The Company faces exposure to movements in foreign currency
exchange rates. These exposures may change over time as business practices
evolve. Currently, a majority of the Company's business outside the United
States is conducted in U.S. dollar-denominated transactions, whereas the
Company's operating expenses in its international subsidiaries are denominated
in local currency. The Company does not use derivative financial instruments to
hedge foreign currency exposures or for trading. Historically, the Company's
primary exposures have been related to the operations of its foreign
subsidiaries. To date, the net impact of foreign currency changes have not been
material and is unlikely to have a material adverse effect on the Company's
business, results of operations or financial condition in the near term. The
introduction of the Euro as a common currency for most members of the European
Monetary Union has taken place in the Company's fiscal year 1999. The Company
has not determined the impact, if any, that the Euro will have on foreign
currency and business exposure.
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information called for by this Item 9 was previously reported in a
current report on Form 8-K filed with the SEC on February 8, 2000. Such filing
is incorporated herein by reference.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 concerning Segue's directors
and officers is incorporated by reference to the information under the heading,
"Election of Directors - Information Regarding the Nominees and Executive
Officers" in Segue's 2000 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference
to the Segue's 2000 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 Segue's 2000 Proxy Statement under the heading, "Security Ownership of
Management and Certain Beneficial Owners".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
28
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:
Page
----
Table of Contents F-1
Reports of Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-4
Consolidated Statements of Operations for the Years Ended December 31,
1999, 1998 and 1997 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997 F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1999, 1998 and 1997 F-7
Notes to Consolidated Financial Statements F-8
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. Documents listed below, except for documents identified by
footnotes, are not being filed as exhibits herewith. Documents identified by
footnotes are being filed herewith and, pursuant to Rule 12b-32 of the General
Rules and Regulations promulgated by the Commission under the Securities
Exchange Act of 1934 (the "Act") reference is made to such documents as
previously filed as exhibits with the Commission. The Company's file number
under the Act is 0-27794.
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
-------------- -----------------------
3.1 (1) Restated Certificate of Incorporation (Exhibit 3.2 of
Registration Statement on Form S-1 (File No. 333-
1488))
3.2 (1) By-Laws (Exhibit 3.3 of Registration Statement on
Form S-1 (File No. 333-1488))
4.1 (1) Specimen Certificate representing the Common Stock
(Exhibit 4.2 of Registration Statement on Form S-1
(File No. 333-1488))
10.1 (1) 1996 Amended and Restated Incentive and Non-Qualified
Stock Option Plan
10.2 (1) 1996 Employee Stock Purchase Plan
29
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
-------------- -----------------------
10.7 (1) 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 (1) 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))
10.10 (2) 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 (2) 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 (2) Segue Software, Inc. Special Termination and Vesting
Plan adopted February 5, 1997
10.14 (3) Sublease Agreement dated March 31, 1998 by and between
MediaOne of Delaware, Inc. and the Registrant
10.15 (4) 1998 Employee Stock Option Plan
10.16 (5) Agreement and Plan of Merger by and among the
Registrant, SSI Merger Corp. and Eventus Software,
Inc. and the Stockholders of Eventus Software, Inc.
dated as of December 3, 1998
10.17 (6) Agreement and Plan of Merger by and among the
Registrant, SBW Merger Corp. and Black & White
Software, Inc. ("B&W"), and the Stockholders of B&W
and beneficial owners of the outstanding capital stock
of B&W dated as of December 31, 1998
*10.18 Amendment No. 1 to Segue Software 1998 Employee Stock
Option Plan, as of December 17, 1999
*10.19 Lease Agreement dated November 5, 1999 by and between
Albright Properties and the Registrant
*21.1 Subsidiaries of the Registrant
*23.1 Consent of PricewaterhouseCoopers LLP
*23.2 Consent of Grant Thornton LLP
*27.1 Financial Data Schedules
30
(1) 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.
(2) Incorporated by reference to the exhibits filed with the
Registrant's Annual Report on Form 10-K/A for the year ended December
31, 1997.
(3) Incorporated by reference to the exhibits filed with the
Registrant's Quarterly Report on Form 10-Q dated August 14, 1998.
(4) Incorporated by reference to the exhibit filed with the
Registrant's Registration Statement on Form S-8 dated December 17,
1998.
(5) Incorporated by reference to the exhibits filed with the
Registrant's Report on Form 8-K dated December 17, 1998.
(6) Incorporated by reference to the exhibits filed with the
Registrant's Report on Form 8-K dated January 14, 1999.
*Filed herewith.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the registrant during the quarter
ended December 31, 1999.
31
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 30th 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.
Signature Titles Date
- --------- ------ ----
/s/ STEPHEN B. BUTLER President, Chief Executive Officer March 30, 2000
- --------------------- and Director (Principal Executive Officer)
Stephen B. Butler
/s/ DOUGLAS ZACCARO Chief Financial Officer March 30, 2000
- ------------------- (Principal Financial Officer and
Douglas Zaccaro principal Accounting Officer)
/s/ JAMES H. SIMONS Chairman of the Board March 30, 2000
- -------------------
James H. Simons
/s/ LEONARD E. BAUM Director March 30, 2000
- -------------------
Leonard E. Baum
/s/ JYOTI PRAKASH Director March 30, 2000
- ------------------
Jyoti Prakash
/s/ JOHN R. LEVINE Director March 30, 2000
- ------------------
John R. Levine
/s/ HOWARD L. MORGAN Director March 30, 2000
- --------------------
Howard L. Morgan
32
SEGUE SOFTWARE, INC.
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
Page
----
Reports of Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-4
Consolidated Statements of Operations for the Years Ended December 31,
1999, 1998 and 1997 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997 F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1999, 1998 and 1997 F-7
Notes to Consolidated Financial Statements F-8
F-1
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
Segue Software, Inc.
We have audited the accompanying consolidated balance sheet of
Segue Software, Inc., as of December 31, 1999, and the related consolidated
statements of operations, changes in stockholders' equity, and cash flows for
the year then ended. 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 audit.
We conducted our audit in accordance with auditing standards
generally accepted in the United States. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial
position of Segue Software, Inc., as of December 31, 1999, and the consolidated
results of their operations and their consolidated cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States.
/s/ Grant Thornton LLP
Boston, Massachusetts
March 10, 2000
F-2
Report Of Independent Accountants
To the Board of Directors and
Stockholders of Segue Software, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Segue
Software, Inc. at December 31, 1998, and the results of its operations and its
cash flows for the years ended December 31, 1998 and 1997 in conformity with
accounting principles generally accepted in the United States. 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 of these statements in accordance with
auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
April 15, 1999, except as to Note 15
which is as of February 7, 2000
F-3
SEGUE SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
December 31,
-------------------
1999 1998
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 7,429 $ 16,096
Short-term investments 13,287 17,335
Accounts receivable, net of allowances
of $600 and $608 12,014 8,823
Other current assets 1,320 1,505
-------- --------
Total current assets 34,050 43,759
Property and equipment, net 5,734 3,560
Completed technology, net 989 1,976
Goodwill, net 4,516 6,022
Other assets 277 962
-------- --------
Total assets $ 45,566 $ 56,279
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable - current portion $ 883 $ 2,983
Accounts payable 1,896 2,464
Accrued compensation and benefits 2,881 1,389
Accrued royalties 147 377
Accrued expenses 2,007 1,346
Deferred revenue 8,407 4,296
-------- --------
Total current liabilities 16,221 12,855
Notes payable -- 883
Commitments and contingencies (Note 9)
Stockholders' equity:
Preferred stock, par value $.01 per share;
9,000 shares authorized; no shares issued
and outstanding -- --
Common stock, par value $.01 per share;
30,000 shares authorized; 9,290 and 8,912
shares issued and outstanding 93 89
Additional paid-in capital 56,426 53,698
Unearned compensation -- (20)
Accumulated deficit (27,174) (11,226)
-------- --------
Total stockholders' equity 29,345 42,541
-------- --------
Total liabilities and stockholders' equity $ 45,566 $ 56,279
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended December 31,
1999 1998 1997
-------- -------- --------
Revenue:
Software $ 29,448 $ 26,249 $ 19,662
Services 16,973 14,599 7,977
-------- -------- --------
Total revenue 46,421 40,848 27,639
Cost of revenue:
Cost of software 2,762 4,291 3,673
Cost of services 8,942 6,119 2,641
-------- -------- --------
Total cost of revenue 11,704 10,410 6,314
Gross margin 34,717 30,438 21,325
Operating expenses:
Sales and marketing 29,461 20,764 14,071
Research and development 10,224 8,571 7,084
General and administrative 7,757 4,500 3,933
Amortization of goodwill 1,506 1,506 --
Non-recurring and other charges 2,499 1,531 835
-------- -------- --------
Total operating expenses 51,447 36,872 25,923
-------- -------- --------
Loss from operations (16,730) (6,434) (4,598)
Interest expense (289) (449) (31)
Interest income 1,245 1,970 2,186
-------- -------- --------
Loss before provision for income taxes (15,774) (4,913) (2,443)
Provision for income taxes 174 140 56
-------- -------- --------
Net loss $(15,948) $ (5,053) $ (2,499)
======== ======== ========
Net loss per share - basic and diluted $ (1.76) $ (0.59) $ (0.32)
Weighted average shares outstanding - basic and diluted 9,041 8,626 7,761
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
SEGUE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS)
Common Stock Total
----------------------- Additional Unearned Accumulated Stockholders'
Shares Par value Paid-in Capital Compensation deficit Equity
-------------------------------------------------------------------------------------
Balance at December 31, 1996 7,619 $ 76 $ 46,391 $ (440) $ (3,674) $ 42,353
Return of capital - B&W (49) (49)
Issuance of common stock
under stock plans 291 3 924 927
Issuance of common stock,
net of issuance costs 55 1 513 514
Issuance of restricted common stock
for acquisition 144 1 1,539 1,540
Compensation cost related to
stock options 523 523
Stock options cancelled and
amortization of unearned compensation (192) 335 143
Net loss (2,499) (2,499)
-------------------------------------------------------------------------------------
Balance at December 31, 1997 8,109 81 49,649 (105) (6,173) 43,452
Return of capital - B&W (15) (15)
Issuance of common stock
under stock plans 753 8 3,088 3,096
Issuance of common stock,
net of issuance costs 50 989 989
Stock options cancelled and
amortization of unearned compensation (57) 85 28
Compensation cost related to stock
options and warrants 44 44
Net loss (5,053) (5,053)
-------------------------------------------------------------------------------------
Balance at December 31, 1998 8,912 89 53,698 (20) (11,226) 42,541
Issuance of common stock
under stock plans 378 4 2,623 2,627
Compensation costs related to
stock options 118 118
Stock options cancelled and
amortization of unearned compensation (13) 20 7
Net loss (15,948) (15,948)
-------------------------------------------------------------------------------------
Balance at December 31,1999 9,290 $ 93 $ 56,426 $ -- $(27,174) $ 29,345
=====================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
SEGUE SOFTWARE, INC
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31,
1999 1998 1997
-------- -------- --------
Cash flows from operating activities:
Net loss $(15,948) $ (5,053) $ (2,499)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,667 4,480 1,342
Charge for purchased research and development
in process -- -- 117
Loss on disposal of property and equipment -- 4 4
Noncash compensation charges 118 10 666
Write-off of other assets -- 378 --
Changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable (3,191) (3,589) (618)
Other current assets 185 (886) 590
Other assets 701 (433)
Accounts payable (568) 687 616
Accrued expenses, royalties, compensation
and benefits 1,923 (215) 1
Deferred revenue 4,111 879 812
-------- -------- --------
Net cash provided by (used in) operating activities (8,002) (3,738) 1,031
-------- -------- --------
Cash flows from investing activities:
Additions to property and equipment (4,348) (2,678) (1,401)
Additions to other assets (16) (735) (368)
Acquisition of businesses -- -- (4,499)
Payments of notes payable for acquisition (2,649) (883) --
Maturities of short-term investments 35,229 16,200 57,725
Purchases of short-term investments (31,181) (19,150) (38,018)
-------- -------- --------
Net cash provided by (used in) investing activities (2,965) (7,246) 13,439
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 7 989 514
Proceeds from issuance of notes payable -- 110 299
Payments of notes payable (334) (493) (308)
Proceeds from exercise of stock options and
stock purchase plan 2,627 3,096 926
Return of capital to shareholders -- (15) (49)
-------- -------- --------
Net cash provided by financing activities 2,300 3,687 1,382
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (8,667) (7,297) 15,852
Cash and cash equivalents, beginning of the year 16,096 23,393 7,541
-------- -------- --------
Cash and cash equivalents, end of the year $ 7,429 $ 16,096 $ 23,393
======== ======== ========
Supplemental disclosure of noncash investing and financing transactions:
Issuance of notes payable for acquisition $ -- $ -- $ 4,415
Issuance of restricted common stock for acquisition $ -- $ -- $ 1,540
Cash paid during the year for interest $ 286 $ 419 $ 58
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Segue Software, Inc. and its subsidiaries (hereafter, collectively, "Segue" or
the "Company") develop, market and support software products, and provide
related professional services, for the management and testing of eBusiness
applications. The Company's products are used by webmasters, quality assurance
professionals and software developers to improve software quality, reduce
development costs, manage the growing number of application components, and
shorten the time required to develop and deploy these mission critical
applications. The Company's products provide a solution designed to assemble,
model, deploy, monitor and analyze electronic commerce ("e-commerce") systems as
well as to provide automated functional and load testing of applications
deployed on the World Wide Web and on client/server systems.
OPERATING MATTERS
The Company has generally incurred losses since it began operations, which has
resulted in an accumulated deficit of approximately $27.2 million at
December 31, 1999. As a result, the Company has used, and expects to continue to
use, significant amounts of cash, cash equivalents and short-term investments to
fund its operations.
Management has taken certain steps to improve operating results in fiscal 2000
including the recent transformation of its product from a client/server
environment to products providing e-Business solutions. Additionally, the
Company plans to continue its increased product development, marketing and
selling expenditures in an effort to increase revenue.
Additional long-term cash requirements, other than normal operating expenses,
are anticipated for the development of new software products and enhancements of
existing products, the potential opening of additional international offices,
and the possible acquisition of software products or technologies complementary
to the Company's business. There are no assurances, however, that the actions
taken or to be taken by the Company will achieve the above intended objectives.
Management believes that the existing cash, cash equivalents and short-term
investments as well as cash flow from operations will be sufficient to meet
working capital requirements for at least the next twelve months.
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
As described in Note 2, in December 1998, the Company acquired Eventus Software,
Inc. ("Eventus") and Black & White Software, Inc. ("B&W"). Both acquisitions
were accounted for using the pooling-of-interests method and, accordingly, the
historical consolidated financial statements of the Company prior to the
acquisitions presented herein have been restated to include the financial
position, results of operations and cash flows of Eventus and B&W.
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. Intercompany transactions and balances have been
eliminated in consolidation.
REVENUE RECOGNITION
Effective January 1, 1998, the Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), which provides guidance on applying
generally accepted accounting principles in recognizing revenue on software
transactions. SOP 97-2 requires that revenue allocated to software products,
specified upgrades and enhancements is generally recognized upon delivery of the
related products, upgrades or enhancements. Revenue allocated to post contract
customer support (maintenance) is generally recognized ratably over the term of
the support, and revenue allocated to service elements (training and consulting)
is generally recognized as the services are performed.
The Company recognizes revenue from software licenses upon product shipment and
receipt of a signed purchase order or contract, provided that collection is
probable and the other revenue recognition criteria of SOP 97-2 are met. The
Company's products do not require significant modification or customization of
software.
F-8
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Post contract customer support (maintenance) and service revenue (training and
consulting) which is not yet earned is included in deferred revenue.
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 specified products. The Company also provides reserves for customer
receivable balances that are considered potentially uncollectible. Included in
accounts receivable allowances are a sales allowance provided for expected
returns and credits and an allowance for bad debts.
The following table sets forth the activity in the Company's allowance for bad
debts and sales returns:
Charges to
Balance at the General & Balance at the
Beginning of the Administrative Offsets to Write-offs, End of
Year Ended: Year Expense Product Revenue net the Year
-----------------------------------------------------------------------------------
December 31, 1997 $ 223,000 $ 201,000 $ 247,000 $ (217,000) $ 454,000
December 31, 1998 $ 454,000 $ 203,787 $ 666,644 $ (716,431) $ 608,000
December 31, 1999 $ 608,000 $ 225,000 $ 284,000 $ (517,000) $ 600,000
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.
F-9
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
INCOME TAXES
The Company accounts for income taxes using the asset and liability method,
pursuant to which deferred income taxes are recognized based on temporary
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
temporary differences are expected to reverse. Valuation allowances are provided
if, based upon the weight of available evidence, it is more likely than not that
some or all of the deferred tax assets will not be realized.
The Company does not provide for U.S. income taxes on the undistributed earnings
of foreign subsidiaries, which the Company considers to be permanent
investments.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Company's foreign operations are translated into
U.S. dollars at the exchange rate in effect at the balance sheet date, and
revenues and expenses are translated using the average rates in effect during
the period. The resultant translation adjustments to date have been
insignificant. Foreign currency transaction gains and losses are included in
results of operations.
NET INCOME (LOSS) PER SHARE
Basic earnings per share ("EPS") is based upon the weighted average number of
common shares outstanding during the period. Diluted EPS is based upon the
weighted average number of common and common equivalent shares outstanding
during the period. Common stock equivalent shares are included in the diluted
EPS calculation where the effect of their inclusion would be dilutive. Common
equivalent shares result from the assumed exercise of outstanding stock options
and warrants, the proceeds of which are then assumed to have been used to
repurchase outstanding common stock using the treasury stock method.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments purchased with maturities of
three months or less to be cash equivalents. Investments with maturities greater
than three months are considered to be short-term investments. Cash equivalents
and short-term investments consist primarily of commercial paper (approximately
$21 million at December 31, 1999). The Company has classified its securities as
"available for sale" and reports them at fair value, with unrealized gains and
losses excluded from earnings and reported as an adjustment to stockholders'
equity. As of December 31, 1999 and 1998, unrealized gains and losses on
securities were not material.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated on a straight-line
basis over their estimated useful lives, generally three to five years.
Leasehold improvements are amortized over the shorter of the assets' useful
lives or the term of the related leases. Expenditures for major improvements
which substantially increase the useful lives of assets are capitalized. Repair
and maintenance costs are expensed as incurred.
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 or loss.
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 2). 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-10
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LONG LIVED ASSETS
Long-lived assets to be held and used are recorded at cost. Management reviews
long-lived assets, including intangible assets, for impairment whenever events
or changes in circumstances indicate the carrying amount of such assets is less
than the undiscounted expected future cash flows from such assets.
Recoverability of these assets is assessed using a number of factors including
operating results, business plans, budgets, and economic projections and
undiscounted cash flows. 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 places its excess cash in cash equivalents and short-term
investments, primarily consisting of commercial paper. There are no significant
concentrations in any one issuer of debt securities. The Company places its
cash, cash equivalents and investments with financial institutions with high
credit standing. The Company has not experienced any significant losses on its
cash, cash equivalents and short-term investments to date. The Company believes
credit risk with respect to investments of commercial paper are minimal due to
the duration of such investments, which are generally less than six months.
The Company sells its products principally through a worldwide direct sales
force and through distributors outside of the United States to customers in a
broad range of industries. The Company provides credit, in the normal course of
business, to various types and sizes of companies located throughout North
America and Europe and does not require collateral or other security. The
Company maintains reserves for potential credit losses.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reported periods. The most significant estimates included in
these financial statements are the valuation of accounts receivable and
long-term assets, including intangibles and deferred tax assets.
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to the current year
presentation.
COMPREHENSIVE LOSS
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
requires the reporting of comprehensive income in addition to net income from
operations. Comprehensive income is a more inclusive reporting methodology that
includes disclosure of certain financial information that historically has not
been recognized in the calculation of net income. To date the Company's
comprehensive income items have consisted exclusively of foreign translation
adjustments. For the years ended December 31, 1999, 1998 and 1997, comprehensive
loss substantially equaled net loss.
SEGMENT REPORTING
In 1998, the Company adopted Statement of Financial Accounting Standards No.
131, "Disclosure about Segments of an Enterprise and Related Information" ("SFAS
131"), 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, requires disclosures about products and services,
major customers, and geographic areas. Information related to segment reporting
is included in Note 11.
F-11
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
RECENT ACCOUNTING DEVELOPMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which was
effective for fiscal years beginning after June 15, 1999. SFAS No. 133 must be
adopted prospectively and retroactive application is not permitted. SFAS No. 133
will require the Company to record all derivatives on the balance sheet at fair
value. Changes in derivative fair values will either be recognized in earnings
as offsets to the changes in fair value of related hedged assets, liabilities
and firm commitments or for forecasted transactions, deferred and recorded as a
component of accumulated other comprehensive income (loss) in stockholders'
equity until the hedged transactions occur and are recognized in earnings. The
ineffective portion of a hedging derivative's change in fair value will
immediately recognized in earnings. In June 1999, the FASB issued SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133", which delayed the effective date.
SFAS No. 133 is now effective for fiscal years beginning after June 15, 2000.
The Company expects to adopt SFAS No. 133 on January 1, 2001 and does not
believe the effect of adopting SFAS No. 133 will have any material effect on its
consolidated financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101")
which provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements filed with the SEC. SAB 101 outlines the basic
criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. We believe that the impact
of SAB 101 will not have a material effect on our results of operations,
financial position or cash flows.
2. BUSINESS COMBINATIONS
On December 31, 1998, the Company acquired all of the outstanding capital stock
of B&W in exchange for 224,809 shares of the Company's common stock and the
conversion of all B&W outstanding common stock options into options to purchase
41,870 shares of the Company's common stock. This acquisition was accounted for
using the pooling-of-interests method and, accordingly, the historical
consolidated financial statements of the Company prior to the acquisition
presented herein have been restated to reflect the financial position, results
of operations and cash flows of B&W. Founded in 1992 as a California S
Corporation, B&W supplied a wide range of products for application development
and productivity enhancement, including tools for creating object-oriented
client/server applications and building applications with dynamic graphics and
visual animation for graphical user interface. During 1998, B&W began to focus
its efforts on products that diagnose and monitor communications between
distributed application objects. B&W had approximately 40 employees at the time
of the acquisition.
On December 3, 1998, the Company acquired all of the outstanding capital stock
of Eventus in exchange for 312,990 shares of the Company's common stock and the
conversion of all Eventus outstanding common stock options and warrants into
options and warrants to purchase 31,951 shares of the Company's common stock.
This acquisition was accounted for using the pooling-of-interests method and,
accordingly, the historical consolidated financial statements of the Company
prior to the acquisition presented herein have been restated to reflect the
financial position, results of operations and cash flows of Eventus. Founded in
September 1996 and based in California, Eventus' principal product manages the
assembly and deployment of web applications. Eventus had approximately 20
employees at the time of the acquisition.
The following information presents certain statement of operations data (in
thousands) of Segue, Eventus and B&W for the periods prior to the acquisitions.
Year Ended December 31,
-----------------------
1998 1997
---- ----
Revenue:
Segue $36,167 $21,794
Eventus 789 2,197
B&W 3,892 3,648
----- -----
Total revenue $40,848 $27,639
======= =======
F-12
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net loss:
Segue $(3,267) $(610)
Eventus (2,358) (730)
B&W 572 (1,159)
------- -------
Net loss $(5,053) $(2,499)
======= =======
Acquisition costs of $1.5 million, consisting primarily of investment banking,
legal, accounting and other professional fees, were charged to operations in the
fourth quarter of 1998. Prior to the mergers, there were no intercompany
transactions between Segue, Eventus, and B&W.
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.
Accordingly, the operating results of SQLBench are included in the Company's
consolidated financial statements from the date of acquisition. 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 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; $117,000 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 cash flows, discounted for risks and
uncertainties related to the target markets and the completion of the products
and reflecting each project's stage of completion at the acquisition date.
Consequently, at the date of acquisition, the $117,000 allocated to purchased
research and development in process was recorded as a non-recurring charge. For
the years ended December 31, 1999 and 1998, accumulated amortization related to
completed technology was $1,975,000 and $988,000, respectively, and accumulated
amortization related to goodwill was $3,012,000 and $1,506,000, respectively.
Set forth below are unaudited pro forma combined results of operations of the
Company and SQLBench as if the SQLBench acquisition had been completed at the
beginning of 1997. The pro forma combined information set forth below is not
necessarily indicative of the 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 (amounts in
thousands, except per share data).
Year Ended December 31,
1997 1996
------------------------
Net revenue $28,049 $22,306
Net loss $(3,332) $(737)
Net loss per share - basic and diluted $(0.42) $(0.13)
F-13
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. OTHER ASSETS
In March 1998, the Company entered into an agreement with a vendor whereby the
vendor licensed specific software to the Company for purposes of marketing and
distribution. Under the initial terms of the agreement, the Company paid
$780,000 in 1998, which represented a non-refundable non-recurring engineering
and initial license fee ("NRE") of $480,000 and guaranteed royalties of
$300,000. Under this agreement, an additional $200,000 for guaranteed royalties
was to be paid by September 30, 1998. In October 1998, the parties amended this
agreement to, among other things, remove the Company's obligation to make the
remaining payment for guaranteed royalties (see Note 9). The NRE fee was being
amortized into cost of software revenue on a straight-line basis over its
estimated life of two years, and the royalty expense was being recognized as
cost of software revenue based upon sales of the related products. For the year
ended December 31, 1998, amortization expense and royalty expense related to
this agreement was approximately $180,000 and $10,000, respectively.
Based on minimal sales of the licensed products and management's decision in the
first quarter of 1999 to cease selling the licensed products related to the
above agreement in order to focus efforts on the EBMS products, the Company
wrote off the remaining balances of the NRE ($300,000) and prepaid royalties
($290,000) as cost of software as of December 31, 1998. Additionally in the
fourth quarter of 1998, the Company wrote off $77,000 of other prepaid
royalties, based on an analysis of their recoverability.
In December 1998, the Company entered into a five-year agreement with a vendor
that provides for future royalty payments to the vendor of 10% of net revenues
achieved on sales of the Company's products to the vendor's customer base. Under
the terms of the agreement, the Company paid a guaranteed, non-refundable
minimum royalty of $650,000 in December 1998. As of December 31, 1999 and 1998,
other current assets included approximately $220,000 for both years and other
long-term assets included approximately $210,000 and $430,000, respectively,
related to the guaranteed royalties. Royalty expense is recognized as cost of
software revenue based upon qualified sales of the Company's products and
amounted to $220,000 and $0 for the years ended December 31, 1999 and 1998,
respectively.
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of December 31 (in
thousands):
1999 1998
---- ----
Computer equipment $8,764 $5,514
Office equipment 403 145
Furniture and fixtures 1,131 962
Leasehold improvements 660 456
------- ------
10,958 7,077
Accumulated depreciation and amortization (5,224) (3,517)
------- -------
Total $5,734 $3,560
======= ======
Depreciation and amortization of property and equipment totaled $1,964,000,
$1,514,000, and $1,096,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.
F-14
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. NOTES PAYABLE
In conjunction with the SQLBench acquisition on December 30, 1997, the Company
issued $4.4 million of notes payable that bear interest at the designated prime
rate (8.5% at December 31, 1999). These notes become subordinated debt upon the
issuance of qualified Senior Debt, as defined by the note agreements. As of
December 31, 1999 and 1998, these notes were not subject to subordination.
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 at
certain defined dates or (ii) terminated by the Company without cause or by
reason of death or permanent disability, remaining payments under the notes
shall be made on December 30, 2000.
At December 31, 1999 and 1998, respectively, $883,000 and $2,649,000 was
recorded as the current portion of long-term debt related to this note.
In February 1997, B&W obtained a $350,000 revolving line of credit (increased to
$500,000 in November 1997) and an $85,000 term note with a bank, both of which
bore interest at the bank's prime rate plus 1.50%. At December 31, 1998,
$334,000 was outstanding under these notes. The notes were paid in full in
January 1999.
In September 1996, Eventus issued a promissory note for $492,000 in
consideration for assets purchased and certain technology rights received. In
October 1996, Eventus received proceeds of $300,000 in exchange for a promissory
note. The notes, which originally bore interest at 7%, were to mature on July
31, 1997. On June 30, 1997 and September 30, 1997, the maturity dates were
extended and the interest rates were amended to 9.5% and 11.0%, respectively, on
the remaining unpaid principal. As of December 31, 1997, approximately $443,000
was outstanding related to these notes. These notes were paid in full in
December 1998.
6. STOCKHOLDERS' EQUITY
COMMON STOCK
The Company's Certificate of Incorporation authorizes 30 million shares
of $.01 par value common stock and 9 million shares of $.01 par value preferred
stock; 4 million shares of such 9 million shares of preferred stock are
designated as Series A preferred stock.
Each series of Preferred Stock will have the rights, preferences, privileges and
restrictions, including voting rights, dividend rights, conversion rights,
redemption privileges and liquidation preferences, as shall be determined by the
Company's Board of Directors.
In conjunction with the SQLBench acquisition in December 1997, the Company
issued approximately 144,000 shares of unregistered restricted stock that by
agreement cannot be sold or otherwise disposed of for two years from the
acquisition date.
STOCK COMPENSATION PLANS
Stock Option Plans
In June 1998, the Company's 1996 Amended and Restated Incentive and
Non-Qualified Stock Option Plan (the "Option Plan") was amended to increase the
maximum number of shares of common stock available for issuance to 3,250,000
shares. Under the Option Plan, incentive stock options may be granted to any
officer or employee of the Company, and nonqualified stock options may be
granted to any officer, employee, consultant, director or other agent of the
Company.
In November 1998, the Company established the 1998 Employee Stock Option Plan
(the "1998 Option Plan"). On December 17, 1999, the Board of Directors approved
an amendment to increase by 250,000 the number of shares authorized for issuance
under the 1998 Option Plan. The 1998 Option Plan, as amended, provides for
grants of nonqualified options to purchase up to 1.25 million shares of the
Company's common stock to employees and consultants of the Company.
All options issued under the Option Plan and the 1998 Option Plan are granted at
the fair market value of the stock on the date of grant, become exercisable at
varying rates, generally over three or four years, as determined by the Board of
Directors, and generally expire 10 years from the date of grant.
With the acquisition of Eventus on December 3, 1998, the Company assumed 836
outstanding stock warrants and 31,115 outstanding stock options (adjusted for
the merger exchange ratio of 0.021378 common Eventus shares for each share of
the Company's common stock) representing all of Eventus' obligations under its
existing stock option plan. The assumed stock options and warrants were granted
to employees, directors, and consultants of Eventus at the fair market value of
the Eventus common stock at the date of grant, as established by the Eventus
Board of Directors, and expire 10 years from the date of grant. Vesting was
established by the Eventus Board of Directors and generally occurs over a three
to five year period. As of December 31, 1998, 98,060 shares (adjusted for the
merger exchange ratio) were authorized under the Eventus stock option plan, with
57,348 shares available for future grants. No additional stock options or
warrants will be granted under the Eventus plan.
With the acquisition of B&W on December 31, 1998, the Company assumed 41,870
outstanding stock options (adjusted for the merger exchange ratio of 0.112405
common B&W shares for each share of the Company's common stock) representing all
of B&W's obligations under its existing stock option plan. The assumed stock
options were granted to employees of B&W at the fair market value of the B&W
common stock at the date of grant, as established by the B&W Board of Directors,
and expire 10 years from the date of grant. Vesting was established by the B&W
Board of Directors and generally occurs over a four year period, with 50%
vesting on the second anniversary of the grant date, and 25% vesting on each of
the third and fourth anniversary of the grant dates. As of December 31, 1998,
56,202 shares (adjusted for the merger exchange ratio) were authorized under the
B&W stock option plan, with 14,332 shares available for future grants. No
additional stock options will be granted under the B&W plan.
F-15
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes activity of the Company's option plans since
December 31, 1996. Information with respect to Eventus and B&W stock options has
been retroactively restated to reflect their merger exchange ratios noted above.
Weighted
average
Shares exercise
in thousands price
------------ --------
Outstanding at December 31, 1996 1,899 $ 6.43
Granted 1,202 $ 10.49
Exercised (250) $ 2.33
Cancelled (379) $ 10.20
-------------
Outstanding at December 31, 1997 2,472 $ 8.24
Granted 1,107 $ 17.40
Exercised (711) $ 3.88
Cancelled (468) $ 12.81
-------------
Outstanding at December 31, 1998 2,400 $ 12.87
Granted 1,601 $ 9.31
Exercised (320) $ 2.08
Cancelled (1,193) $ 14.34
-------------
Outstanding at December 31, 1999 2,488 $ 10.68
=============
As of December 31, 1999, 1998, and 1997, options to purchase 645,800, 552,000
and 906,000 shares, respectively, were exercisable with weighted average
exercise prices of $10.19, $7.67 and $4.90 per share, respectively. As of
December 31, 1999, approximately 497,000 shares were available for future grants
under the Option Plan and the 1998 Option Plan.
For various price ranges, weighted average information for options outstanding
at December 31, 1999 was as follows:
Options Outstanding Exercisable Options
---------------------------------------------------- -------------------------------------
Weighted average Weighted Weighted
Range of remaining life average average
exercise prices Shares (in years) exercise price Shares exercise price
---------------------------------------------------- -------------------------------------
(in thousands) (in thousands)
$0.75 - 6.31 252 6.43 $ 4.59 84 $ 2.10
$6.38 - 6.38 299 6.97 $ 6.38 39 $ 6.38
$7.25 - 8.90 384 8.50 $ 7.83 66 $ 8.04
$9.00 - 9.00 370 7.64 $ 9.00 189 $ 9.00
$9.25 - 11.75 310 8.09 $ 10.21 105 $ 10.15
$11.88 - 13.38 259 8.83 $ 12.25 20 $ 12.86
$13.69 - 16.13 265 8.91 $ 14.69 55 $ 15.02
$16.69 - 22.25 349 8.90 $ 19.86 88 $ 20.24
----- ---
$.075 - $22.25 2,488 8.06 $ 10.68 646 $ 10.19
===== ===
F-16
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Employee Stock Purchase Plan
In February 1996, the Company established the Segue Software, Inc. 1996 Employee
Stock Purchase Plan (the "ESPP"), which made available 100,000 shares of the
Company's common stock for purchase by eligible employees through payroll
deduction. 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. In June 1998,
the ESPP was amended in order to increase the maximum number of shares of common
stock available for issuance from 100,000 to 200,000 shares. As of December 31,
1999, approximately 136,000 shares have been issued under the ESPP.
In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", ("SFAS 123") was issued. SFAS 123
required the Company to elect either expense recognition under SFAS 123 or its
disclosure-only alternative for stock-based employee compensation. The expense
recognition provision encouraged by SFAS 123 requires fair-value based financial
accounting to recognize compensation expense for employee stock compensation
plans. The Company adopted SFAS 123 in 1997 and elected the disclosure-only
alternative. Had compensation cost for the Company's stock and stock option
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
loss and net loss per share would have been adjusted to the pro forma amounts
indicated below for the years ended December 31, (in thousands, except per share
data):
1999 1998 1997
---- ---- ----
Net loss As reported $(15,948) $(5,053) $(2,499)
Pro forma $(19,182) $(7,644) $(4,668)
Net loss per common
share - basic and diluted As reported $(1.76) $(0.59) $(0.32)
Pro forma $(2.12) $(0.89) $(0.60)
For the years ended December 31, 1999, 1998 and 1997, total compensation cost
recognized in pro forma net loss for stock-based employee compensation awards
was $3,234,000, $2,591,000 and $2,169,000, 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.
The weighted average fair value of the stock options granted during 1999, 1998
and 1997 was $5.15, $9.65, and $5.74 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 1999,
1998 and 1997, respectively: risk-free interest rate of 5.3%, 5.0%, and 6.1%;
dividend yield of 0%; expected life of five years; and expected volatility of
60%, 59%, and 59%. For the computation in accordance with SFAS 123, the fair
value of the employees' purchase rights under the ESPP is estimated using the
Black-Scholes model with the following assumptions for 1999, 1998, and 1997:
risk-free interest rate of 4.6%, 5.5%, and 5.3%, respectively; dividend yield of
0%; expected life of six months; and expected average volatility of 108%, 60%
and 60%, respectively.
Options to purchase approximately 2,488,000, 2,400,000 and 2,472,000 shares of
common stock were outstanding for the years ended December 31, 1999, 1998 and
1997, respectively, but were not included in the calculation of diluted net loss
per common share because their inclusion would have been antidilutive.
7. EMPLOYEE SAVINGS PLAN
The Company maintains a 401(k) plans under which all U.S. 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, 1999, 1998 or 1997.
F-17
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. INCOME TAXES
Income (loss) before income taxes and the components of the income tax provision
(benefit) are as follows for the years ended December 31, (in thousands):
1999 1998 1997
---- ---- ----
Loss before income taxes:
United States $(16,359) $(5,107) $(2,443)
Foreign 585 194 0
-------- ------- -------
Total loss before income taxes $(15,774) $(4,913) $(2,443)
======== ======= =======
Provision for (benefit from) income taxes:
Current:
Foreign $ 114 $ 71 $ 0
State 60 69 56
-------- ------- -------
Total Current $ 174 $ 140 $ 56
-------- ------- -------
Deferred: Federal $(5,372) $(1,167) $ (551)
Foreign (22) (26)
State (1,244) (192) (167)
Change in valuation allowance 6,638 1,385 718
-------- ------- -------
Total deferred tax provision -- -- --
Total tax provision $ 174 $ 140 $ 56
======== ======= ======
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
components of the net deferred tax asset are as follows (in thousands):
1999 1998
---- ----
Gross deferred tax assets:
Net operating losses $ 10,832 $ 5,436
Intangible assets 1,468 695
Accounts receivable 250 198
Accrued expenses & deferred compensation 206 115
Fixed assets 102 42
Research and experimentation credits 1,558 936
---------- ----------
Total assets 14,416 7,422
Valuation Allowance (14,416) (7,422)
---------- ----------
Net Deferred Tax Asset (Liability) $ 0 $ 0
========== ==========
Of the changes in the valuation allowance described above approximately
$356,000, $3,902,000 and $3,119,000, respectively relates to tax return
deductions attributable to the exercise of non-qualifying stock options and
disqualifying dispositions of incentive stock options, and are not benefited
through income.
F-18
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of December 31, 1999, the Company had federal net operating loss
carryforwards of approximately $28.6 million, of which $10.5 million relates to
deductions attributable to the exercise of nonqualified stock options and
disqualifying dispositions of incentive stock options; state net operating loss
carryforwards of approximately $21.6 million, of which at least $2.6 million is
subject to annual limitations on utilization; and $1,152,000 of federal and
$616,000 of state tax credit carryforwards available for income tax purposes.
These carryforwards generally expire in the years 2000 through 2019 and may be
subject to additional annual limitations as a result of changes in the Company's
ownership. The benefits of stock option deductions included in net operating
loss carryforwards will be credited to additional paid-in capital when realized.
Management of the Company has evaluated the positive and negative evidence
impacting the realizability of its deferred tax assets. 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.
The following schedule reconciles the difference between the federal income tax
rate and the effective income tax rate for the years ended December 31 (in
thousands):
1999 1998 1997
---- ---- -----
U.S. federal statutory tax $(5,423) $(1,670) $(831)
S Corporation (income) loss taxed
at shareholders' level (Black & White) -- (194) 456
State tax provision, net (781) (81) (74)
Foreign rate differential 6 4
Federal and state tax credits (622) --
Nondeductible acquisition costs -- 520 30
Change in valuation allowance 6,638 1,385 718
Amortization of nondeductible goodwill 218 218 --
Other 138 (42) (243)
------- ------- -----
Effective tax $174 $140 $56
======= ======= =====
9. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On or about April 27, 1999, a putative class action complaint was filed in the
United States District Court for the District of Massachusetts against Segue,
its Chief Executive Officer and a former Chief Financial Officer of Segue,
captioned Nathan Rice v. Segue Software, Inc., et al., Civil No. 99-CV-10891RGS.
------------- ---------------------------
The class action complaint alleged the defendants violated the federal
securities laws by making material misrepresentations and omissions in certain
public disclosures during the period beginning on October 13, 1998 through April
9, 1999, inclusive. The public disclosures relate to, among other things,
Segue's past and future financial performance and results. On or about May 3,
1999, another similar putative class action complaint was filed against Segue,
its Chief Executive Officer and a former Chief Financial Officer of Segue in the
United States District Court for the District of Massachusetts, captioned
Anthony Moumouris v. Segue Software, Inc., et al., Civil No. 99-CV-10933RGS.
- ------------------- ---------------------------
These cases were consolidated under the caption In Re Segue Software, Inc.
-------------------------
Securities Litigation, Civil No. 99-CV-10891-RGS and the plaintiffs filed a
- ---------------------
consolidated amended complaint on September 27, 1999 alleging a putative class
period of July 14, 1998 through April 9, 1999, inclusive. The complaints sought
an unspecified amount of damages. Segue intends to defend the claims vigorously.
On November 8, 1999 each of the defendants filed a motion to dismiss the amended
complaint for failure to state a cause of action. The plaintiffs have opposed
the motions to dismiss on various grounds. The court heard arguments on the
motions on March 15, 2000, but has not yet rendered a decision on the motion. It
is not possible to predict when the court will rule on the motions or whether
they will be granted in whole or in part. Segue believes the defense of the
claims could involve significant litigation-related expenses. The outcome of
these matters is uncertain and, as a result, at this time Segue is not able to
quantify any related financial exposure. In the event that any of the claims set
forth in the class action complaints are determined or settled in a manner
adverse to Segue, then such determination or settlements could adversely affect
Segue's financial position or results of operations in the period in which the
litigation is resolved.
F-19
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Various other claims, charges and litigation have been asserted or commenced
against the Company arising from or related to contractual or employee
relations. Management does not believe these claims will have a material adverse
effect on the financial position or results of operations of the Company.
LEASE COMMITMENTS
In August 1998, the Company moved its corporate headquarters to Lexington,
Massachusetts under a non-cancelable operating lease that expires in 2007. The
Company has an obligation to provide a security deposit of up to approximately
$2.2 million if the Company's current assets become less than $20.0 million. The
Company has the right to terminate the lease on September 30, 2004 for a fee of
approximately $2.2 million. The Company also leases certain U.S. and foreign
sales offices and certain equipment under various operating leases with lease
terms ranging from month-to-month up to five 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, 1999 (in thousands):
Amount
------
2000 $3,540
2001 3,086
2002 2,937
2003 2,846
2004 2,838
Thereafter 6,120
-------
Total $21,367
=======
Rent expense for the years ended December 31, 1999, 1998 and 1997 totaled $2.6
million, $1.9 million and $1.3 million, respectively.
ROYALTY COMMITMENTS
The Company participates in royalty arrangements with third parties and as
revenues from the related products are recognized, the Company records the
related royalty expense.
10. NON-RECURRING AND OTHER CHARGES
During the second quarter of 1999, The Company restructured its product
development operations and delayed indefinitely the introduction of the Eventus
product, SilkControl. These activities were aimed at reducing costs associated
with the development of that product and enhancing the sales force's ability to
focus on other products. The restructuring resulted in the consolidation of four
development labs into three and included the termination of 15 employees
associated with the development of the Eventus product. Additionally, during the
second quarter of 1999 the Company shifted its sales strategy away from creating
and managing a large network of resellers towards building deeper relationships
with a few large system integrators. This revised strategy resulted in the
termination of seven employees who focused sales efforts on these channel
resellers. The Company also terminated the employment of two senior vice
presidents during the second quarter of 1999, each of whom has subsequently been
replaced. Associated with all the events noted above, the Company recorded
during the second quarter of 1999 non-recurring and other charges of
approximately $1.5 million, of which $1.0 million relates exclusively to
severance and other employee-related costs associated with a restructuring, and
$481,000 (including a noncash compensation charge of approximately $118,000),
which relates to severance of two senior vice presidents. As of
December 31, 1999, the Company
F-20
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
had made payments of approximately $882,000 related to the restructuring costs,
and the related restructuring accrual balance was approximately $131,000.
During the first quarter of 1999, the Company executed a restructuring
plan to consolidate its marketing, product development and administrative
operations in order to achieve cost efficiencies through the elimination of
redundant functions. The Company realigned its marketing and product development
operations to redirect focus to its strongest product lines and better integrate
the efforts of certain product development teams. As a result, the Company
recognized a non-recurring charge of approximately $1.0 million during the first
quarter of 1999. The restructuring charge included approximately $830,000 for
severance and other employee-related costs for the termination of 10 employees
and approximately $190,000 for facility-related costs, including the accrual of
estimated lease obligations associated with the closure of excess office
facilities. As of December 31, 1999, the Company had made payments of
approximately $700,000 related to these costs. The related restructuring accrual
balance was approximately $300,000.
In the fourth quarter of 1998, the Company recorded a charge of $1.5 million, of
which substantially all was paid in fiscal 1998, consisting primarily of
investment banking, legal, accounting, and other professional fees, related to
the Eventus and B&W acquisitions.
In the fourth quarter of 1997, the Company recorded 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.
11. SEGMENT REPORTING
The Company considers that it has the following four reportable operating
segments based on differences in products and services. Operating segments are
defined as components of the enterprise about which separate financial
information is available that is reviewed regularly by the chief operating
decision maker, or decision-making group, in deciding how to allocate resources
and in assessing their performance.
1999 1998 1997
---- ---- ----
Gross Gross Gross
Revenue Margin Revenue Margin Revenue Margin
------- ------- ------- ------- ------- -------
Operating Segments:
eBusiness product licenses $28,434 $16,125 $ 6,544
Client/server testing product licenses 1,014 10,124 13,118
------- ------- -------
Total software $29,448 $26,249 $19,662
------- ------- -------
Training and consulting $ 8,088 $ 1,222 $ 7,373 $ 2,712 $ 2,320 $ 701
Maintenance 8,885 6,809 7,226 5,768 5,657 4,635
------- ------- ------- ------- ------- -------
Total services $16,973 $ 8,031 $14,599 $ 8,480 $ 7,977 $ 5,336
------- ------- ------- ------- ------- -------
Total revenue $46,421 $40,848 $27,639
======= ======= =======
F-21
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents revenue and long-lived asset information by
geographic area as of and for the years ended December 31 (in thousands):
Total Revenue Long Lived Assets
------------- -----------------
1999 1998 1997 1999 1998 1997
---- ---- ---- ---- ---- ----
United States $42,518 $35,792 $25,413 $ 5,161 $ 4,995 $ 3,906
Foreign 3,903 5,056 2,226 850 197 144
------- ------- ------- ------- ------- -------
$46,421 $40,848 $27,639 $ 6,011 $ 5,192 $ 4,050
======= ======= ======= ======= ======== =======
Foreign revenue is based on the country in which the sale originates. Revenue
from no single foreign country was material to the consolidated revenues of the
Company. No customer accounted for 10% or more of total revenue in 1999, 1998 or
1997.
F-22
SEGUE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
F-23