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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, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____.
Commission file number: 0 - 27794
SEGUE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4188982
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1320 Centre Street, Newton Centre, Massachusetts 02159
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 796-1000
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant was approximately $49,151,124 as of February 28, 1997, 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
February 28, 1997 was 7,224,840.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A for Registrant's 1997 Annual Meeting of Stockholders to be held
on May 2, 1997, 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 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 11
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 23
PART III
Item 10. Directors and Executive Officers of the Registrant 23
Item 11. Executive Compensation 23
Item 12. Security Ownership of Management and Certain Beneficial Owners 24
Item 13. Certain Relationships and Related Transactions 24
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 24
1
Statements made or incorporated in 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 Segue Software, Inc.'s (hereafter "Segue" or the "Company") future
performance. The Company's actual results could differ materially from those set
forth in the forward-looking statements. Certain factors that might cause such a
difference are discussed in the section entitled "Certain Factors Affecting
Future Operating Results" on page 18 of this Form 10-K.
PART I
Item 1. Business
General
Segue Software, Inc. is a leader in automated testing for software
reliability. The Company's product family, QualityWorks, is used by quality
assurance professionals and software developers to improve software quality,
reduce development costs and shorten the time required to develop and deploy
software applications. QualityWorks integrates test planning, creation,
execution, management and analysis to provide unattended automated testing of
software applications across the various components of a distributed,
multi-platform client/server system.
Segue was incorporated in California in 1988 and reincorporated in
Delaware in March 1996.
Industry Background
As businesses expand the use of technology to manage information and
processes, and as software has become a more important component in the delivery
of their products and services, consistent and effective operation of software
applications has become more critical to their success. These applications are
increasingly deployed in client/server configurations. In an August 1996 report,
Gartner Group wrote, "Software quality is finally getting some attention. The
`cost of nonquality' has grown exponentially. The threat of application disaster
means profitability and growth for the client/server automated-testing tools
market. The worldwide market for automated client/server testing tools will grow
at a compounded annual growth rate of 60 percent to 70 percent through 1999." As
client/server software is increasingly utilized to support mission-critical
applications, effective software quality management and testing is required to
avoid defects.
Unlike mainframe environments, where applications, operating systems and
hardware were designed by a single vendor as an integrated solution,
client/server systems consist of component layers of applications, middleware,
operating systems, databases, servers, processors and network technology
designed separately by multiple vendors. For example, in a client/server
configuration, a Microsoft Windows95 client might send requests to a router
installed on a Microsoft NT server that distributes them to an Oracle database
2
located on a Sun Solaris server. There is a higher probability for application
instability or failure when the component layers of client/server applications
are developed separately by multiple vendors and integrated to form a business
system.
The transition to client/server environments has occurred in two phases.
In the first phase, client/server application logic exists on either the client
or the server. Typically the business logic is supported by the client and only
the data resides on the database server. In the second phase, referred to as
distributed client/server, application logic and business data are distributed
among multiple client, middleware and server layers.
Distributed client/server computing presents enormous challenges to
quality assurance professionals and software developers. Moreover, advances in
client/server software development tools have enabled rapid development of
client/server applications. The complexity of distributed client/server
environments, and rapid application development, greatly increase the likelihood
that a combination of events will cause an application or system to fail or
produce unintended results ("bugs"). At the same time, competitive pressures
force software developers to compress development schedules in order to shorten
time to deployment.
To date, quality assurance professionals and software developers have
primarily used manual testing techniques to test software application functions
and features. Manual testing is slow, tedious and difficult to replicate in a
systematic manner, and is often performed at the end of the development process
when bugs are difficult and costly to correct. As a result, quality assurance
professionals and software developers have begun to invest in automated software
testing tools.
Traditional automated testing tools, which are designed for a specific
component on a particular platform, do not adequately address the complexities
of distributed client/server computing. First, they are not designed to validate
distributed application logic and data. Second, tests created by these tools
become obsolete when a component is replaced or upgraded. Third, traditional
automated testing tools are unable to recover when a bug is encountered in the
component being tested, meaning that truly unattended testing in a distributed
environment is impossible with such tools. Finally, they do not deliver the
capability to design, create, manage and reuse tests across multiple platforms
and system configurations, resulting in additional costs and time spent on the
software development and quality assurance processes.
In addition to automated testing tools, defect tracking and performance
load testing are important components of the automated testing solution. With
integrated defect tracking, the quality assurance department and the software
development organization can work more closely in the process of finding,
tracking and fixing software errors. By building performance load testing into
the application testing process early in the development cycle, the performance
of the application in a "real world" environment can be tested as well.
3
Products
The Company's product family of software testing and quality management
tools, QualityWorks, provides an automated testing solution for distributed
client/server applications. QualityWorks consists of the QA Partner
cross-platform testing tool and integrated companion products.
The following comprise the QualityWorks product family:
QualityWorks. QualityWorks is a bundled suite of the Company's products
designed to integrate test planning, creation, execution, management and
analysis.
QA Partner. QA Partner extends testing beyond the client across multiple
platforms using the Company's Universal Testing Architecture (UTA). The product
supports concurrent cross-platform testing of clients, middleware and servers.
QA Partner delivers the following key benefits:
. Ease of use through intelligent, object-level recorders and graphical
error highlighting;
. Reuse of test scripts;
. Unattended testing through a built-in recovery system;
. Platform independence; and
. Extensibility.
QA DBTester. QA DBTester allows direct access to the application's
database, extending automated testing to the direct verification and management
of the application's data.
QA Organizer. QA Organizer is integrated with QA Partner to provide a
single point for users to drive the testing process, allowing seamless
integration of test planning with test creation, execution, management and
analysis.
QA Partner Agents. QA Partner Agents automatically translate test scripts
into platform-specific languages in order to test the applications running on a
particular platform, allowing for scripts to be reused over multiple platforms.
QA Partner Extension Kit. QA Partner Extension Kit enables customers to
publish an interface to their non-displayable or non-standard objects, so that
QA Partner can test them. The Company believes that the testing of non-standard
objects is unique to the Segue solution.
GO!. GO! increases testing productivity by providing out-of-the-box
tests, enabling users to automatically generate test plans and test scripts to
verify standard application behavior.
QA Radar. QA Radar is a defect management system that automates the
bug-tracking life cycle. It is customizable and tightly integrated with other
members of the QualityWorks family of products. It uses a powerful central
repository to simplify bug management, is scalable and provides native support
for a variety of databases and operating modes.
4
QA Performer. QA Performer is a multi-platform load testing tool that
quickly creates simulated user tests to predict the performance and robustness
of distributed applications. It is designed to work throughout the application
life cycle. It features point-and-click load test creation; an unlimited number
of simulated users; unique real-time, client-side load test monitoring; and
powerful reporting and modeling tools. The QA Performer technology has been
licensed from a vendor under an exclusive world-wide reseller agreement which
the Company entered into in November 1996. Under this agreement, the Company
will pay a royalty to the vendor for every copy of QA Performer that it licenses
to its end-users. The Company has guaranteed certain royalty payments during the
first year of the agreement and must meet certain minimum royalty levels in
order to maintain exclusivity. There can be no assurance that the Company will
generate sufficient QA Performer revenue to meet the minimum royalty required to
maintain exclusivity. The Company may choose to make additional payments over
and above the royalties paid, based on sales of QA Performer, in order to
maintain exclusivity.
Services
The Company supplements all of its product offerings with training,
consulting and technical support services. The Company's services are designed
to promote a clear and consistent approach to automated testing and to
facilitate the penetration of the Company's products in a broader market. As of
February 28, 1997, these services were provided by 18 employees.
Training and Consulting. The Company offers training courses and
consulting services in support of its product family. The training courses are
held regionally in selected U.S. cities or at the customer site. The Company has
two principal objectives for its fee-based training courses and consulting
services: to produce the agreed-upon deliverables for the projects and to
enhance the customers' understanding of the Company's methodologies and
techniques.
Support Services. The Company offers annual maintenance contracts for an
annual fee to customers who have entered into license agreements for the use of
the Company's software products. The Company provides customer service and
support through its internal technical support organization. Support services
include the maintenance of the Company's software products in accordance with
specifications contained in the user's guide for such products and access to
technical support personnel. This support includes technical support through the
Company's internal customer support group via phone, fax and e-mail
communications. Customers who are under an active software maintenance contract
are entitled to product upgrades and enhancements, when and if released. The
Company's distributors and some of its channel partners provide initial
telephone support to end-users.
Sales and Marketing
The Company sells its products through three channels: a direct sales
force consisting of field and telesales representatives; a channel partner
program; and international distributors and resellers. The Company has made a
significant investment in sales and marketing in each of the last two years. As
of February 28, 1997, the Company's sales and marketing force consisted of 52
employees.
5
Direct Sales. The Company has historically relied principally on direct
sales of its products. The Company has structured its domestic direct sales
force in teams consisting of a field sales representative, a telesales
representative and a field application engineer. As of February 28, 1997, the
Company's direct sales force consisted of 27 employees. The Company has seven
sales centers throughout the United States and one sales center in the United
Kingdom. The Company intends to hire additional sales and support personnel to
broaden its direct selling and distribution capabilities.
Channel Partner Programs. In 1995, the Company established its Channel
Partner Programs, which aim to generate revenues from alternate channels. These
programs consist of four channels, Value Added Resellers (VARs), Business
Integration Partners, Technology Integration Providers and Original Equipment
Manufacturers (OEMs). Current partners include Andersen Consulting, EDS, Interim
Technology and INTERSOLV.
International Sales. In international markets, the Company uses
distributors in twelve countries, which are supported by three members of the
Company's sales organization. The Company derived approximately 8% and 7% of its
total product sales from international customers in 1996 and 1995, respectively.
In support of its sales efforts, the Company conducts sales training
courses, targeted marketing programs, including direct mail, public relations,
advertising, seminars, trade shows and telemarketing, and ongoing customer and
third party communications programs. The Company also seeks to stimulate
interest in computer and software quality management tools through a public
relations program, speaking engagements, white papers, technical notes and other
publications. The Company has established a home page on the Internet's World
Wide Web, where potential customers can access information about the Company and
its products.
Backlog
The time between order and delivery of the Company's products is generally
quite short. The number of orders, as well as the size of individual orders, can
vary substantially from month to month. Because of the short period between
order receipt and shipment of products, the Company typically does not have a
backlog of unfilled orders.
Research and Development
The Company has made substantial investments in research and product
development. The Company's research and development is conducted by project
teams consisting of development and quality assurance engineers and technical
writers. The Company uses many of its own products in its development process.
The Company organizes development and quality assurance schedules to optimize
usage of automated tests by starting script development very early in the
development life cycle. The Company's research and development staff originates,
produces and tests many of the Company's prototype products. The research and
development department consults with the Company's sales and marketing staff
and utilizes the feedback from customer support and training to ensure the
6
satisfaction of its current customers. The Company also licenses technology from
vendors to be embedded in its product for resale or to be resold as products by
the Company.
As of February 28, 1997, the Company's Research and Development Department
consisted of 35 employees: 19 in research and development, 13 in quality
assurance and three in documentation. The Company's annual research and
development expense for 1996, 1995 and 1994 was $3.8 million, $2.3 million and
$1.6 million, respectively. The Company anticipates that it will continue to
commit substantial resources to research, development and quality assurance in
the future. Historically, the Company has expensed its research and development
costs as incurred.
The Company recently announced its plans to develop and market a Web
application testing tool to be known as Silk. Release 1.0 of this automated Web
application testing product is scheduled for release in 1997.
Competition
The market for software quality management tools is new, intensely
competitive, rapidly evolving and subject to rapid technological change. The
Company's competitors offer a variety of products and services to address this
market. The Company currently encounters direct competition from a number of
public and private companies such as Mercury Interactive Corporation and SQA,
Inc. (recently acquired by Rational Software Corporation). In addition, the
possible entrance of new competitors may intensify competition in the software
quality management market. Many of the Company's current and possible future
competitors have significantly greater financial, technical, marketing and other
resources than the Company, and many have well established relationships with
current and potential customers of the Company. It is also possible that
alliances among competitors may emerge and rapidly acquire significant market
share. The Company also expects that competition will increase as a result of
software industry consolidations. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any of which would
materially adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the Company will be able to
compete effectively against current and future competitors.
The Company believes that the principal competitive factors affecting its
market include product features and functionalities, such as flexibility,
scalability, ease of integration, ease of implementation, ease of use, quality,
performance, price and total cost of ownership; customer service and support;
company reputation and financial viability; and effectiveness of sales and
marketing efforts. Although the Company believes that it currently competes
effectively with respect to such factors, there can be no assurance that the
Company will be able to maintain its competitive position against current and
potential competitors.
7
Proprietary Technology
The Company primarily relies upon a combination of trademark, copyright
and trade secret laws and employee and third-party non-disclosure agreements to
protect its proprietary rights in its products. The Company has a patent which
was recently awarded, but there can be no assurance that this patent would be
upheld if challenged. There can be no assurance that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. There can also be no assurance that the
measures taken by the Company to protect its proprietary rights will be adequate
to prevent misappropriation of the technology or independent development by
others of similar technology. In addition, the laws of various countries in
which the Company's products may be sold may not protect the Company's products
and intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
intellectual property infringement claims against the Company or that any such
claims will not require the Company to enter into royalty arrangements or result
in costly litigation. The Company is not aware of any patent infringement charge
or any violation of other proprietary rights claimed by any third party relating
to the Company or the Company's products. However, the computer software market
is characterized by frequent and substantial intellectual property litigation.
Intellectual property litigation is complex and expensive, and the outcome of
such litigation is difficult to predict. The Company believes that, due to rapid
pace of technological innovation for software quality management products, the
Company's ability to establish and maintain a position of technology leadership
in the industry is dependent more upon the skills of its development personnel
than upon the legal protections afforded its existing technology.
Employees
As of February 28, 1997, the Company had 125 full-time employees, all but
one of whom were based in the United States. These employees include 35 in
Research and Development, 52 in Sales and Marketing, 22 in Customer Support,
Training and Distribution, and 16 in Finance and Administration. The Company's
employees are not represented by any collective bargaining organizations and the
Company has never experienced any work stoppages. The Company considers its
relations with its employees to be good.
Executive Officers of the Registrant
The executive officers of the Company, their ages and their positions with
the Company as of December 31, 1996 are as follows:
Name Age Position
Elisabeth Elterman 44 President, Chief Executive Officer and Director
J. Jeffrey Bingenheimer 53 Vice President, Chief Financial Officer, Treasurer
and Assistant Secretary
Brian J. LeSuer 37 Executive Vice President of Research and
Development
David C. Laroche 31 Chief Technical Officer
8
F. Kent Bradford 51 Senior Vice President of Worldwide Sales
Gareth S. Taube 47 Vice President of Marketing
Betsy R. Rudnick 46 Vice President of Human Resources and
Administration
Paul R. Maguire 37 Vice President of Sales
Stephen L. Adams 46 Vice President of International Sales
Michael D. Maggio 35 Vice President of Business Development
Ms. Elterman has served as President, Chief Executive Officer and as a
director of the Company since July 1995. Ms. Elterman joined the Company in
April 1992 as an Executive Vice President and was promoted to Chief Operating
Officer in October 1993. Ms. Elterman held a senior management position at
Softbridge Microsystems, Inc., a software company, prior to joining the Company
from April 1984 through April 1992.
Mr. Bingenheimer has served as Vice President, Chief Financial Officer and
Assistant Secretary of the Company since September 1995 and as Treasurer since
February 1996. Prior to joining the Company, Mr. Bingenheimer served as Vice
President--Finance and Administration and Treasurer of CenterLine Software,
Inc., a software company, from April 1991 to September 1995. From April 1985 to
March 1991, Mr. Bingenheimer served as Vice President--Finance and
Administration, Senior Vice President of Finance and Administration and
Treasurer of Index Technology Corporation, a software company.
Mr. LeSuer joined the Company in September 1992 to establish the Training,
Consulting and Quality Assurance Departments. He has served as Executive Vice
President of Research and Development since November of 1995. From May 1991 to
September 1992, he was a senior quality assurance engineer for Datalogix
International Inc., a software company. Prior to 1991, he held various positions
in quality assurance at People's Bank, the NASD and The Traveler's Insurance
Companies.
Mr. Laroche has served as the Company's Chief Technical Officer since
October 1991. In March 1991, Mr. Laroche co-founded Software Quality Management
to assist companies in the implementation and usage of automated testing
technology. From October 1988 to March 1991, Mr. Laroche held various positions
at Softbridge Microsystems, Inc., most recently as an architect of the Automated
Testing Facility.
Mr. Bradford has served as Senior Vice President of Worldwide Sales since
December 1996. He served as Vice President of Sales at UniKix Technologies, a
software company, from July 1994 until he joined Segue. Prior to that he
consulted as Vice President of Sales and Marketing at Corex Technologies Corp.,
a software company, from January 1994 to June 1994. He served as Vice President
of Sales at OpenBooks Software, a software company, from November 1990 to
January 1994.
Mr. Taube has served as Vice President of Marketing since November 1996.
From 1994 to November 1996, he served as Vice President of Marketing and
Business Development at Praxis International, a software company. From 1980 to
1994 he served as Senior Director, Director and Worldwide Sales Manager at
9
Digital Equipment Corporation, a computer hardware and software company.
Ms. Rudnick has served as Vice President, Human Resources and
Administration since January 1995. Prior to her full-time employment at the
Company, Ms. Rudnick was a consultant to the Company. From August 1987 to
January 1995, Ms. Rudnick worked as an independent consultant to several
software companies in the areas of organizational development, human resource
management and facilities planning and leasing.
Mr. Maguire has served as Vice President of Sales since January 1994. From
November 1992 to December 1993, Mr. Maguire was the Vice President of Sales and
Marketing for Software Partners/32, a software company. From 1985 to November
1992, Mr. Maguire served as Vice President of Sales of V.I. Corporation, a
software company.
Mr. Adams joined the Company as Vice President, International Sales in
March 1996. From April 1993 to March 1996, Mr. Adams was the Director of
International Sales for Atria Software, Inc., a software company. From September
1988 to February 1993, Mr. Adams was a Regional Sales Manager for NeXT Computer,
a software company.
Mr. Maggio has served as Vice President of Business Development for the
Company since January 1995. From June 1993 to December 1994, Mr. Maggio served
as the Director, Eastern Region in the Company's sales organization. Mr. Maggio
joined the Company in October 1991 and served as the Vice President of
Development until June 1993. From June 1991 to October 1991, Mr. Maggio was the
Manager of the User Environments Group at Honeywell Bull, a computer
manufacturer. Mr. Maggio was the Principal Software Engineer and Manager at
Siemens-Nixdorf Information Systems from June 1988 to June 1991.
Item 2. Properties
The Company's corporate headquarters are located in Newton Centre,
Massachusetts, where it leases approximately 22,750 square feet under a lease
that expires in November 1998. The Company's field sales and support operations
occupy leased facilities in six locations throughout the United States and one
location in the United Kingdom. The facility in Newton Centre is being fully
utilized, and the Company is actively pursuing additional property at the
current location to meet its expansion needs for the remainder of 1997.
Item 3. Legal Proceedings
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
10
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Market Price for Common Stock
The Company's Common Stock began trading publicly on March 28, 1996 on the
National Market Tier of the NASDAQ Stock Market under the symbol: SEGU. The
following table sets forth, for the period indicated, the high and low closing
prices of the Common Stock as reported on the NASDAQ National Market System.
These prices do not include retail markups, markdowns, or commissions.
Year Ended December 31, 1996: High Low
------- -------
First Quarter (March 28, 1996 to March 31, 1996) $21.500 $21.000
Second Quarter $39.500 $21.250
Third Quarter $24.500 $ 9.875
Fourth Quarter $18.250 $12.000
On February 28, 1997, the closing price reported on the NASDAQ National
Market System for the Common Stock was $11.00. The market price of the
Company's Common Stock has fluctuated significantly and is subject to
significant fluctuations in the future.
Holders of Record
As of February 28, 1997, there were approximately 95 holders of record of
the Company's Common Stock and 7,224,840 shares of Common Stock outstanding. The
Company estimates that as of February 28, 1997, there were approximately 1,100
beneficial stockholders.
Dividend Policy
The Company has never paid cash dividends on the Common Stock and does not
anticipate paying such dividends in the foreseeable future. The Company intends
to retain future earnings for use in the Company's business. The payment of any
future dividends will be determined by the Board of Directors in light of
conditions then existing, including the Company's financial condition and
requirements, future prospects, restrictions in financing agreements, business
conditions and other factors deemed relevant by the Board of Directors.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with
the Financial Statements and the Notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere in
this Annual Report on Form 10-K. The selected financial data set forth below as
of and for the years ended December 31, 1996, 1995 and 1994 are derived from the
financial statements of the Company, included elsewhere in this Annual Report on
Form 10-K that have been audited by Coopers & Lybrand L.L.P., independent public
accountants. The selected financial data for the years ended December 31, 1993
and 1992 are derived from audited financial statements of the Company not
included in this Annual Report on Form 10-K.
11
Year ended December 31,
------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
Statement of Operations Data:
(in thousands, except per share data)
Revenue:
Software $12,592 $ 8,312 $4,770 $2,173 $ 463
Services 4,381 2,627 1,253 466 25
Royalties - 129 335 770 1,134
------- ------- ------ ------ ------
Total revenue 16,973 11,068 6,358 3,409 1,622
Cost of revenue:
Cost of software 475 315 243 165 3
Cost of services 1,776 1,194 601 352 -
Cost of royalties - 30 80 169 165
------- ------- ------ ------ ------
Total cost of revenue 2,251 1,539 924 686 168
Gross margin 14,722 9,529 5,434 2,723 1,454
Operating expenses:
Sales and marketing 8,500 5,378 2,546 925 21
Research and development 3,806 2,273 1,574 1,041 1,460
General and administrative 2,546 1,709 1,284 724 229
Severance charges - 449 - - -
------- ------- ------ ------ ------
Total operating expenses 14,852 9,809 5,404 2,690 1,710
Income (loss) from operations (130) (280) 30 33 (256)
Litigation settlement (744) - - - -
Other income (expense), net 1,535 (23) (21) (34) (53)
------- ------- ------ ------ ------
Income (loss) before provision for
income taxes 661 (303) 9 (1) (309)
Provision for income taxes 20 - - - -
------- ------- ------ ------ ------
Net income (loss) $ 641 $ (303) $ 9 $ (1) $ (309)
======= ======= ====== ====== ======
Net income (loss) per common and
common equivalent share $ .09 $ (.17) $ - $ - $ (.24)
======= ======= ====== ======= ======
Weighted average common and common
equivalent shares outstanding 7,142 1,795 4,245 1,638 1,266
======= ======= ====== ======= ======
Balance Sheet Data:
December 31,
------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(in thousands)
Cash and cash equivalents $ 7,112 $ 442 $ 711 $ 218 $ 768
Working capital (deficit) 40,667 (57) 1,211 504 733
Total assets 47,631 4,496 3,810 1,991 1,112
Convertible debt - 654 654 654 654
Total stockholders' equity 42,707 1,305 1,546 613 305
There were no cash dividends declared per common share for any of the years
shown above.
12
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of revenue represented by certain items reflected in the Company's statements
of operations:
Year ended December 31,
-----------------------
1996 1995 1994
----- ---- ----
Revenue:
Software 74.2% 75.1% 75.0%
Services 25.8 23.7 19.7
Royalties - 1.2 5.3
----- ----- -----
Total revenue 100.0 100.0 100.0
Cost of revenue:
Cost of software 2.8 2.8 3.8
Cost of services 10.5 10.8 9.4
Cost of royalties - 0.3 1.3
----- ----- -----
Total cost of revenue 13.3 13.9 14.5
Gross margin 86.7 86.1 85.5
Operating expenses:
Sales and marketing 50.1 48.6 40.0
Research and development 22.4 20.5 24.8
General and administrative 15.0 15.4 20.2
Severance charges - 4.1 -
----- ----- -----
Total operating expenses 87.5 88.6 85.0
----- ----- -----
Income (loss) from operations (0.8) (2.5) 0.5
Litigation settlement (4.4) - -
Other income (expense), net 9.1 (0.2) (0.4)
----- ----- -----
Income (loss) before provision for income taxes 3.9 (2.7) 0.1
Provision for income taxes 0.1 - -
----- ----- -----
Net income (loss) 3.8% (2.7)% 0.1%
===== ===== =====
13
Revenue
Total Revenue
Total revenue increased 53% to $17.0 million in 1996 and 74% to $11.1
million in 1995 from $6.4 million in 1994.
Total revenue primarily consists of software and services revenue. Software
revenue consists of revenue from the granting of perpetual licenses to use the
Company's products. Services revenue consists of revenue from maintenance,
training and consulting. Royalty revenue consists of royalties from the sale of
products sold by a third party which is related to the porting business that was
the focus of the Company's operations prior to 1992. Consistent with fiscal
1995, the Company sold its licenses through its direct sales force,
international distributors and systems integrators.
Revenue from Software
Software revenue increased 51% to $12.6 million in 1996 and 74% to $8.3
million in 1995 from $4.8 million in 1994. The increases in software revenue
are primarily the result of increased unit shipments in each of the respective
periods. The Company believes that the increased unit shipments were due to an
increase in the demand for automated testing products; the introduction by the
Company of new and upgraded products; increased market acceptance of the
QualityWorks family of products; and expansion of the Company's sales and
marketing activities.
Revenue from Services
Services revenue increased 67% to $4.4 million in 1996 and 110% to $2.6
million in 1995 from $1.3 million in 1994. The increases in revenue from
services are principally the result of increased volume of maintenance, training
and consulting services, primarily due to the expansion of the installed base of
users of the Company's products. Maintenance revenue increased 75% to $2.8
million in 1996 and 181% to $1.6 million in 1995 from $569,000 in 1994. Training
and consulting revenue increased 60% to $1.6 million in 1996 and 46% to $1.0
million in 1995 from $684,000 in 1994.
Revenue from Royalties
Royalty revenue totaled $335,000 in 1994 and declined to $129,000 in 1995.
There were no royalties received in 1996. This royalty revenue was the result
of work done by the Company for Lotus Development Corporation in 1990 and 1991.
The Company received royalties from the sale of Lotus 1-2-3 on the UNIX
platform. The Company does not expect to receive any royalty revenue pursuant
to this arrangement in the future.
14
Cost of Revenue
Cost of Software
Cost of software includes documentation reproduction costs, product
packaging, product media, employment costs for distribution, amortization of
purchased intellectual property costs and patent costs and royalties due to
third parties for their software included in the Company's products or sold
separately by the Company. These costs increased 51% to $475,000 in 1996 and
30% to $315,000 in 1995 from $243,000 in 1994. As a percentage of software
revenue, cost of software was 3.8% in 1996 and 1995 and 5.1% in 1994. The
increase in the absolute dollar amount of cost of software revenue in each
period primarily reflects the increased volume of units sold. The reduction in
cost of software revenue as a percentage of software revenue from 1994 to 1996
was due to operating efficiencies.
The Company recently licensed technology from a vendor for its QA
Performer product and is required to pay royalties to the vendor based on the
net sales of QA Performer. The Company has guaranteed royalty payments of $1.0
million for 1997. Additionally, the Company must meet certain minimum royalty
levels in order to maintain exclusivity. These guaranteed royalty payments may
cause the cost of software to increase as a percentage of revenue.
Cost of Services
Cost of services consists principally of employment-related costs for the
Company's customer support staff, which provides services under maintenance
contracts, and the Company's training and consulting staff, as well as the cost
of materials and facilities used in training customers. Cost of services
increased 49% to $1.8 million in 1996 and 99% to $1.2 million in 1995 from
$601,000 in 1994. As a percentage of services revenue, cost of services was
41%, 45% and 48% in 1996, 1995 and 1994, respectively. Cost of services has
decreased as a percentage of services revenue due to increased productivity in
providing maintenance services. The Company expects to expand its customer
support, training and consulting capabilities in 1997.
Cost of Royalties
The Company contracted with third parties to assist in the work of porting
the Lotus 1-2-3 spreadsheet software to the UNIX operating system. As part of
those contractual relationships, the Company pays a percentage of the royalties
that it receives from Lotus to the third parties. Cost of royalties was $80,000
in 1994 and decreased 63% to $30,000 in 1995. There were no royalties received
from Lotus in 1996 and therefore no cost of royalties relating to this contract
for 1996. The Company anticipates that the cost of these royalties, if any, in
future periods will be insignificant.
15
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of salaries, commissions and
related costs of Company personnel and promotional marketing programs, including
advertising, brochures, direct mail programs and seminars. Sales and marketing
expenses increased 58% to $8.5 million in 1996 and 111% to $5.4 million in 1995
from $2.5 million in 1994. The principal reasons for the increases in sales and
marketing expenses in all periods were increases in the number of sales and
marketing personnel, increases in commissions as a result of higher revenue
levels and increases in promotional marketing programs. Sales and marketing
expenses increased as a percentage of revenue to 50.1% and 48.6% in 1996 and
1995, respectively, as a result of significant increases in the number of sales
staff hired by the Company and in the Company's promotional marketing programs.
Sales and marketing expense as a percentage of revenue in 1994 totaled 40.0%.
The Company intends to increase the amount of spending for sales and marketing
in 1997, both internationally and domestically. This increase will be
principally related to hiring additional sales and marketing personnel and
increased spending on marketing programs. There can be no assurance that these
increased expenditures will result in increased revenue or improvement in the
effectiveness of the sales organization.
Research and Development
Research and development expenses consist primarily of the employment-
related costs for engineering and technical personnel associated with developing
new products or enhancing existing products, for quality assurance personnel and
for product documentation specialists to provide user product documentation and
tutorials. To date, all of the Company's costs for research and development
have been charged to operations as incurred since the amount of software
development costs qualifying for capitalization has been insignificant.
Research and development expenses increased 67% to $3.8 million in 1996 and 44%
to $2.3 million in 1995 from $1.6 million in 1994. The increases are
attributable to increases in the number of research and development employees
active in the development of new products and the enhancement of existing
products. The Company intends to continue making significant investments in
research and development to develop new products and expand the development
environments on which its products are offered.
General and Administrative
General and administrative expenses consist principally of employment-
related costs for executive and administrative personnel, professional fees,
consulting fees, system support costs and other general corporate expenses.
General and administrative expenses increased 49% to $2.5 million in 1996 and
33% to $1.7 million in 1995 from $1.3 million in 1994. The absolute increases
in all periods are attributable to increased employment of both executive and
administrative personnel and increases in professional fees, system support
costs and other general corporate expenses. The Company anticipates that
general and administrative expenses will increase in 1997 due to the growth in
management systems and administrative infrastructure.
16
Severance Charges
In 1995, the Company entered into an employment separation agreement with
its former Chief Executive Officer. The costs of the employment separation
agreement totaled $449,000 and included severance pay and the purchase of vested
options.
Litigation Settlement
On September 30, 1996, the Company entered into a definitive agreement with
a plaintiff to settle litigation brought against the Company and certain of its
current and former employees. The Company recorded a charge of $744,000 in the
third quarter of fiscal 1996 to cover the settlement and other expenses incurred
in connection therewith.
Other Income (Expense), Net
Other income (expense), net is comprised primarily of interest income
from cash, cash equivalents and short-term investments. Prior to April 2, 1996,
the Company generally invested in money market accounts. On April 2, 1996, the
Company completed an initial public offering of common stock and received net
proceeds of $39.5 million. The Company has invested, and will continue to
invest, the offering proceeds primarily in U.S. Government and government agency
securities, in investment-grade commercial paper and in money market accounts
until such time as the proceeds are needed to fund operations. As a result of
the Company's receipt and investment of the offering proceeds, other income has
increased substantially over prior periods. Interest income was partially
offset by interest expense related to the Company's convertible debt. As of
December 31, 1996, all of the Company's convertible debt was converted into
common stock of the Company.
Provision for Income Taxes
The Company had a $20,000 provision for income taxes in 1996 and no
provision for income taxes in 1995 and 1994 due to the fact that it either
utilized net operating loss carryforwards or incurred net losses. As of
December 31, 1996, the Company had net operating loss carryforwards of
approximately $1.9 million as well as approximately $800,000 of tax credit
carryforwards available for income tax purposes. These carryforwards generally
expire in the years 2003 through 2010 and may be subject to annual limitations
as a result of changes in the Company's ownership. Management of the Company
has evaluated the positive and negative evidence impacting the realizability of
its deferred tax assets, which are comprised principally of net operating loss
carryforwards and tax credits, as required by Statement of Financial Accounting
Standards No. 109. Management has considered its history of annual and
cumulative losses and recent limited quarterly periods of income and concluded,
in accordance with the applicable accounting standards, that it is more likely
than not that it will not generate future taxable income prior to the expiration
of these items in the years 2003 through 2010. 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
Net Income (Loss)
For the year ended December 31, 1996, the Company had net income of
$641,000 compared with a net loss of $303,000 for the year ended December 31,
1995 and net income of $9,000 for the year ended December 31, 1994.
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments increased to $41.2
million as of December 31, 1996 from $442,000 as of December 31, 1995, primarily
as a result of the funds raised in the Company's initial public offering of
common stock.
The Company generated $2.2 million and $425,000 from operations in 1996 and
1995, respectively. In 1996, funds provided by operating activities were
primarily the result of net income and growth in accrued expenses and deferred
revenue, partially offset by growth in accounts receivable and other current
assets. In 1995, funds provided by operating activities were primarily the
result of growth in accrued expenses and deferred revenue, partially offset by
growth in accounts receivable.
The Company utilized $35.5 million and $755,000 for investing activities in
1996 and 1995, respectively. The investing activities in 1996 involved the
investment of the initial public offering proceeds in short-term investments,
generally in U.S. Government and government agency securities, and the purchase
of computer equipment, software and furniture. The investing activities in 1995
involved the purchase of computer equipment, software and furniture.
The Company generated funds from financing activities of $40.0 million
and $62,000 in 1996 and 1995, respectively. The Company generated $39.5 million
from its initial public offering of common stock.
Assuming there is no significant change in the Company's business, the
Company believes that the existing cash and short-term investments as well as
cash flows from operations will be sufficient to meet its working capital
requirements for at least the next twelve months.
Certain Factors Affecting Future Operating Results
Statements made or incorporated in 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
the Company's future performance. The Company's actual results could differ
materially from those set forth in the forward-looking statements. Certain
factors that might cause such a difference are discussed below.
18
Short Operating History; Accumulated Deficit
The Company was founded in 1988 to provide software porting services to
independent software vendors. In 1992, the Company reorganized its business to
focus on the development and marketing of automated testing software for the
quality assurance market. The Company shipped its first automated testing
product, QA Partner, in the quarter ended March 31, 1993. Accordingly, the
Company has a limited operating history and, although the Company has
experienced growth in recent periods, continued growth at the same rate is not
sustainable and is not necessarily indicative of future operating results.
Losses have resulted in an accumulated deficit of approximately $3.1 million as
of December 31, 1996. The Company had net income of $9,000 in 1994, a loss of
$303,000 in 1995 and net income of $641,000 in 1996. The limited operating
history of the Company makes the prediction of future results difficult and,
therefore, there can be no assurance that the Company will sustain revenue
growth or achieve profitability on a consistent basis.
Potential Fluctuations in Operating Results
The Company may experience significant fluctuations in future quarterly
operating results, which may be caused by many factors, including: the timing of
introductions of new products or product enhancements by the Company or its
competitors; personnel changes; the size and timing of individual orders;
software bugs or other product quality problems; competition and pricing;
customer order deferrals in anticipation of new products or product
enhancements; reduction in demand for automated software testing products;
changes in operating expenses; product mix; and general economic conditions. A
substantial portion of the Company's operating expenses are related to
personnel, facilities and marketing programs. The level of spending for such
expenses cannot be adjusted quickly and is based, in significant part, on the
Company's expectations of future revenues. If actual revenue levels are below
management's expectations, results of operations are likely to be adversely
affected. In addition, the Company does not typically experience order backlog.
Furthermore, the Company has often recognized a substantial portion of its
revenues in the last month of a quarter, with these revenues frequently
concentrated in the last weeks or days of a quarter. As a result, product
revenues in any quarter are substantially dependent on orders booked and shipped
in the latter part of that quarter, and revenues for any future quarter are not
predictable with any significant degree of accuracy. For these reasons, the
Company believes that period-to-period comparisons of its results of operations
are not necessarily meaningful and should not be relied upon as indications of
future performance. Moreover, although the Company has not historically
experienced seasonal fluctuations in its revenue or results of operations, such
fluctuations are not uncommon in the software industry and may affect the
Company in the future.
Dependence on Principal Product
To date, the Company has derived substantially all of its revenues from
licenses of QA Partner and related products and from fees for related services.
As a result, any factors adversely affecting the sales of QA Partner, such as
increased price competition or the introduction of technologically superior
products, could have a material adverse effect on the Company. The Company's
future financial performance will depend in significant part on its ability to
develop and introduce new releases of QA Partner with enhanced features and
functionalities and related products. There can be no assurance that any such
new releases or products will be successfully developed or achieve market
acceptance.
19
Emerging Market
The market for automatic software testing products is relatively new and
undeveloped. Marketing and sales techniques in the automated software testing
marketplace, as well as the bases for competition, are not well established.
There can be no assurance as to the extent that a significant market for
automated software testing products will develop or the extent to which the
Company's products will be accepted in that market. Although the Company
believes that the current trend toward increased use of automated software
testing will continue, a majority of software testing is still carried out
manually, and there can be no assurance that the automated software testing
market will enjoy continued growth.
The commercial market for products and services designed for use with the
Internet and the Internet's World Wide Web has only recently begun to develop,
and the success of the Company's products may depend, in part, on their
compatibility with the Internet and the Internet's World Wide Web. It is
difficult to predict with any assurance whether the Internet will prove to be a
viable commercial marketplace or whether the demand for Internet-related
products and services will increase or decrease in the future. There can be no
assurance that the Company will be able to effectively adapt its products to the
Internet or to successfully compete in the market for Internet-related products
and services.
Management of Growth
The Company has recently experienced a period of rapid growth, including a
substantial increase in the number of orders, customers and employees. Such
growth has placed, and may continue to place, strains on the Company's
management, operations and systems. The Company's ability to compete effectively
will depend, in part, upon its ability to expand, improve and effectively
utilize its operational, management, marketing, sales and financial systems as
necessitated by changes in the Company's business. Any failure by the Company's
management to effectively anticipate, implement and manage the changes required
to sustain the Company's growth could have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that the Company will be able to effectively manage such change.
Rapidly Changing Technology; New Products; Risk of Product Defects
The market for computer software products is generally characterized by
rapidly changing technology and frequent new product introductions that can
render existing products obsolete or unmarketable. The Company believes that a
major factor in its future success will be its ability to develop and introduce
in a timely manner enhancements to its existing products and new products that
will gain market acceptance. If the Company is unable to introduce new products
and respond to industry changes on a timely basis, its business could be
materially adversely affected. Software products as complex as those offered by
the Company may contain undetected errors or failures when first introduced or
as new versions are released. Although the Company has not experienced material
adverse effects resulting from undetected errors in the past, there can be no
assurance that errors will not be found in new products after commencement of
commercial shipments, resulting in loss of or delay in market acceptance, which
could have a material adverse effect upon the Company's business, financial
condition and results of operations. Further, because the Company is in the
quality assurance business, any errors in its software could harm the Company's
reputation in the quality assurance software market and make it more difficult
for the Company to sell its products.
20
Competition
The market for software quality management tools is new, intensely
competitive and subject to rapid technological change. The Company expects
competition to intensify in the future. The Company currently encounters direct
competition from a number of public and private companies including Mercury
Interactive Corporation and SQA, Inc. (recently acquired by Rational Software
Corporation). Due to the expansion of the market for software quality management
tools, the Company may face competition from new entrants in the software
quality management industry, possibly including the Company's resellers or
current customers. There can be no assurance that the Company's current and
potential competitors will not develop software quality management tools that
may be more effective or achieve greater market acceptance than the Company's
current or future products or that the Company's technologies and products would
not be rendered obsolete by such developments. Many of the Company's current and
potential competitors have longer operating histories, greater name recognition,
larger installed customer bases, and significantly greater financial, technical
and marketing resources than the Company. The Company may also face increased
competition from the recent consolidation of several companies in the automated
software quality market. As a result, these competitors may be able to adapt
more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the promotion and sale of their
products than the Company. An increase in competition could result in price
reductions and loss of market share. Such competition and any resulting
reduction in profitability could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Key Personnel
The Company's success depends upon its ability to attract and retain highly
skilled technical, managerial and sales personnel. Competition for such
qualified sales, marketing and software development personnel in the computer
industry in general, and the automated software testing industry in particular,
is intense. Future results will depend on the Company's ability to attract and
retain such personnel, and the failure to do so could have a material adverse
effect on the Company's ability to develop and market competitive products and
its ability to achieve projected operating results.
International Activities
The Company derived approximately 8% of its total product sales from
international customers in 1996. The international market for software products
is highly competitive and the Company expects to face substantial competition in
this market from established and emerging companies. Risks inherent in the
Company's international business activities also include currency fluctuations,
imposition of government controls, export license requirements, restrictions on
the export of critical technology, political and economic instability, tailoring
of products to local requirements, trade restrictions, changes in tariffs and
taxes, difficulties in staffing and managing international operations, longer
accounts receivable payment cycles and the burdens of complying with a wide
variety of foreign laws and regulations. To the extent that the Company is
unable to expand international sales in a timely and cost-effective manner, the
Company's business could be materially adversely affected.
Development of Indirect Channels; Potential for Channel Conflict
Although the Company has not historically sold significant amounts of its
products through indirect channels, the Company intends to continue to develop
channel sales as part of its growth strategy. In 1995, the Company established
21
its Channel Partner Program. The Company licenses its products to its channel
partners at a discount and such partners relicense the products to end-users.
The Company's agreements with its channel partners are non-exclusive and provide
the channel partners with 60-day price protection. Because the Company's channel
partners generally order the Company's products after they have received
purchase orders, there is no requirement that the Company repurchase any
product. The Company selects its channel partners based on the partner's
financial viability, product expertise and market focus. In order for the
Company's strategy to broaden market penetration through its Channel Partner
Program to be successful, the Company must increase its unit sales to offset the
discount it is providing the channel partners. There can be no assurance that
the Company will succeed in the development of these channels. Moreover, selling
through indirect channels may limit the Company's contact with the end users of
its products. As a result, the Company's ability to accurately forecast sales,
evaluate customer satisfaction and recognize emerging customer requirements may
be hindered and its ability to develop and maintain customer goodwill may be
limited. In addition, the Company's strategy of marketing its products directly
to end-users and indirectly through its channel program and through distributors
may result in distribution channel conflicts. Although the Company has attempted
to manage its distribution channels in a manner to avoid potential conflicts,
there can be no assurance that channel conflicts will not materially adversely
affect its relationships with existing channel partners or distributors or
adversely affect its ability to attract new channel partners and distributors.
In addition, there can be no assurance that the Company's resellers will be able
to effectively market the Company's products or that they will not commence the
sale of competitive products. The Company recently entered an OEM arrangement
with INTERSOLV whereby INTERSOLV has the right to resell QA Partner and related
products to its customers. The Company has no assurance that this will be a
successful sales channel for the Company's products or that it will not result
in significant channel conflict.
Product Liability
In selling its products, the Company relies primarily on "shrink wrap"
licenses that contain, among other things, provisions protecting against the
unauthorized use, copying and transfer of the licensed program and limiting the
Company's exposure to potential product liability claims. However, these
licenses are not signed by the licensees and the provisions of these licenses,
including the provisions limiting the Company's exposure to product liability
claims, may therefore be unenforceable under the laws of certain jurisdictions.
Intellectual Property and Proprietary Rights
The Company currently relies on a combination of trademark, copyright and
trade secret laws and contractual provisions to protect its proprietary rights
in its products. The Company presently has no registered copyrights. The Company
has an approved patent but there can be no assurance that the patent would be
upheld if challenged. There can be no assurance that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. There can also be no assurance that the
measures taken by the Company to protect its proprietary rights will be adequate
to prevent misappropriation of the technology or independent development by
others of similar technology. In addition, the laws of various countries in
which the Company's products may be sold may not protect the Company's products
and intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
intellectual property infringement claims against the Company or that any such
22
claims will not require the Company to enter into royalty or cross-license
arrangements or result in costly litigation. In the event of litigation to
determine the validity of any third-party claims, such litigation could result
in significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is determined
in favor of the Company.
Stock Market Volatility
Market prices for securities of software companies have generally been
volatile. In particular, the market price of the Company's common stock has been
and may continue to be subject to significant fluctuations as a result of
factors affecting the computer industry or the securities markets in general.
These factors include, but are not limited to, quarterly variations,
announcements of technological innovations by the Company or competitors,
announcements of mergers or acquisitions by the Company or competitors, changes
in prices by the Company or competitors, change in product mix, and change in
revenue or revenue growth rates for geographic areas or products.
Item 8. Financial Statements and Supplementary Data
Financial statements required pursuant to this Item 8 are presented
beginning on page F-1 of this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item 10 concerning the Company's executive
officers is incorporated by reference to the section of Part I of this Form 10-K
entitled "Item 1. Business - Executive Officers of the Registrant". The
information concerning the Company's directors required by this Item 10 is
incorporated by reference to the information under the heading, "Election of
Directors -Information Regarding the Nominees and Executive Officers" in the
Company's 1997 Proxy Statement.
Item 11. Executive Compensation
The information required by this Item 11 is incorporated by reference to
the Company's 1997 Proxy Statement under the heading, "Compensation of Directors
and Executive Officers".
23
Item 12. Security Ownership of Management and Certain Beneficial Owners
The information required by this Item 12 is incorporated by reference to
the Company's 1997 Proxy Statement under the heading, "Security Ownership of
Management and Certain Beneficial Owners".
Item 13. Certain Relationships and Related Transactions
Not applicable.
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
Report of Independent Accountants F-2
Balance Sheets as of December 31, 1996 and 1995 F-3
Statements of Operations for the Years ended December 31, 1996,
1995 and 1994 F-4
Statements of Stockholders' Equity for the Years ended
December 31, 1996, 1995 and 1994 F-5
Statements of Cash Flows for the Years ended December 31, 1996,
1995 and 1994 F-6
Notes to Financial Statements F-7
2. Financial Statement Schedules. All schedules have been omitted
because they are not applicable or the required information is shown in the
financial statements or notes thereto.
3. Exhibits. The following is a complete list of Exhibits filed as part
of this Form 10-K.
Number Description of Exhibits
- ------ ---------------------------------------------------------------------
*(3.1) Restated Certificate of Incorporation (Exhibit 3.2 of Registration
Statement on Form S-1 (File No. 333-1488))
*(3.2) By-Laws (Exhibit 3.3 of Registration Statement on Form S-1 (File No.
333-1488))
24
*(4.1) Specimen Certificate representing the Common Stock (Exhibit 4.2 of
Registration Statement on Form S-1 (File No. 333-1488))
*(10.1) 1996 Amended and Restated Incentive and Non-Qualified Stock Option Plan
*(10.2) 1996 Employee Stock Purchase Plan
*(10.3) Preferred Stock Purchase and Sale Agreement, dated as of February 11,
1994, by and between the Registrant and John J. Cullinane
*(10.4) Non-Qualified Stock Option Agreement, dated as of February 11, 1994, by
and between the Registrant and John J. Cullinane
*(10.5) Letter Agreement, dated as of April 14, 1994, by and between the
Registrant and John J. Cullinane
*(10.6) Employment Separation Agreement, dated as of June 30, 1995, by and
between the Registrant and Laurence R. Kepple
*(10.7) Form of Shareholder Rights Agreement, dated as of February 8, 1996,
entered into between the Registrant and certain of its stockholders
(Exhibit 10.9 of Registration Statement on Form S-1 (File No. 333-1488))
*(10.8) Form of Indemnification Agreement to be entered into between the
Registrant and its directors and officers (Exhibit 10.10 of Registration
Statement on Form S-1 (File No. 333-1488))
*(10.9) Lease, dated as of October 19, 1995, by and between the Registrant and
1330 Centre Street Associates Limited Partnership (Exhibit 10.11 of
Registration Statement on Form S-1 (File No. 333-1488))
(11.1) Computation of Net Income (Loss) per Common and Common Equivalent Share
(23.1) Consent of Coopers & Lybrand L.L.P.
(27.1) Financial Data Schedule
* All exhibits with an asterisk are incorporated by reference to identically
numbered exhibits (unless otherwise indicated) filed in response to Item 16(a),
"Exhibits", of the Registrant's Registration Statement on Form S-1, as amended
(File No. 333-1488), which was declared effective on March 28, 1996.
(b) Reports on Form 8-K
On November 22, 1996, the Company filed a Report under Item 5 on
Form 8-K.
25
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 28th day of March,
1997.
SEGUE SOFTWARE, INC.
By: /s/ ELISABETH ELTERMAN
-----------------------------
Elisabeth Elterman, 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.
/s/ ELISABETH ELTERMAN President, Chief Executive Officer March 28, 1997
- ---------------------- and Director (Principal Executive
Elisabeth Elterman Officer)
/s/ J. JEFFREY BINGENHEIMER Vice President and Chief Financial March 28, 1997
- --------------------------- Officer (Principal Financial Officer
J. Jeffrey Bingenheimer and Principal Accounting Officer)
/s/ JAMES H. SIMONS Chairman of the Board March 28, 1997
- ---------------------------
James H. Simons
/s/ LEONARD E. BAUM Director March 28, 1997
- ---------------------------
Leonard E. Baum
/s/ JOHN J. CULLINANE Director March 28, 1997
- ---------------------------
John J. Cullinane
/s/ RONALD D. FISHER Director March 28, 1997
- ---------------------------
Ronald D. Fisher
/s/ JOHN R. LEVINE Director March 28, 1997
- ---------------------------
John R. Levine
/s/ MILTON E. MOHR Director March 28, 1997
- ---------------------------
Milton E. Mohr
/s/ HOWARD L. MORGAN Director March 28, 1997
- ---------------------------
Howard L. Morgan
26
SEGUE SOFTWARE, INC.
FINANCIAL STATEMENTS
TABLE OF CONTENTS
Page
----
Report of Independent Accountants F-2
Balance Sheets as of December 31, 1996 and 1995 F-3
Statements of Operations for the Years ended December 31, 1996, 1995
and 1994 F-4
Statements of Stockholders' Equity for the Years ended December 1996,
1995 and 1994 F-5
Statements of Cash Flows for the Years ended December 31, 1996, 1995
and 1994 F-6
Notes to Financial Statements F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Segue Software, Inc.:
We have audited the accompanying balance sheets of Segue Software, Inc. as of
December 31, 1996 and 1995 and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Segue Software, Inc. as of
December 31, 1996 and 1995 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996 in conformity
with generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
January 31, 1997
F-2
SEGUE SOFTWARE, INC.
BALANCE SHEETS
December 31,
------------
1996 1995
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 7,111,690 $ 442,191
Short-term investments 34,091,859 --
Accounts receivable, net of allowances of
$200,000 and $150,000 3,022,468 2,594,962
Other current assets 1,365,135 96,165
----------- ----------
Total current assets 45,591,152 3,133,318
Property and equipment, net 1,960,178 1,153,476
Intangible assets, net of accumulated amortization
of $330,000 and $266,125 -- 63,875
Other assets 79,338 145,387
----------- ----------
Total assets $47,630,668 $4,496,056
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 473,889 $ 461,422
Accrued compensation and benefits 885,154 604,000
Accrued expenses 641,737 184,446
Deferred revenue 1,875,815 1,067,468
Accrued royalties 1,047,098 219,274
Convertible debt to stockholders -- 654,200
----------- ----------
Total current liabilities 4,923,693 3,190,810
Commitments and contingencies (Note I)
Stockholders' equity:
Series A Preferred Stock, $.01 and no par value;
noncumulative; 4,000,000 shares authorized;
no and 2,291,458 shares issued and outstanding -- 4,338,280
Common Stock, $.01 and no par value; 30,000,000
and 10,000,000 shares authorized; 7,195,857
and 1,586,090 shares issued and outstanding 71,959 727,680
Additional paid-in capital 46,194,554 --
Unearned compensation (440,171) --
Accumulated deficit (3,119,367) (3,760,714)
----------- ----------
Total stockholders' equity 42,706,975 1,305,246
----------- ----------
Total liabilities and stockholders' equity $47,630,668 $4,496,056
=========== ==========
The accompanying notes are an integral part of the financial statements.
F-3
SEGUE SOFTWARE, INC.
STATEMENTS OF OPERATIONS
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Revenue:
Software $12,591,958 $8,312,207 $4,769,519
Services 4,380,909 2,626,435 1,253,363
Royalties -- 129,498 334,713
----------- ---------- ----------
Total revenue 16,972,867 11,068,140 6,357,595
Cost of revenue:
Cost of software 475,192 315,111 242,742
Cost of services 1,775,486 1,194,129 600,628
Cost of royalties -- 29,502 80,050
----------- ---------- ----------
Total cost of revenue 2,250,678 1,538,742 923,420
Gross margin 14,722,189 9,529,398 5,434,175
Operating expenses:
Sales and marketing 8,500,255 5,378,504 2,545,653
Research and development 3,805,723 2,272,515 1,574,465
General and administrative 2,546,116 1,710,233 1,284,535
Severance charges -- 448,500 --
----------- ---------- ----------
Total operating expenses 14,852,094 9,809,752 5,404,653
----------- ---------- ----------
Income (loss) from operations (129,905) (280,354) 29,522
Litigation settlement (743,819) -- --
Interest expense (43,952) (57,242) (39,252)
Interest income 1,579,023 34,432 18,365
----------- ---------- ----------
Income (loss) before provision for
income taxes 661,347 (303,164) 8,635
Provision for income taxes 20,000 -- --
----------- ---------- ----------
Net income (loss) $ 641,347 $ (303,164) $8,635
=========== ========== ==========
Net income (loss) per common and
common equivalent share $ .09 $ (.17) $ --
Weighted average common and
common equivalent shares outstanding 7,142,000 1,795,000 4,245,000
Pro forma net income (loss) per
common and common equivalent share $ .09 $ (.07) $ --
Pro forma weighted average common and
common equivalent shares outstanding 7,142,000 4,136,000 4,245,000
The accompanying notes are an integral part of the financial statements.
F-4
SEGUE SOFTWARE, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
for the years ended December 31, 1996, 1995 and 1994
Additional Total
Series A paid-in Unearned Accumulated stockholders'
Preferred Stock Common Stock capital compensation deficit equity
--------------- ------------ ------- ------------ ------- ------
Shares Par value Shares Par value
------ --------- ------ ---------
Balance at December 31, 1993 1,791,458 $3,413,562 1,527,500 $665,500 $(3,466,185) $612,877
Issuance of Series A
preferred stock, net of
issuance costs 500,000 924,718 924,718
Net income 8,635 8,635
---------- ---------- --------- -------- ----------- -----------
Balance at December 31, 1994 2,291,458 4,338,280 1,527,500 665,500 (3,457,550) 1,546,230
Issuance of common stock
under option plan 58,590 62,180 62,180
Net loss (303,164) (303,164)
---------- ---------- --------- -------- ----------- -----------
Balance at December 31, 1995 2,291,458 4,338,280 1,586,090 727,680 (3,760,714) 1,305,246
Change in par value (4,315,365) (711,819) $5,027,184 --
Issuance of common stock
under option plan 125,000 1,250 126,609 1,266 1,016,867 $(574,700) 444,683
Conversion of Series A
preferred stock to common
stock (2,416,458) (24,165) 2,416,458 24,165 --
Conversion of convertible
debt to common stock 654,200 6,542 647,658 654,200
Issuance of common stock,
net of issuance costs 2,412,500 24,125 39,502,845 39,526,970
Amortization of unearned
compensation 134,529 134,529
Net income 641,347 641,347
---------- ---------- --------- -------- ----------- --------- ----------- -----------
Balance at December 31, 1996 -- $ -- 7,195,857 $71,959 $46,194,554 $(440,171) $(3,119,367) $42,706,975
========== ========== ========= ======== =========== ========= =========== ===========
The accompanying notes are an integral part of the financial statements.
F-5
SEGUE SOFTWARE, INC.
STATEMENTS OF CASH FLOWS
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Cash flows from operating activities:
Net income (loss) $ 641,347 $(303,164) $ 8,635
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 655,345 381,577 222,837
Loss on disposal of property and equipment 15,968 34,568 --
Noncash compensation charges 134,529 -- --
Net changes in assets and liabilities:
Accounts receivable (427,506) (547,713) (1,085,050)
Other current assets (368,970) (34,297) (13,663)
Other assets 66,049 (33,592) (13,682)
Accounts payable 12,467 125,450 149,523
Accrued expenses, compensation and benefits 738,445 272,464 254,537
Accrued royalties (72,176) 29,502 80,293
Deferred revenue 808,347 499,718 400,819
------------ --------- -----------
Net cash provided by operating activities 2,203,845 424,513 4,249
------------ --------- -----------
Cash flows from investing activities:
Additions to property and equipment (1,414,140) (760,386) (436,304)
Proceeds from sale of property and equipment -- 5,000 --
Sales (purchases) of short-term investments (34,091,859) -- 37,546
------------ --------- -----------
Net cash used in investing activities (35,505,999) (755,386) (398,758)
------------ --------- -----------
Cash flows from financing activities:
Net proceeds from initial public offering of common stock 39,526,970 -- --
Net proceeds from issuance of preferred stock -- -- 924,718
Proceeds from exercise of stock options 444,683 62,180 --
------------ --------- -----------
Net cash provided by financing activities 39,971,653 62,180 924,718
------------ --------- -----------
Net increase (decrease) in cash and cash equivalents 6,669,499 (268,693) 530,209
Cash and cash equivalents at beginning of year 442,191 710,884 180,675
------------ --------- -----------
Cash and cash equivalents at end of year $ 7,111,690 $ 442,191 $ 710,884
============ ========= ===========
Supplemental disclosure of noncash financing transactions:
Conversion of convertible debt into common stock $ 654,200 $ -- $ --
============ ========= ===========
Supplemental disclosure:
Cash paid during the year for interest $ 38,134 $ 57,242 $ 39,252
============ ========= ===========
The accompanying notes are an integral part of the financial statements.
F-6
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
A. The Company:
The Company develops, markets and supports integrated software solutions
for the automated testing and quality management of client/server software
applications. The Company also provides maintenance, training and consulting
services in support of its product offerings.
The Company operates in one industry segment. No customer accounted for
10% or more of total revenue in 1996, 1995 or 1994.
B. Summary of Significant Accounting Policies:
Revenue Recognition
Revenue from software license fees is recognized upon shipment and receipt
of a signed purchase order or contract. At the time the Company recognizes
revenue from the sale of software products, collection is probable, no
significant vendor obligations remain and the costs of insignificant support
obligations, if any, are accrued. Maintenance revenue associated with initial
product license contracts is recognized ratably over the initial term, which is
generally one year. Maintenance revenue for annual contracts is deferred and
recognized ratably over the term of agreement. Revenue from training and
consulting services is recognized as the related services are performed. Royalty
revenue is recognized based upon the sale of the related products.
The Company typically does not grant to its customers a contractual right to
return software products. When approved by management, however, the Company has
accepted returns of certain software products and has provided an allowance for
those specific products. The Company also provides reserves for customer
receivable balances which are considered potentially uncollectible. The
Company's allowances amounted to $200,000, $150,000 and $40,000 as of December
31, 1996, 1995 and 1994, respectively. The provision charged to the statement of
operations was $489,000, $249,000 and $50,000 in 1996, 1995 and 1994,
respectively, and write-offs against the allowances were $439,000, $139,000 and
$25,000 in 1996, 1995 and 1994, respectively.
Deferred Revenue
Service revenue (maintenance, training and consulting) which is not yet
earned is included in deferred revenue.
F-7
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
Research and Development and Software Development Costs
Research and development expenditures are charged to operations as incurred.
Software development costs subsequent to the establishment of technological
feasibility are capitalized and amortized to cost of software. Based on the
Company's product development process, technological feasibility is established
upon completion of a working model. Costs incurred by the Company between
completion of the working model and the point at which the product is ready for
general release have been insignificant.
Income Taxes
The Company uses the liability method of accounting for income taxes. Under
this method, deferred tax liabilities and assets are determined based on
the differences between the tax and financial reporting basis of assets and
liabilities and are measured using the tax rates and laws that will be in effect
when the differences are expected to reverse. The Company provides a valuation
allowance against net deferred tax assets if, based upon the available evidence,
it is more likely than not that some or all of the deferred tax assets will not
be realized.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents. Short-term investments
are those with maturities in excess of three months but less than one year. All
cash equivalents and short-term investments have been classified as
available-for-sale and are reported at fair value with unrealized gains and
losses included in stockholders' equity. As of December 31, 1996, unrealized
gains and losses on available-for-sale securities were insignificant.
Property and Equipment
Property and equipment are stated at cost. Expenditures for major
improvements which substantially increase the useful lives of assets are
capitalized. Repair and maintenance costs are expensed as incurred. Depreciation
is provided on a straight-line basis over the useful lives of the assets,
generally three to five years. Amortization of leasehold improvements is
computed on a straight-line basis over the remaining term of the lease.
Upon retirement or sale, the cost of the assets disposed and the related
accumulated depreciation and amortization are removed from the accounts and any
resulting gain or loss is included in the determination of net income.
F-8
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
Intangible Assets
During 1993, the Company completed the acquisition of certain intellectual
property rights from certain employees, principally in exchange for forgiveness
of $150,000 in notes receivable and 400,000 shares of common stock. During such
period, the common stock had a value of $.375 per share, as determined by the
Company's Board of Directors. The intangible asset was amortized on a
straight-line basis over a period of three years, its estimated useful life. As
of December 31, 1996, the asset is fully amortized.
Long-lived assets to be held and used are recorded at cost. Management
reviews long-lived assets and the related intangible assets for impairment
whenever events or changes in circumstances indicate the carrying amount of such
assets may not be recoverable. Recoverability of these assets is determined by
comparing the forecasted undiscounted net cash flows of the operation to which
the assets relate, to the carrying amount including associated intangible assets
of such operation. In addition, the Company's evaluation considers non-financial
data such as market trends, product development cycles and changes in
management's market emphasis.
Computation of Income (Loss) per Share
Net income (loss) per common share is computed based upon the weighted
average number of common and common equivalent shares outstanding. Common
equivalent shares are included in the per share calculations where the effect of
their inclusion would be dilutive. The convertible debt outstanding prior to
December 31, 1996 was not considered a common stock equivalent. In accordance
with the Securities and Exchange Commission's Staff Accounting Bulletin No. 83,
all common and common equivalent shares (including stock options) issued during
the twelve month period prior to the initial filing date in February 1996 of the
Registration Statement relating to the Company's initial public offering of
common stock have been included in the calculation as if they were outstanding
for all periods presented. As a result, the common equivalent shares for stock
options were determined using the treasury stock method at an assumed initial
public offering price.
Net income (loss) per common share on a pro forma basis is computed in the
same manner as net income (loss) per common share on a historical basis except
all outstanding shares and options of the Series A preferred stock are included
in the computation as if they had been converted into an equivalent number of
shares of common stock even if anti-dilutive.
Fully diluted net income (loss) per common share is the same as primary
net income (loss) per common share.
F-9
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
Concentration of Credit Risk
The Company invests its cash, cash equivalents and short-term investments
primarily in U.S. Government and government agency securities, in
investment-grade commercial paper and in money market accounts. The Company has
established guidelines relative to credit ratings, diversification and
maturities that maintain safety and liquidity. The Company has not experienced
any losses on its cash, cash equivalents and short-term investments.
The Company sells its products principally through a direct sales force
domestically and through distributors outside of the United States to customers
in a broad range of industries. The Company performs ongoing credit evaluations
of its customers but does not require collateral or other security to support
customer receivables. The Company maintains reserves for credit losses and such
losses have been within management's expectations.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the 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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 ("SFAS 123"), Accounting for
Stock-Based Compensation, which is effective for the Company's financial
statements for fiscal year 1996. SFAS 123 allows companies to either account for
stock-based compensation under the new provisions of SFAS 123 or under the
provisions of Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting
for Stock Issued to Employees, but requires pro forma disclosure in the notes to
the financial statements as if the measurement provisions of SFAS 123 had been
adopted. The Company has continued to account for its stock-based compensation
in accordance with the provisions of APB 25.
C. Development Contracts and Royalty Arrangements:
In 1991, the Company entered into a development agreement with Lotus
Development Corporation ("Lotus") to develop and provide support for certain
versions of a product. The Company in turn subcontracted certain work to a third
party to assist in the development. Development was completed in 1992. The
Company earns royalties on sales of the product developed under this agreement.
The Company also must pay a certain percentage of the royalties received to
F-10
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
the third party who assisted with development. For the year ended December 31,
1996, there were no royalties earned pursuant to this agreement. During the
years ended December 31, 1995 and 1994, the Company earned $101,000 and $249,000
respectively, pursuant to this agreement.
In 1989, the Company entered into a development agreement with Lotus to
develop a version of a product. The Company, in turn, subcontracted with
another third party to assist in development. Product development was completed
in 1990. The Company also earns royalties on sales of the product developed
under this agreement. The Company shares these royalties equally with the third
party who assisted with development. For the year ended December 31, 1996, the
Company earned no royalties pursuant to this agreement. During the years ended
December 31, 1995 and 1994, the Company received $29,000 and $86,000
respectively, pursuant to this agreement.
In addition, the Company participates in other royalty arrangements with
third parties.
D. Property and Equipment:
Property and equipment consisted of the following as of December 31:
1996 1995
----------- -----------
Computer equipment $2,466,571 $1,313,588
Other equipment 66,680 52,884
Furniture and fixtures 343,051 256,619
Leasehold improvements 76,006 52,501
---------- ----------
2,952,308 1,675,592
---------- ----------
Accumulated depreciation
and amortization (992,130) (522,116)
---------- ----------
$1,960,178 $1,153,476
========== ==========
Depreciation and amortization of property and equipment amounted to
$591,000, $258,000 and $133,000 during the years ended December 31, 1996, 1995
and 1994, respectively.
E. Convertible Debt to Stockholders:
The Company's Convertible Subordinated Notes were converted into 654,200
shares of common stock during the year ended December 31, 1996 at $1.00 per
share.
F-11
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
F. Stockholders' Equity:
Common Stock
In February 1996, the Board of Directors of the Company voted for the
following, which were approved by the stockholders on February 16, 1996: (i) the
reincorporation of the Company from a California corporation to a Delaware
corporation; (ii) an amendment of the Company's Certificate of Incorporation to
increase the number of authorized shares of common stock and preferred stock to
30,000,000 and 9,000,000 shares, respectively; (iii) the designation of
4,000,000 shares of such 9,000,000 shares of preferred stock as Series A
preferred stock; (iv) the changing of the per share par value of the common
stock and preferred stock from no par value to $.01 par value; (v) the amendment
and restatement of the Company's 1989 Incentive and Non-Qualified Stock Option
Plan, pursuant to which, among other things, the number of shares of common
stock reserved for issuance pursuant to options granted pursuant to the plan was
increased to 2,450,000 shares, the name of the plan was changed to the 1996
Amended and Restated Incentive and Non-Qualified Stock Option Plan (the "Option
Plan"), and stock option grants to non-employee directors were authorized; and
(vi) the Employee Stock Purchase Plan, which permits eligible employees to
purchase common stock of the Company up to a maximum of 100,000 shares of common
stock.
In April 1996, the Company consummated an initial public offering of
3,162,500 shares of the Company's common stock ($.01 par value) at an initial
public offering price of $18.00 per share. The total shares issued pursuant to
the initial public offering consisted of 2,000,000 shares sold by the Company,
750,000 shares sold by selling shareholders, and an additional 412,500 shares
sold by the Company pursuant to the underwriters' over-allotment option.
Proceeds to the Company, net of underwriters' discount and associated costs of
$858,000, were approximately $39,500,000. Concurrent with the closing of the
offering, all outstanding shares of Series A preferred stock were converted into
common stock.
In February 1994, the Company sold 500,000 shares of Series A preferred
stock at a purchase price of $2.00 per share and received aggregate proceeds of
$1,000,000 in cash. The Company paid $75,000 in related issuance costs. This
transaction included the sale of 375,000 shares of Series A preferred stock and
the issuance of a non-qualified stock option to purchase 125,000 shares of
Series A preferred stock exercisable at $2.00 per share, to an investor who
became a member of the Board of Directors. The option vested over three years
and provided that vesting of the option may be accelerated by the Board of
Directors or upon occurrence of certain events, including a public offering,
merger or liquidation. This option was exercised immediately prior to the
closing of the initial public offering. The Company had also entered into a
consulting agreement with this member of the Board of Directors. The Company
paid no amounts in 1996. In 1995 and 1994, the Company paid a total of $120,000
and $45,000, respectively.
F-12
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
Stock Compensation Plans
As of December 31, 1996, the Company has two stock-based compensation plans
(the "Plans"). The Company applies APB 25 in accounting for the Plans. Had
compensation cost for the Company's Plans been determined based on the fair
value at the grant dates for awards under those Plans consistent with the
methodology of SFAS 123, the Company's net income (loss) and income (loss) per
share would have been adjusted to the pro forma amounts indicated below:
1996 1995
---- ----
Net income (loss) As reported $ 641,347 $(303,164)
Pro forma $(511,145) $(387,221)
Income (loss) per common
and common equivalent share As reported $ .09 $ (.17)
Pro forma $ (.07) $ (.22)
For the years ended December 31, 1996 and 1995, total compensation cost
recognized in pro forma income for stock-based employee compensation awards was
$1,152,000 and $84,000, respectively.
Since the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting compensation cost may not be
representative of that to be expected in future years.
Stock Option Plan
The Option Plan provides for the grant of common stock options, for which
there were 2,450,000 shares of common stock reserved as of December 31, 1996.
Incentive stock options (ISOs) may be granted to any officer or employee of
the Company. Nonqualified stock options may be granted to any officer,
employee, consultant, director or other agent of the Company. In the case of
ISOs, the exercise price shall be at least 100% (110% in certain cases) of the
fair market value of the common stock on the date of grant. Options become
exercisable at varying rates, generally over three or four years, as determined
by the Board of Directors.
F-13
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
The following table summarizes option activity:
Weighted
Average
Exercise
Shares Exercise Prices Prices
------ --------------- ------
Outstanding at
December 31, 1993 406,500 $1.00-$2.00 $1.14
Granted 667,906 1.00- 2.00 1.67
Canceled (58,766) 1.00- 2.00 1.12
---------
Outstanding at
December 31, 1994 1,015,640 1.00- 2.00 1.44
Granted 826,260 2.00- 3.50 2.39
Exercised (58,590) 1.00- 2.00 1.06
Canceled (457,032) 1.00- 3.50 1.79
---------
Outstanding at
December 31, 1995 1,326,278 1.00- 3.50 1.93
Granted 833,350 9.00-35.25 15.01
Exercised (126,609) 1.00- 9.00 1.54
Canceled (183,230) 1.00-35.25 16.54
---------
Outstanding at
December 31, 1996 1,849,789 $1.00-$22.25 $6.43
=========
Subject to certain exceptions defined under the Option Plan, options expire
10 years from the date of grant. As of December 31, 1996, 1995 and 1994, options
to purchase 627,799, 415,116 and 238,792 shares, respectively, were exercisable
with a weighted average exercise price of $2.51, $1.43 and $1.05 per share,
respectively. The weighted average fair value of the stock options granted
during 1996 and 1995 was $7.30 and $.68 per share, respectively. The outstanding
stock options as of December 31, 1996 have a weighted average remaining
contractual life of 8.2 years.
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 1996 and 1995, respectively: risk-free interest rate of 5.9% and 7.1%;
dividend yield of 0%; expected life of five years; and expected volatility of
47% and 0%.
F-14
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
Employee Stock Purchase Plan
On February 12, 1996, the Company established the Segue Software, Inc. 1996
Employee Stock Purchase Plan, under which eligible employees may purchase shares
of the Company's common stock through payroll deductions. The shares can be
purchased for 85% of the lower of the beginning or ending fair market value of
each six-month segment within the offering period. Purchases are limited to 10%
of an employee's annual compensation. A total of 100,000 shares of the
Company's common stock are reserved for issuance under the stock purchase plan,
of which no shares have been issued as of December 31, 1996.
For the computation in accordance with SFAS 123, the fair value of the
employees' purchase rights is estimated using the Black-Scholes model with the
following assumptions for 1996: risk-free interest rate of 5.4%; dividend yield
of 0%; expected life of six months; and expected volatility of 60%.
G. Employee Savings Plan:
On November 1, 1990, the Company established the Segue Software, Inc.
401(k) Plan, under which all employees may make contributions to their
respective participant accounts. The Company may, at its discretion, make
matching contributions on behalf of its employees. Employees must have completed
two years of service to be eligible for the Company's contributions. No matching
contributions were made during the years ended December 31, 1996, 1995 and 1994.
H. Income Taxes:
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-15
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
Deferred tax liabilities (assets) are comprised of the following as of
December 31:
1996 1995
---- ----
Gross deferred tax assets:
Net operating losses $ (664,446) $(1,047,066)
Research and development credits (763,631) (660,611)
Other (230,557) (80,589)
----------- -----------
Total (1,658,634) (1,788,266)
Gross deferred tax liabilities:
Depreciation 82,891 79,488
Cash basis method of accounting - 23,498
----------- -----------
Total 82,891 102,986
Valuation allowance 1,575,743 1,685,280
----------- -----------
Net deferred tax liability (asset) $ - $ -
=========== ===========
As of December 31, 1996, the Company has net operating loss carryforwards
of approximately $1,900,000 as well as approximately $800,000 of tax credit
carryforwards available for income tax purposes. These carryforwards generally
expire in the years 2003 through 2010 and may be subject to annual limitations
as a result of changes in the Company's ownership. Management of the Company has
evaluated the positive and negative evidence impacting the realizability of its
deferred tax assets, which are comprised principally of net operating loss
carryforwards and tax credits, as required by Statement of Financial Accounting
Standards No. 109. Management has considered the Company's history of annual and
cumulative losses and recent limited quarterly periods of income and concluded,
in accordance with the applicable accounting standards, that it is more likely
than not that it will not generate future taxable income prior to the expiration
of these items in the years 2003 through 2010. 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.
For the year ended December 31, 1996, the Company recorded a provision for
income taxes of $20,000, which consists principally of alternative minimum and
state income taxes. During 1996, the Company utilized approximately $1,000,000
of net operating loss carryforwards. No provision for income taxes was recorded
in 1995 or 1994 as the Company either incurred net losses or utilized net
operating loss carryforwards.
F-16
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
I. Commitments and Contingencies:
Lease Commitments
The Company leases facilities for its headquarters in Massachusetts under
non-cancelable operating leases that expire in 1998. The Company also leases
certain U.S. and foreign sales offices and certain equipment under various
leases with lease terms ranging from month-to-month up to three years. Certain
of these leases contain renewal options. The agreements generally require the
payment of utilities, real estate taxes, insurance and repairs. Future minimum
payments under the facilities and equipment leases with non-cancelable terms in
excess of one year are as follows as of December 31, 1996:
1997 $389,956
1998 426,948
1999 25,115
2000 18,836
--------
$860,855
========
Rent expense for the years ended December 31, 1996, 1995 and 1994 amounted
to $585,000, $263,000 and $214,000, respectively.
Royalty Commitments
In November 1996, the Company entered into an agreement with a vendor
whereby the vendor will license specific software to the Company for purposes of
marketing and distribution. Under the terms of the agreement, the Company is
required to pay $1,000,000 in royalties by December 31, 1997. As of December 31,
1996, the Company had paid $100,000 and recorded a minimum royalty commitment of
$900,000. Royalty expense is recognized based upon the sale of the related
product.
J. Line of Credit:
In June 1995, the Company increased its demand line of credit with a bank
to $1,000,000 from $750,000. Interest was charged at the bank's prime rate plus
1%. The line of credit was collateralized by all of the Company's assets and
expired April 30, 1996. The line of credit was not renewed.
F-17
SEGUE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
K. Severance Charges:
Severance charges reflect costs incurred pursuant to an employment
separation agreement dated as of June 30, 1995 between the Company and its
former Chief Executive Officer. Amounts totaling $84,000 and $252,000 remaining
to be paid under the agreement are included in accrued compensation and benefits
as of December 31, 1996 and 1995, respectively.
L. Litigation Settlement:
On September 30, 1996, the Company entered into a definitive agreement with
a plaintiff, a software company located in Cambridge, MA, to settle litigation
brought against the Company and certain of its current and former employees. The
Company recorded a charge of $744,000 during the third quarter of 1996 to cover
the settlement and other expenses incurred in connection therewith.
F-18