##### 



---

---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number

1-15681




---

webMethods, Inc.

(Exact name of Registrant as Specified in its Charter)

|                                         |  |                    
|---------------------------------------- |  | -------------------
|Delaware                                 |  | 54-1807654         
|                                         |  |                    
|(State or Other Jurisdiction of          |  | (I.R.S. Employer   
|Incorporation or Organization)           |  | Identification No.)
|                                         |  |                    
|3930 Pender Drive, Fairfax, Virginia     |  | 22030              
|(Address of Principal Executive Offices) |  | (Zip Code)         

Registrants telephone number, including area code: (703) 460-2500

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value

Preferred Stock Purchase Rights




---

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 þ No o

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes þ No o

As of
November 13, 2003, there were outstanding 52,077,646 shares of the
registrants Common Stock.



---

---





---



##### 



WEBMETHODS, INC.

QUARTERLY REPORT ON FORM 10-Q


FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003


TABLE OF CONTENTS


|        |  |                                                                                       |  |                                                                                                                                            
|------- |  | ------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|Part I  |  | Financial Information                                                                
|Item 1  |  | Financial Statements                                                                 
|        |  |                                                                                       |  | Condensed Consolidated Financial Statements                                                                                                
|        |  |                                                                                       |  | Condensed Consolidated Balance Sheets as of
September 30, 2003 and March 31, 2003 (unaudited)                                              
|        |  |                                                                                       |  | Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited) -
Three and six months ended September 30, 2003 and 2002
|        |  |                                                                                       |  | Condensed Consolidated Statements of Cash Flows (unaudited) -
Six months ended September 30, 2003 and 2002                                 
|        |  |                                                                                       |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                           
|Item 2  |  | Managements Discussion and Analysis of Financial
Condition and Results of Operations
|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk                           
|Item 4  |  | Controls and Procedures                                                              
|Part II |  | Other Information                                                                    
|Item 1  |  | Legal Proceedings                                                                    
|Item 4  |  | Submission of Matters to a Vote of Security Holders                                  
|Item 6  |  | Exhibits and Reports on Form 8-K                                                     
|        |  |                                                                                       |  | (a) Exhibits                                                                                                                               
|        |  |                                                                                       |  | (b) Reports on Form 8-K                                                                                                                    

2



---



##### 



PART I

FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

WEBMETHODS, INC.

CONDENSED CONSOLIDATED BALANCE
SHEETS
(unaudited)


|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |         | 
|---------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | --------------------------- | ------- | --------- | ------ | -------- | ------- | 
|                                         |                                                                                                                       |                                            |        | SEPTEMBER 30,               |         | MARCH 31,
|                                         |                                                                                                                       |                                            |        | 2003                        |         | 2003     
|                                         |                                                                                                                       |                                            |        |                             |         |          
|                                         |                                                                                                                       |                                            |        | (In thousands, except share
|                                         |                                                                                                                       |                                            |        | and per share data)        
|ASSETS                                   |                                                                                                                       |                                            |        |                             |         |           |        |         
|Current assets:                          |                                                                                                                       |                                            |        |                             |         |           |        |         
|                                         | Cash and cash equivalents                                                                                             |                                            | $      | 79,075                      |         |           | $      | 79,702   |        
|                                         | Marketable securities available for sale                                                                              |                                            |        | 75,461                      |         |           |        | 97,079   |        
|                                         | Accounts receivable, net of allowance of $2,447 and $2,850                                                            |                                            |        | 39,477                      |         |           |        | 43,691   |        
|                                         | Prepaid expenses and other current assets                                                                             |                                            |        | 8,876                       |         |           |        | 7,562    |        
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|                                         |                                                                                                                       | Total current assets                       |        |                             | 202,889 |           |        |          | 228,034 | 
|Marketable securities available for sale |                                                                                                                       |                                            | 37,659 |                             |         |           | 24,845 |         
|Property and equipment, net              |                                                                                                                       |                                            | 10,609 |                             |         |           | 12,068 |         
|Goodwill                                 |                                                                                                                       |                                            | 29,838 |                             |         |           | 29,838 |         
|Other assets                             |                                                                                                                       |                                            | 8,966  |                             |         |           | 9,651  |         
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|                                         |                                                                                                                       | Total assets                               |        | $                           | 289,961 |           |        | $        | 304,436 | 
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|LIABILITIES AND STOCKHOLDERS EQUITY     |                                                                                                                       |                                            |        |                             |         |           |        |         
|Current liabilities:                     |                                                                                                                       |                                            |        |                             |         |           |        |         
|                                         | Accounts payable                                                                                                      |                                            | $      | 9,880                       |         |           | $      | 9,768    |        
|                                         | Accrued expenses                                                                                                      |                                            |        | 14,441                      |         |           |        | 14,802   |        
|                                         | Accrued salaries and commissions                                                                                      |                                            |        | 11,272                      |         |           |        | 11,648   |        
|                                         | Deferred revenue                                                                                                      |                                            |        | 36,898                      |         |           |        | 39,649   |        
|                                         | Current portion of capital lease obligations                                                                          |                                            |        | 1,549                       |         |           |        | 2,743    |        
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|                                         |                                                                                                                       | Total current liabilities                  |        |                             | 74,040  |           |        |          | 78,610  | 
|                                         | Capital lease obligations, net of current portion and other                                                           |                                            |        | 737                         |         |           |        | 567      |        
|                                         | Long term deferred revenue                                                                                            |                                            |        | 3,806                       |         |           |        | 6,700    |        
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|                                         |                                                                                                                       | Total liabilities                          |        |                             | 78,583  |           |        |          | 85,877  | 
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|Commitments and contingencies            |                                                                                                                       |                                            |        |                             |         |           |        |         
|Stockholders equity:                    |                                                                                                                       |                                            |        |                             |         |           |        |         
|                                         | Common stock, $0.01 par value; 500,000,000 shares authorized; 52,057,159 and
51,766,572 shares issued and outstanding |                                            |        | 520                         |         |           |        | 518      |        
|                                         | Additional paid-in capital                                                                                            |                                            |        | 517,473                     |         |           |        | 515,828  |        
|                                         | Deferred stock compensation and warrant charge                                                                        |                                            |        | (7,984                      | )       |           |        | (9,450   | )      
|                                         | Accumulated deficit                                                                                                   |                                            |        | (299,684                    | )       |           |        | (288,449 | )      
|                                         | Accumulated other comprehensive income                                                                                |                                            |        | 1,053                       |         |           |        | 112      |        
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|                                         |                                                                                                                       | Total stockholders equity                 |        |                             | 211,378 |           |        |          | 218,559 | 
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        
|                                         |                                                                                                                       | Total liabilities and stockholders equity |        | $                           | 289,961 |           |        | $        | 304,436 | 
|                                         |                                                                                                                       |                                            |        |                             |         |           |        |          |        

The accompanying notes are an integral part of these condensed
consolidated financial statements.

3



---



##### 



WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |        |        |        |  
|-------------------------------------------------------------------- | -------------------------------------- | ------------------------ | ------------------------- | ----------------------------------------------------------- | ------ | ----------------------------------------------- | ---------- | ---------------- | ------ | ------ | ---------- | ------ | ------- | ------- | ---------- | ------ | ------ | ------ | ------ | -
|                                                                     |                                        |                          |                           |                                                             |        | THREE MONTHS ENDED                              |            | SIX MONTHS ENDED
|                                                                     |                                        |                          |                           |                                                             |        | SEPTEMBER 30,                                   |            | SEPTEMBER 30,   
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                 
|                                                                     |                                        |                          |                           |                                                             |        | 2003                                            |            | 2002             |        | 2003   |            | 2002  
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |       
|                                                                     |                                        |                          |                           |                                                             |        | (In thousands, except share and per share data)
|Revenue:                                                             |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |       
|                                                                     | License                                |                          | $                         | 22,025                                                      |        |                                                 | $          | 26,475           |        |        | $          | 43,827 |         |         | $          | 55,144 |       
|                                                                     | Professional services                  |                          |                           | 10,578                                                      |        |                                                 |            | 8,584            |        |        |            | 19,451 |         |         |            | 16,786 |       
|                                                                     | Maintenance                            |                          |                           | 12,786                                                      |        |                                                 |            | 11,103           |        |        |            | 25,336 |         |         |            | 21,913 |       
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        | Total revenue            |                           |                                                             | 45,389 |                                                 |            |                  | 46,162 |        |            |        | 88,614  |         |            |        | 93,843 |       
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Cost of revenue:                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |       
|                                                                     | License                                |                          |                           | 555                                                         |        |                                                 |            | 525              |        |        |            | 1,022  |         |         |            | 660    |       
|                                                                     | Professional services and maintenance: |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        |                          |                           | Stock based compensation                                    |        |                                                 | 22         |                  |        |        | 76         |        |         |         | 44         |        |        |        | 152    |  
|                                                                     |                                        |                          |                           | Other professional services and maintenance costs           |        |                                                 | 12,403     |                  |        |        | 10,668     |        |         |         | 24,062     |        |        |        | 20,935 |  
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        | Total cost of revenue    |                           |                                                             | 12,980 |                                                 |            |                  | 11,269 |        |            |        | 25,128  |         |            |        | 21,747 |       
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Gross profit                                                         |                                        |                          | 32,409                    |                                                             |        |                                                 | 34,893     |                  |        |        | 63,486     |        |         |         | 72,096     |       
|Operating expenses:                                                  |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |       
|                                                                     | Sales and marketing:                   |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        |                          |                           | Stock based compensation and warrant charge                 |        |                                                 | 721        |                  |        |        | 983        |        |         |         | 1,417      |        |        |        | 1,953  |  
|                                                                     |                                        |                          |                           | Other sales and marketing costs                             |        |                                                 | 21,467     |                  |        |        | 22,592     |        |         |         | 43,917     |        |        |        | 46,902 |  
|                                                                     | Research and development:              |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        |                          |                           | Stock based compensation                                    |        |                                                 | 10         |                  |        |        | 40         |        |         |         | 10         |        |        |        | 59     |  
|                                                                     |                                        |                          |                           | Other research and development costs                        |        |                                                 | 10,857     |                  |        |        | 11,821     |        |         |         | 22,058     |        |        |        | 24,100 |  
|                                                                     | General and administrative:            |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        |                          |                           | Stock based compensation                                    |        |                                                 | 3          |                  |        |        | 23         |        |         |         | 6          |        |        |        | 44     |  
|                                                                     |                                        |                          |                           | Other general and administrative costs                      |        |                                                 | 4,524      |                  |        |        | 4,228      |        |         |         | 8,947      |        |        |        | 8,293  |  
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        | Total operating expenses |                           |                                                             | 37,582 |                                                 |            |                  | 39,687 |        |            |        | 76,355  |         |            |        | 81,351 |       
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Operating loss                                                       |                                        |                          | (5,173                    | )                                                           |        |                                                 | (4,794     | )                |        |        | (12,869    | )      |         |         | (9,255     | )     
|Interest income, net                                                 |                                        |                          | 699                       |                                                             |        |                                                 | 913        |                  |        |        | 1,634      |        |         |         | 2,252      |       
|Impairment of equity investment in private company                   |                                        |                          |                          |                                                             |        |                                                 | (1,000     | )                |        |        |           |        |         |         | (1,000     | )     
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|                                                                     |                                        | Net loss                 |                           | $                                                           | (4,474 | )                                               |            | $                | (4,881 | )      |            | $      | (11,235 | )       |            | $      | (8,003 | )     
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Basic and diluted net loss per common share                          |                                        | $                        | (0.09                     | )                                                           |        | $                                               | (0.10      | )                |        | $      | (0.22      | )      |         | $       | (0.16      | )     
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Shares used in computing basic and diluted net loss per common share |                                        |                          | 52,038,339                |                                                             |        |                                                 | 50,845,878 |                  |        |        | 51,922,154 |        |         |         | 50,706,018 |       
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Comprehensive loss:                                                  |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |       
|                                                                     |                                        |                          | Net loss                  |                                                             | $      | (4,474                                          | )          |                  | $      | (4,881 | )          |        | $       | (11,235 | )          |        | $      | (8,003 | )     
|                                                                     |                                        |                          | Other comprehensive loss: |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |        |        |       
|                                                                     |                                        |                          |                           | Unrealized loss on marketable securities
available for sale |        |                                                 | (32        | )                |        |        | (260       | )      |         |         | (91        | )      |        |        | (230   | )
|                                                                     |                                        |                          |                           | Foreign currency cumulative translation adjustment          |        |                                                 | 877        |                  |        |        | (209       | )      |         |         | 1,032      |        |        |        | 326    |  
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       
|Total comprehensive loss                                             |                                        | $                        | (3,629                    | )                                                           |        | $                                               | (5,350     | )                |        | $      | (10,294    | )      |         | $       | (7,907     | )     
|                                                                     |                                        |                          |                           |                                                             |        |                                                 |            |                  |        |        |            |        |         |         |            |        |       

The accompanying notes are an integral part of these condensed
consolidated financial statements.

4



---



##### 



WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|----------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------ | - | ------------------------------ | ------- | ---- | - | ------- | ------- | -
|                                                                              |                                                                                                                                |   | SIX MONTHS ENDED SEPTEMBER 30,
|                                                                              |                                                                                                                                |   |                               
|                                                                              |                                                                                                                                |   | 2003                           |         | 2002
|                                                                              |                                                                                                                                |   |                                |         |     
|                                                                              |                                                                                                                                |   | (in thousands)                
|Cash flows from operating activities:                                         |                                                                                                                                |   |                                |         |      |   |         |        
|                                                                              | Net loss                                                                                                                       |   | $                              | (11,235 | )    |   | $       | (8,003  | )
|                                                                              | Adjustments to reconcile net loss to net cash used in operating activities:                                                    |   |                                |         |      |   |         |         |  
|                                                                              | Depreciation and amortization                                                                                                  |   |                                | 4,320   |      |   |         | 4,835   |  
|                                                                              | Recoveries of allowance for doubtful accounts                                                                                  |   |                                |        |      |   |         | (12     | )
|                                                                              | Amortization of deferred stock compensation related to employee and
non-employee stock options and non-employee stock warrants |   |                                | 1,477   |      |   |         | 2,208   |  
|                                                                              | Impairment of equity investment in private company                                                                             |   |                                |        |      |   |         | 1,000   |  
|                                                                              | Conversion of interest income into equity in private company                                                                   |   |                                | (257    | )    |   |         |        |  
|Increase (decrease) in cash resulting from changes in assets and liabilities: |                                                                                                                                |   |                                |         |      |   |         |        
|                                                                              | Accounts receivable                                                                                                            |   |                                | 5,433   |      |   |         | 6,549   |  
|                                                                              | Prepaid expenses and other current assets                                                                                      |   |                                | (1,210  | )    |   |         | (1,604  | )
|                                                                              | Other non-current assets                                                                                                       |   |                                | 41      |      |   |         | 807     |  
|                                                                              | Accounts payable                                                                                                               |   |                                | (217    | )    |   |         | (2,871  | )
|                                                                              | Accrued expenses                                                                                                               |   |                                | (686    | )    |   |         | (2,676  | )
|                                                                              | Accrued salaries and commissions                                                                                               |   |                                | (637    | )    |   |         | (4,627  | )
|                                                                              | Accrued ESPP                                                                                                                   |   |                                | 15      |      |   |         | (141    | )
|                                                                              | Deferred revenue                                                                                                               |   |                                | (6,537  | )    |   |         | (10,032 | )
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Net cash used in operating activities                                         |                                                                                                                                |   | (9,493                         | )       |      |   | (14,567 | )      
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Cash flows from investing activities:                                         |                                                                                                                                |   |                                |         |      |   |         |        
|                                                                              | Purchases of property and equipment                                                                                            |   |                                | (1,597  | )    |   |         | (1,958  | )
|                                                                              | Net sales (purchases) of marketable securities available for sale                                                              |   |                                | 8,712   |      |   |         | (18,697 | )
|                                                                              | Proceeds from the sale of investment in private company                                                                        |   |                                | 1,000   |      |   |         |        |  
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|                                                                              | Net cash provided by/(used in) investing activities                                                                            |   |                                | 8,115   |      |   |         | (20,655 | )
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Cash flows from financing activities:                                         |                                                                                                                                |   |                                |         |      |   |         |        
|                                                                              | Borrowings under leasing agreements                                                                                            |   |                                |        |      |   |         | 2,500   |  
|                                                                              | Payments on capital leases                                                                                                     |   |                                | (2,085  | )    |   |         | (2,070  | )
|                                                                              | Proceeds from exercise of stock options and stock issued under the ESPP                                                        |   |                                | 1,636   |      |   |         | 2,606   |  
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Net cash (used in)/provided by financing activities                           |                                                                                                                                |   | (449                           | )       |      |   | 3,036   |        
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Effect of exchange rate on cash and cash equivalents                          |                                                                                                                                |   | 1,200                          |         |      |   | 622     |        
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Net decrease in cash and cash equivalents                                     |                                                                                                                                |   | (627                           | )       |      |   | (31,564 | )      
|Cash and cash equivalents at beginning of period                              |                                                                                                                                |   | 79,702                         |         |      |   | 98,497  |        
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  
|Cash and cash equivalents at end of period                                    |                                                                                                                                | $ | 79,075                         |         |      | $ | 66,933  |        
|                                                                              |                                                                                                                                |   |                                |         |      |   |         |         |  

The accompanying notes are an integral part of these condensed
consolidated financial statements.

5



---



##### 



WEBMETHODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying consolidated financial statements of webMethods, Inc. and
its subsidiaries (collectively, the Company) have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC). This Quarterly Report on Form 10-Q should be read in
conjunction with the Companys Annual Report on Form 10-K for the year ended
March 31, 2003. Certain information and footnote disclosures which are normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to SEC rules and
regulations. The information reflects all normal and recurring adjustments
that, in the opinion of management, are necessary for a fair presentation of
the financial position of the Company, and its results of operations for the
interim periods set forth herein. The results for the three and six months
ended September 30, 2003 are not necessarily indicative of the results to be
expected for the full year or any future period. Certain amounts previously
reported have been reclassified to conform with current year presentation.

2. PRO FORMA STOCK BASED COMPENSATION

The Company measures compensation expense for its employee stock-based
compensation using the intrinsic value method and provides pro forma
disclosures of net loss as if the fair value method had been applied in
measuring compensation expense. Under the intrinsic value method of accounting
for stock based compensation, when the exercise price of options granted to
employees is less than the fair value of the underlying stock on the grant
date, compensation expense is recognized over the applicable vesting period.

The following table summarizes the Companys results on a pro forma basis
as if it had recorded compensation expense based upon the fair value at the
grant date for awards consistent with the methodology prescribed in SFAS 123,
Accounting for Stock-Based Compensation, for the three and six months ended
September 30, 2003 and 2002 :

|                                                         |  |                                       |         |                                |  |      |         |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------- |  | ------------------------------------- | ------- | ------------------------------ |  | ---- | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                         |  | THREE MONTHS ENDED SEPTEMBER 30,      |         | SIX MONTHS ENDED SEPTEMBER 30,
|                                                         |  |                                       |         |                               
|                                                         |  | 2003                                  |         | 2002                           |  | 2003 |         | 2002
|                                                         |  |                                       |         |                                |  |      |         |     
|                                                         |  | (In thousands, except per share data)
|Net loss, as reported                                    |  | $                                     | (4,474  | )                              |  | $    | (4,881  | )    |  | $ | (11,235 | ) |  | $ | (8,003  | )
|Net loss, pro forma                                      |  |                                       | (16,325 | )                              |  |      | (13,108 | )    |  |   | (34,583 | ) |  |   | (28,457 | )
|Basic and diluted net loss per common share, as reported |  |                                       | (.09    | )                              |  |      | (.10    | )    |  |   | (.22    | ) |  |   | (.16    | )
|Basic and diluted net loss per common share, pro forma   |  |                                       | (.31    | )                              |  |      | (.26    | )    |  |   | (.67    | ) |  |   | (.56    | )

The fair value of each option grant is estimated on the date of grant
using the Black-Scholes valuation model with the following weighted average
assumptions: Risk-free interest rates of 2.93% and 4.40% for the three and six
months ended September 30, 2003 and 2002, respectively; expected volatility of
97% and 125% for the three and six months ended September 30, 2003 and 2002,
respectively; expected life of 4 years, and no anticipated dividends.

The weighted average fair value per share for stock option grants awarded
during the three months ended September 30, 2003 and 2002 was $8.84 and $8.48,
respectively. The weighted average fair value per share for stock option
grants awarded during the six months ended September 30, 2003 and 2002 was
$8.92 and $10.66, respectively.

3. COMPUTATION OF NET LOSS PER SHARE

The Companys net loss per share calculation for basic and diluted is
based on the weighted average number of common shares outstanding. There are no
reconciling items in the numerator and denominator of the Companys net loss
per share calculation. Employee stock options and warrants of 792,098 and
1,168,819 for the quarters ended September 30, 2003 and 2002, respectively,
have been excluded from the net loss per share calculation because their effect
would be anti-dilutive. Employee stock options and warrants of 890,435 and
1,320,340 for the six months ended September 30, 2003 and 2002, respectively,
have been excluded from the net loss per share calculation because their effect
would be anti-dilutive.

6



---



##### 



4. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

|                                             |                                                                |   |                                |       |      |   |     |      |  
|-------------------------------------------- | -------------------------------------------------------------- | - | ------------------------------ | ----- | ---- | - | --- | ---- | -
|                                             |                                                                |   | SIX MONTHS ENDED SEPTEMBER 30,
|                                             |                                                                |   |                               
|                                             |                                                                |   | 2003                           |       | 2002
|                                             |                                                                |   |                                |       |     
|                                             |                                                                |   | (in thousands)                
|Cash paid during the period for interest     |                                                                | $ | 101                            |       |      | $ | 353 |     
|                                             |                                                                |   |                                |       |      |   |     |     
|Non-cash investing and financing activities: |                                                                |   |                                |       |      |   |     |     
|                                             | Equipment purchased under capital lease                        |   | $                              | 1,111 |      |   | $   | 900  |  
|                                             |                                                                |   |                                |       |      |   |     |     
|                                             | Conversion of debt and interest to equity in a private company |   | $                              | 1,257 |      |   | $   |     |  
|                                             |                                                                |   |                                |       |      |   |     |     
|                                             | Change in net unrealized gain on marketable securities         |   | $                              | (91   | )    |   | $   | (230 | )
|                                             |                                                                |   |                                |       |      |   |     |     

5. SEGMENT INFORMATION

The Company conducts operations worldwide and is primarily managed on a
geographic basis with those geographic segments being the Americas,
Europe/Middle-East/Africa (EMEA),
Japan and Asia Pacific region. Revenue is primarily attributable to the region
in which the contract is signed and the product is deployed. Information
regarding geographic areas is as follows:

|             |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 
|------------ |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|             |  | THREE MONTHS ENDED |        | SIX MONTHS ENDED
|             |  | SEPTEMBER 30,      |        | SEPTEMBER 30,   
|             |  |                    |        |                 
|REVENUES     |  | 2003               |        | 2002             |  | 2003 |        | 2002
|             |  |                    |        |                  |  |      |        |     
|             |  | (In thousands)    
|Americas     |  | $                  | 26,083 |                  |  | $    | 30,441 |      |  | $ | 51,413 |  |  | $ | 63,265 | 
|EMEA         |  |                    | 11,965 |                  |  |      | 7,308  |      |  |   | 22,662 |  |  |   | 16,538 | 
|Japan        |  |                    | 4,495  |                  |  |      | 5,737  |      |  |   | 8,740  |  |  |   | 8,109  | 
|Asia Pacific |  |                    | 2,846  |                  |  |      | 2,676  |      |  |   | 5,799  |  |  |   | 5,931  | 
|             |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 
|Total        |  | $                  | 45,389 |                  |  | $    | 46,162 |      |  | $ | 88,614 |  |  | $ | 93,843 | 
|             |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 

|                  |  |                |        |           |  |   |        | 
|----------------- |  | -------------- | ------ | --------- |  | - | ------ | 
|                  |  | AS OF          |        | AS OF    
|                  |  | SEPTEMBER 30,  |        | MARCH 31,
|LONG LIVED ASSETS |  | 2003           |        | 2003     
|                  |  |                |        |          
|                  |  | (In thousands)
|Americas          |  | $              | 45,062 |           |  | $ | 47,853 | 
|EMEA              |  |                | 2,308  |           |  |   | 2,228  | 
|Japan             |  |                | 1,599  |           |  |   | 935    | 
|Asia Pacific      |  |                | 444    |           |  |   | 541    | 
|                  |  |                |        |           |  |   |        | 
|Total             |  | $              | 49,413 |           |  | $ | 51,557 | 
|                  |  |                |        |           |  |   |        | 

6. RESTRUCTURING CHARGES

During the quarter ended September 30, 2001, the Company recorded a
restructuring charge of $7.2 million, consisting of $2.5 million for headcount
reductions, $4.0 million for consolidations of facilities, and $700,000 of
other related restructuring charges. These restructuring charges were taken to
align the Companys cost structure with changing market conditions.

7



---



##### 



In
October 2002, the Company recorded a
restructuring charge of $2.2 million due to a headcount reduction of
approximately 43 employees or 5% of the workforce.

As of September 30, 2003 and March 31, 2003, respectively, $1.3 million
and $1.8 million of restructuring charges remained unpaid. This portion
primarily relates to rent on the excess facilities and will be paid over the
remaining rental periods.

7. INVESTMENTS IN PRIVATE COMPANY

In April 2000, the Company made an investment in a private company
totaling $2,000,000 of which $1,000,000 was equity and $1,000,000 was
convertible debt. The Company and this private company currently share a common
Board member. In March 2002, the Company recorded an other-than-temporary
decline in value of $200,000 in this equity investment. In September 2003, the
Company received $1,000,000 as repayment of convertible debt of this
private company. In connection with this transaction, the Company also
converted $257,000 of interest into additional equity in this private company.
As of September 30, 2003 and March 31, 2003, the carrying value of the investment in this
private company was $1,057,000 and $1,800,000, respectively, and the Companys
equity position, excluding conversion of other convertible debt, was less than
4%.

The
Company incurred royalty expense of $396,000 and $341,000 to this
private company in the three months ended September 30, 2003 and
2002, respectively, and $759,000 and $341,000 in the six months ended
September 30, 2003 and 2002, respectively.

8. SUBSEQUENT EVENTS

In October 2003, the Company completed the business and asset acquisitions
of The Mind Electric, Inc. (TME), The Dante Group and the
portal solution previously known as DataChannel. TME was a leading
provider of software for the service-oriented architectures and The Dante Group,
Inc. was a provider of business activity monitoring software. The aggregate purchase price for these three
acquisitions was approximately $32 million in cash excluding advisors fees.
The Company is currently in the process of finalizing the accounting for these acquisitions.

In October
2003, the Company reduced its headcount by approximately 40 employees to better align the Companys
investments and cost structure. In connection with this reduction, the Company expects to record a
restructuring charge in the range of $1.5 million to $2.0 million during the quarter ending December 31, 2003.

ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. Examples of
forward-looking statements include, but are not limited to, (i) projections of
revenue, costs or expense, cost savings, margins, income or loss, earnings or
loss per share, capital expenditures, cash requirements or other financial
items, the impact of expenses on levels of cash and marketable securities,
sufficiency of working capital and projections regarding the market for the
Companys current, anticipated and acquired software, (ii) statements of the
plans or objectives of webMethods, Inc. or its management, including the
development or enhancement of software, dates of availability of new products
and new releases of existing products, development and continuation of
strategic partnerships and alliances, contributions to future financials
performance of acquired technology or businesses, realization of benefits from
acquisitions of technology or companies, implementation and effect of sales and
marketing initiatives by webMethods, strength of results from geographic or
specific vertical markets and allocation of resources to those markets,
predictions of the timing and type of customer or market reaction to those
initiatives, the ability to control expenses, future hiring, webMethods
business strategy and the execution on it and actions by customers and
competitors, (iii) statements of future economic performance, economic
conditions or the impact of recent changes in accounting standards and (iv)
assumptions underlying any of the foregoing. In some instances, forward-looking
statements can be identified by the use of the words believes, anticipates,
plans, expects, intends, may, will, should, estimates,
predicts, continue, the negative thereof or similar expressions. Although
we believe that the expectations reflected in the forward-looking statements
are reasonable, our expectations or the forward-looking statements could prove
to be incorrect, and actual results could differ materially from those
indicated by the forward-looking statements. Our future financial condition and
results of operations, as well as any forward-looking statements, are subject
to risks and uncertainties, including (but not limited to) those discussed in
Item 1 of our Form 10-K for the year ended March 31, 2003 under the
caption Factors That May Affect Future Operating Results and under this Item
under the caption Factors That May Affect Future Operating Results. Achieving
the future results or accomplishments described or projected in forward-looking
statements depends upon events or developments that are often beyond our
ability to control. All forward-looking statements and all reasons why actual
results may differ that are included in this report are made as of the date of
this report, and webMethods disclaims any obligation to publicly update or
revise such forward-looking statements or reasons why actual results may
differ.

8



---



##### 



OVERVIEW

Background

We are a leading provider of web services infrastructure software and
services providing a standards-based, non-proprietary and vendor-neutral
solution, enabling customers to run, measure and optimize their information
technology resources and the business processes utilizing those resources. We
develop and deliver software products and provide related services that give
organizations the ability, seamlessly and in real-time, to integrate disparate
information resources, to connect customers, vendors and business partners with
the organization and its employees, to run, manage and optimize the connected
information resources, data, business processes and human workflows and to
provide Enterprise Web Services. By deploying webMethods software, customers
can reduce costs, create new revenue opportunities, strengthen relationships
with customers, vendors and business partners, increase supply
chain efficiencies and streamline internal business processes.

In
October 2003, the Company completed the business and asset
acquisitions of The Mind Electric, Inc. (TME), The Dante
Group and the portal solution previously known as DataChannel. TME
was a leading provider of software for the service-oriented
architectures and The Dante Group, Inc. was a provider of business
activity monitoring software. The aggregate purchase price for these
three acquisitions was approximately $32 million in cash excluding
advisors fees.

Overview of Second Quarter of Fiscal 2004

Our net loss of $4.5 million for the quarter ended September 30, 2003
decreased by approximately $400,000 from a net loss of $4.9 million in the
quarter ended September 30, 2002. The decrease in net loss is due primarily to
a decrease in operating expenses of $2.1 million and a $1.0 million charge
recorded in the second quarter of our fiscal 2003 for impairment of an equity
investment in a private company. Those items were substantially offset by a
decrease in revenue of approximately $800,000, an increase in cost of sales of
$1.7 million and a decrease in net interest income of approximately $200,000.

Our total revenue decreased to $45.4 million for the quarter ended
September 30, 2003 from $46.2 million for the quarter ended September 30, 2002.
Our revenue decrease resulted from a decline in license revenue of $4.5
million, partially offset by a $1.7 million increase in maintenance revenue and
a $2.0 million increase in professional services revenue in the quarter ended
September 30, 2003 compared to the same quarter in the prior year. The 17%
decrease in license revenue was attributable to the continued uncertainty in
the global economy and in information technology spending, as well as the
continuing impact from our quota bearing sales headcount in the Americas being
down approximately 10% at the beginning of the first quarter of our fiscal year
2004, which affected our North American commercial license sales in our quarter
ended September 30, 2003. During the second quarter of our fiscal year 2004,
many enterprises headquartered in North America continued to be cautious, and
information technology purchases were subjected to rigorous internal reviews
and approvals which often resulted in longer sales cycles, the postponement of
information technology projects, customers placing smaller orders, or
difficulty in closing large deals.

We maintained our intense focus on managing operating expenses throughout
the quarter ended September 30, 2003. This resulted in a 5% reduction in
operating expenses compared to the second quarter of our fiscal year 2003. The
reduction in operating expenses was primarily the result of reductions in total
sales and marketing expense, excluding stock based compensation and warrant
charge, and research and development expense, excluding stock based
compensation, compared to the same quarter of our fiscal year 2003.

We sell
our software and services to Global 2000 customers through our
direct sales force augmented by system integrators, our relationships with
application software partners, and to a lesser extent, resellers. We license
our software to customers primarily on a perpetual basis. As of September 30, 2003, we
had over 1,000 customers, compared to over 850 customers as of September 30,
2002.

We believe one of our competitive differentiators is our strong
partnership with application software companies and system integrators. Under
our partnerships with application software vendors, the partner may resell or
embed our software with their applications under limited use licenses for a
license or royalty fee. Leading enterprise application software vendors with
whom we have strong relationships include AMS, i2 Technologies, Informatica,
Peoplesoft and Siebel Systems. Our application and system integrator
partners actively assist us in selling the full webMethods Integration Platform
to their customers, making us the logical choice for enterprise-wide
integration initiatives. We believe our partners influenced, directly or
indirectly, a substantial portion of our license revenue during the second
quarter of our fiscal year 2004, and we expect this influence to continue.
Under certain partnership arrangements, we may share license fees derived from
joint selling opportunities with our partner. In other partnership
arrangements, we may pay a sales assistance fee to a partner who performs or
assists in certain sales activities, and that fee usually is paid once payment
of license fees from the joint customer is received. During the second quarter
of our fiscal year 2004,
Peoplesoft chose our technology to embed within their AppConnect product suite,
which will allow our technology to be used for a number of complex business process
integration requirements, and AMS chose to embed webMethods Workflow into
twelve of their different applications targeted at the US military and defense
market.

We believe our strong focus and track record of ensuring that our software
is successfully put into production (production event) is a strong
competitive advantage and differentiator. During the second quarter of our
fiscal year 2004, our global customer services

9



---



##### 



group reported and documented
over 110 separate production events as compared to over 75 such events in the
prior year period. Ensuring that our customers successfully implement our software in a timely manner enables
them to achieve a greater return on their investment and, in many cases,
encourages them to purchase additional software for other integration projects
and serve as a referenceable customer for us in our future sales efforts.

We believe the software integration and web services infrastructure market
will continue to provide opportunity for long term growth. Our focus on
customer success and satisfaction has resulted in an increasing number of
referenceable customers and productions events. Approximately 55% of our
bookings in the second quarter of our fiscal year 2004 came from our
existing customers. We strive to provide the most comprehensive integration
platform available, and will continue to invest to ensure an advantageous
positioning relative to our competition, resulting in recognized industry and
technology leadership and increasing market share.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenue and expenses, and related disclosures.
We evaluate our estimates, on an on-going basis, including those related to
allowances for bad debts, investments, intangible assets, income taxes,
contingencies and litigation. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions.

We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our condensed
consolidated financial statements.

Revenue Recognition

We enter into arrangements, which may include the sale of licenses of our
software, professional services and maintenance or various combinations of each
element. We recognize revenue based on Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended, and modified by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions. SOP 98-9 modified SOP 97-2 by requiring revenue to be
recognized using the residual method if certain conditions are met. Revenue
is recognized based on the residual method when an agreement has been signed by
both parties, the fees are fixed or determinable, collection of the fees is
probable, delivery of the product has occurred, vendor specific objective
evidence of fair value exists for any undelivered element, and no other
significant obligations remain. Revenue allocated to the undelivered elements
is deferred using vendor-specific objective evidence of fair value of the
elements and the remaining portion of the fee is allocated to the delivered
elements (generally the software license). See Note 2 of the Consolidated
Financial Statements included in the Companys Annual Report on Form 10-K for
the year ended March 31, 2003 for a more comprehensive discussion of our
revenue recognition policies. Judgments we make regarding these items,
including collection risk, can materially impact the timing of recognition of
license revenue.

Policies related to revenue recognition require difficult judgments on
complex matters that are often subject to multiple sources of authoritative
guidance. These sources may publish new authoritative guidance which might
impact current revenue recognition policies. We continue to evaluate our
revenue recognition policies as new authoritative interpretations and guidance
are published, and where appropriate, may modify our revenue recognition
policies. Application of our revenue recognition policy requires a review of
our license and professional services agreements with customers and may require
management to exercise judgment in evaluating whether delivery has occurred,
payments are fixed and determinable, collection is probable, and where
applicable, if vendor-specific objective evidence of fair value exists for
undelivered elements of the contract. In the event judgment in the application
of our revenue recognition policies is incorrect, the revenue recognized by
webMethods could be impacted.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses which
may result from the inability of our customers to make required payments to us.
These allowances are established through analysis of the credit-worthiness of
each customer with a receivable balance, determined by credit reports from
third parties, published or publicly available financial information, customers
specific experience including payment practices and history, inquiries, and
other financial information from our customers. The use of

10



---



##### 



different estimates
or assumptions could produce materially different allowance balances. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.

Goodwill and Intangibles Assets

We record goodwill and intangible assets when we acquire other companies.
The allocation of acquisition cost to intangible assets and goodwill involves
the extensive use of managements estimates and assumptions, and the result of
the allocation process can have a significant impact on our future operating
results. Financial Accounting Standards Board No. 142, Goodwill and Other
Intangible Assets (SFAS 142), which was issued during fiscal year 2002 and
adopted by us on April 1, 2002, eliminated the amortization of goodwill and
indefinite lived intangible assets. Intangible assets with finite lives are
amortized over their useful lives while goodwill and indefinite lived assets
are not amortized under SFAS 142, but are periodically tested for impairment.
In accordance with SFAS 142, all of our goodwill is associated with our
corporate reporting unit, as we do not have multiple reporting units. On an
annual basis, we will evaluate whether an impairment of the goodwill may exist.
Goodwill is tested for impairment using a two-step process. The first step is
to identify a potential impairment and the second step measures the amount of
the impairment loss, if any. Goodwill is deemed to be impaired if the carrying
amount of the asset exceeds its estimated fair value.

Foreign Currency Effects

The functional currency for our foreign operations is the local currency.
The financial statements of foreign subsidiaries have been translated into
United States dollars. Asset and liability accounts have been translated using
the exchange rate in effect at the balance sheet date. Revenue and expense
accounts have been translated using the average exchange rate for the period.
The gains and losses associated with the translation of the financial
statements resulting from the changes in exchange rates from period to period
have been reported in other comprehensive income or loss. To the extent assets
and liabilities of the foreign operations are realized or the foreign
operations are expected to pay back the intercompany debt in the foreseeable
future, amounts previously reported in other comprehensive income or loss would
be included in net income or loss in the period in which the transaction
occurs. Transaction gains or losses are included in net income or loss in the period in
which they occur.

Accounting for Income Taxes

We have recorded a tax valuation allowance to reduce our deferred tax
assets to the amount that is expected to be realized. While we have considered
future taxable income and ongoing prudent and feasible tax planning strategies
in assessing the need for the valuation allowance, in the event we were to
determine that we would be able to realize our deferred tax assets in the
future in excess of its net recorded amount, an adjustment to the deferred tax
asset would increase income in the period such determination was made.
Likewise, should we determine that we would not be able to realize all or part
of our net deferred tax asset in the future, an adjustment to the deferred tax
asset would be charged to income in the period such determination was made.

RESULTS OF OPERATIONS

The following table summarizes the results of our operations for the three
and six months ended September 30, 2003 and 2002 (all percentages are
calculated using the underlying data in thousands):

|                         |  |                    |        |                  |  |            |        |               |  |               |    |            |  |   |         |    |  |   |        |    |  |  |     |   
|------------------------ |  | ------------------ | ------ | ---------------- |  | ---------- | ------ | ------------- |  | ------------- | -- | ---------- |  | - | ------- | -- |  | - | ------ | -- |  |  | --- | --
|                         |  | Three Months Ended |        | Six Months Ended
|                         |  |                    |        |                 
|                         |  | September 30,      |        | September 30,    |  | Percentage |        | September 30, |  | September 30, |    | Percentage
|                         |  | 2003               |        | 2002             |  | Change     |        | 2003          |  | 2002          |    | Change    
|                         |  |                    |        |                  |  |            |        |               |  |               |    |           
|                         |  | ($ in thousands)  
|Total revenue            |  | $                  | 45,389 |                  |  | $          | 46,162 |               |  |               | (2 | )%         |  | $ | 88,614  |    |  | $ | 93,843 |    |  |  | (6  | )%
|Gross profit             |  |                    | 32,409 |                  |  |            | 34,893 |               |  |               | (7 | )%         |  |   | 63,486  |    |  |   | 72,096 |    |  |  | (12 | )%
|% of total revenue       |  |                    | 71     | %                |  |            | 76     | %             |  |               |    |            |  |   | 72      | %  |  |   | 77     | %  |  |  |     |   
|Total operating expenses |  |                    | 37,582 |                  |  |            | 39,687 |               |  |               | (5 | )%         |  |   | 76,355  |    |  |   | 81,351 |    |  |  | (6  | )%
|% of total revenue       |  |                    | 83     | %                |  |            | 86     | %             |  |               |    |            |  |   | 86      | %  |  |   | 87     | %  |  |  |     |   
|Operating loss           |  |                    | (5,173 | )                |  |            | (4,794 | )             |  |               | 8  | %          |  |   | (12,869 | )  |  |   | (9,255 | )  |  |  | 39  | % 
|% of total revenue       |  |                    | (11    | )%               |  |            | (10    | )%            |  |               |    |            |  |   | (15     | )% |  |   | (10    | )% |  |  |     |   
|Net loss                 |  | $                  | (4,474 | )                |  | $          | (4,881 | )             |  |               | (8 | )%         |  | $ | (11,235 | )  |  | $ | (8,003 | )  |  |  | 40  | % 
|% of total revenue       |  |                    | (10    | )%               |  |            | (11    | )%            |  |               |    |            |  |   | (13     | )% |  |   | (9     | )% |  |  |     |   

11



---



##### 



In the six months ended September 30, 2003, total revenue decreased by 6%,
to $88.6 million from $93.8 million for the six months ended September 30, 2002
due primarily to a decrease in license revenue, which was partially offset by
an increase in maintenance and professional services revenue. During the
quarter ended September 30, 2003, total revenue decreased $773,000, or 2%,
compared to the quarter ended September 30, 2002 due primarily to a decrease in
license revenue which was partially offset by an increase in maintenance and
professional services revenue. The decreases in license revenue in the quarter
and six months ended September 30, 2003, reflect the continued economic
slowdown and decline in information technology spending.

Our net loss of $11.2 million for the six months ended September 30, 2003
increased 40% from a net loss of $8.0 million in the six months ended September
30, 2002, due primarily to a decrease in total revenue of $5.2 million, an
increase in the cost of revenues of $3.4 million and a $618,000 decrease in net
interest income. Those items were partially offset by a $5.0 million decrease
in operating expenses. During the quarter ended September 30, 2003, our net
loss decreased by $407,000, or 8%, compared to the quarter ended September 30,
2002 due primarily to a decrease in operating expenses of $2.1 million and a
$1.0 million impairment charge of an equity investment in a private company
during the September 2002 quarter. Those items were partially offset by a
decrease in revenue of $773,000, an increase in cost of revenues of $1.7
million and a decrease in net interest income of $214,000.

Revenue

The following table summarizes our revenue for the three and six months
ended September 30, 2003 and 2002:

|                      |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |  |  |   |        |  |  |  |     |   
|--------------------- |  | ------------------ | ------ | ---------------- |  | ---------- | ------ | ------------- |  | ------------- | --- | ---------- |  | - | ------ |  |  | - | ------ |  |  |  | --- | --
|                      |  | Three Months Ended |        | Six Months Ended
|                      |  |                    |        |                 
|                      |  | September 30,      |        | September 30,    |  | Percentage |        | September 30, |  | September 30, |     | Percentage
|                      |  | 2003               |        | 2002             |  | Change     |        | 2003          |  | 2002          |     | Change    
|                      |  |                    |        |                  |  |            |        |               |  |               |     |           
|                      |  | ($ in thousands)  
|License               |  | $                  | 22,025 |                  |  | $          | 26,475 |               |  |               | (17 | )%         |  | $ | 43,827 |  |  | $ | 55,144 |  |  |  | (21 | )%
|Professional services |  |                    | 10,578 |                  |  |            | 8,584  |               |  |               | 23  | %          |  |   | 19,451 |  |  |   | 16,786 |  |  |  | 16  | % 
|Maintenance           |  |                    | 12,786 |                  |  |            | 11,103 |               |  |               | 15  | %          |  |   | 25,336 |  |  |   | 21,913 |  |  |  | 16  | % 
|                      |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |  |  |   |        |  |  |  |     |   
|Total revenue         |  | $                  | 45,389 |                  |  | $          | 46,162 |               |  |               | (2  | )%         |  | $ | 88,614 |  |  | $ | 93,843 |  |  |  | (6  | )%
|                      |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |  |  |   |        |  |  |  |     |   

The following table summarizes our net revenue by geographic region for
the three and six months ended September 30, 2003 and 2002:

|              |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |  |  |   |        |  |  |  |     |   
|------------- |  | ------------------ | ------ | ---------------- |  | ---------- | ------ | ------------- |  | ------------- | --- | ---------- |  | - | ------ |  |  | - | ------ |  |  |  | --- | --
|              |  | Three Months Ended |        | Six Months Ended
|              |  |                    |        |                 
|              |  | September 30,      |        | September 30,    |  | Percentage |        | September 30, |  | September 30, |     | Percentage
|              |  | 2003               |        | 2002             |  | Change     |        | 2003          |  | 2002          |     | Change    
|              |  |                    |        |                  |  |            |        |               |  |               |     |           
|              |  | ($ in thousands)  
|Americas      |  | $                  | 26,083 |                  |  | $          | 30,441 |               |  |               | (14 | )%         |  | $ | 51,413 |  |  | $ | 63,265 |  |  |  | (19 | )%
|EMEA          |  |                    | 11,965 |                  |  |            | 7,308  |               |  |               | 64  | %          |  |   | 22,662 |  |  |   | 16,538 |  |  |  | 37  | % 
|Japan         |  |                    | 4,495  |                  |  |            | 5,737  |               |  |               | (22 | )%         |  |   | 8,740  |  |  |   | 8,109  |  |  |  | 8   | % 
|Asia Pacific  |  |                    | 2,846  |                  |  |            | 2,676  |               |  |               | 6   | %          |  |   | 5,799  |  |  |   | 5,931  |  |  |  | (2  | )%
|              |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |  |  |   |        |  |  |  |     |   
|Total Revenue |  | $                  | 45,389 |                  |  | $          | 46,162 |               |  |               | (2  | )%         |  | $ | 88,614 |  |  | $ | 93,843 |  |  |  | (6  | )%
|              |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |  |  |   |        |  |  |  |     |   

Total revenue for the quarter and six months ended September 30, 2003
decreased 2% and 6%, respectively, compared to the quarter and six months ended
September 30, 2002. These decreases were due primarily to decreases in license
revenue, which were partially offset by increases in maintenance and
professional services revenue. The decreases in total revenue in the quarter
and six months ended September 30, 2003, as well as the decreases in license
revenue in those periods, were due primarily to softness in North American
commercial license sales, which were impacted by factors discussed in the
following paragraph. For the quarter and six months ended September 30, 2003,
revenue from EMEA, Asia Pacific and Japan (international revenue) increased
23% and 22%, respectively, compared to the quarter and six months ended
September 30, 2002. The increase in international revenue was principally due
to our increased focus in the EMEA region that has resulted in an increased acceptance of
our software, an increase in the number of larger deals and an increased customer base.

12



---



##### 



License revenue for the quarter and six months ended September 30, 2003,
decreased 17% and 21%, respectively, compared to the quarter and six months
ended September 30, 2002. These decreases reflect the continued economic
slowdown and decrease in technology spending which affected our American
commercial license sales in the quarter and six months ended September 30,
2003. Additionally, we entered the first quarter of our fiscal year 2004 with
our quota bearing sales headcount in the Americas down approximately 10%, which
impacted our license revenue from the Americas during the first six months of
our fiscal year 2004. During the first half of our fiscal year 2004, many
enterprises headquartered in North America remained cautious, and information
technology purchases were subjected to rigorous internal reviews and approvals
that often resulted in longer sales cycles, the postponement of information
technology projects, customers placing smaller orders, or difficulty in closing
large deals.

For the quarter and six months ended September 30, 2003, professional
services revenue increased by 23% and 16%, respectively, compared to the
quarter and six months ended September 30, 2002. These increases in
professional services revenue are attributable primarily to an
increased number of larger customer engagements and increased use of subcontractors.

For the quarter and six months ended September 30, 2003, maintenance
revenue increased by 15% and 16%, respectively compared to the quarter and six
months ended September 30, 2002. These increases in maintenance revenue were a
result of new licenses of our software and the cumulative effect of agreements
for post-contract maintenance and support, which are recognized as revenue
ratably over the term of the agreement.

Gross Profit

The following table summarizes the Companys gross profit by type of
revenue, excluding stock based compensation, for three and six months ended
September 30, 2003 and 2002:

|                                             |  |                    |    |                  |  |               |    |               |  |  |    |   |  |  |    |  
|-------------------------------------------- |  | ------------------ | -- | ---------------- |  | ------------- | -- | ------------- |  |  | -- | - |  |  | -- | -
|                                             |  | Three Months Ended |    | Six Months Ended
|                                             |  |                    |    |                 
|                                             |  | September 30,      |    | September 30,    |  | September 30, |    | September 30,
|                                             |  | 2003               |    | 2002             |  | 2003          |    | 2002         
|                                             |  |                    |    |                  |  |               |    |              
|License margin                               |  |                    | 97 | %                |  |               | 98 | %             |  |  | 98 | % |  |  | 99 | %
|Professional
services and
maintenance margin |  |                    | 47 | %                |  |               | 46 | %             |  |  | 46 | % |  |  | 46 | %
|Gross margin                                 |  |                    | 71 | %                |  |               | 76 | %             |  |  | 72 | % |  |  | 77 | %

Total gross margin, excluding stock based compensation, decreased to 71%
and 72%, respectively, for the quarter and six months ended September 30, 2003,
from 76% and 77% for the quarter and six months ended September 30, 2002,
respectively. These decreases were due to a decrease of license revenue in our
revenue mix and an increase in our cost of licenses as well as an increase in
the cost of professional services and maintenance that is a result of increased
subcontractor costs.

Our cost of license revenue consists of royalties for products licensed
from third parties. Our gross margin on license revenue, excluding stock based
compensation, was 97% and 98% for the quarters ended September 30, 2003 and
2002, respectively, 98% and 99% for the six months ended September 30, 2003 and
2002, respectively. The decrease in license gross margin is due to an increase
in the cost of licensing of royalty bearing products and a decrease in license
revenue.

Our cost of professional services and maintenance consists of costs
related to internal professional services and support personnel, and
subcontractors hired to provide implementation and support services. Our gross
margin on professional services and maintenance, excluding stock based
compensation, was 47% and 46% for the quarters ended September 30, 2003 and
2002, and 46% for the six months ended September 30, 2003 and 2002,
respectively.

Operating Expenses

The following table presents certain information regarding the Companys
operating expenses during the three and six months ended September 30, 2003 and
2002:

13



---



##### 



|                                            |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |   |  |   |        |   |  |  |     |   
|------------------------------------------- |  | ------------------ | ------ | ---------------- |  | ---------- | ------ | ------------- |  | ------------- | --- | ---------- |  | - | ------ | - |  | - | ------ | - |  |  | --- | --
|                                            |  | Three Months Ended |        | Six Months Ended
|                                            |  |                    |        |                 
|                                            |  | September 30,      |        | September 30,    |  | Percentage |        | September 30, |  | September 30, |     | Percentage
|($ in thousands)                            |  | 2003               |        | 2002             |  | Change     |        | 2003          |  | 2002          |     | Change    
|                                            |  |                    |        |                  |  |            |        |               |  |               |     |           
|Operating expenses:                         |  |                    |        |                  |  |            |        |               |  |               |     |            |  |   |        |   |  |   |        |   |  |  |     |   
|Sales and marketing*                        |  | $                  | 21,467 |                  |  | $          | 22,592 |               |  |               | (5  | )%         |  | $ | 43,917 |   |  | $ | 46,902 |   |  |  | (6  | )%
|% of Total revenue                          |  |                    | 47     | %                |  |            | 49     | %             |  |               |     |            |  |   | 50     | % |  |   | 50     | % |  |  |     |   
|Research and development*                   |  |                    | 10,857 |                  |  |            | 11,821 |               |  |               | (8  | )%         |  |   | 22,058 |   |  |   | 24,100 |   |  |  | (8  | )%
|% Total revenue                             |  |                    | 24     | %                |  |            | 26     | %             |  |               |     |            |  |   | 25     | % |  |   | 26     | % |  |  |     |   
|General and administrative*                 |  |                    | 4,524  |                  |  |            | 4,228  |               |  |               | 7   | %          |  |   | 8,947  |   |  |   | 8,293  |   |  |  | 8   | % 
|% of Total revenue                          |  |                    | 10     | %                |  |            | 9      | %             |  |               |     |            |  |   | 10     | % |  |   | 9      | % |  |  |     |   
|Stock based compensation
and warrant charge |  |                    | 734    |                  |  |            | 1,046  |               |  |               | (30 | )%         |  |   | 1,433  |   |  |   | 2,056  |   |  |  | (30 | )%
|% of Total revenue                          |  |                    | 2      | %                |  |            | 2      | %             |  |               |     |            |  |   | 2      | % |  |   | 2      | % |  |  |     |   
|Total operating expenses                    |  | $                  | 37,582 |                  |  | $          | 39,687 |               |  |               | (5  | )%         |  | $ | 76,355 |   |  | $ | 81,351 |   |  |  | (6  | )%
|% of Total revenue                          |  |                    | 83     | %                |  |            | 86     | %             |  |               |     |            |  |   | 86     | % |  |   | 87     | % |  |  |     |   



|* |  | Excludes stock based compensation and warrant charge, as applicable.
|- |  | --------------------------------------------------------------------

Our operating expenses are primarily classified as sales and marketing,
research and development and general and administrative. Each category includes
related expenses for compensation, employee benefits, recruiting, professional fees,
travel, communications and allocated facilities and overhead costs.
Our sales and marketing expenses also include expenses which are specific to
the sales and marketing activities, such as commissions, trade shows, public
relations, business development costs, promotional costs and marketing
collateral. Also included in our operating expenses is the amortization of
deferred stock compensation and warrant charge, as applicable.

Sales and marketing expenses, excluding stock based compensation and
warrant charge, decreased by approximately 5% and 6% in the quarter and six
months ended September 30, 2003, respectively, compared to the quarter and six
months ended September 30, 2002. These decreases were primarily due to a
reduction in personnel and travel costs, external commissions and sales
assistance fees. Sales and marketing expenses, excluding stock based
compensation and warrant charge, as a percentage of total revenue was 50% in
the six months ended September 30, 2003 and 2002 and 47% and 49% in the
quarters ended September 30, 2003 and 2002, respectively.

Research and development expenses, excluding stock based compensation,
decreased by 8% in each of the quarter and six months ended September 30, 2003
compared to the quarter and six months ended September 30, 2002. These
decreases were primarily due to a reduction in personnel and contractor costs.
Research and development expense, excluding stock based compensation, as a
percentage of total revenue was 25% and 26% in the six months ended September
30, 2003 and 2002, respectively, and 24% and 26% in the quarters ended
September 30, 2003 and 2002, respectively.

General and administrative expenses, excluding stock based compensation,
increased by 7% and 8%, respectively, in the quarter and six months ended
September 30, 2003 compared to the quarter and six months ended September 30,
2002. These increases were primarily attributable to an increase in professional fees
and business insurance costs. General and administrative expense,
excluding stock based compensation, as a percentage of total revenue was 10%
and 9% in the six months ended September 30, 2003 and 2002, respectively, and
10% and 9% in the quarters ended September 30, 2003 and 2002, respectively.

Stock based compensation and warrant charge were $1.5 million and $2.2
million during the six months ended September 30, 2003 and 2002, respectively,
of which $44,000 and $152,000, respectively, was included in cost of sales.
During the quarters ended September 30, 2003 and 2002, stock based compensation
and warrant charge were $756,000 and $1.1 million, respectively, of which
$22,000 and $76,000, respectively, was included in cost of sales. Deferred
stock based compensation and warrant charge were recorded for the following
transactions:

(i) The issuance of restricted stock in connection with certain
acquisitions during 2000 and the grant of stock options to employees and
non-employee directors at exercise prices less than the deemed fair value of
our common stock at the date of the grant; and

(ii)  In March 2001, we entered into an OEM/Reseller agreement with i2
Technologies (i2) and issued a warrant that, as amended, permits i2 to purchase
710,000 shares of our common stock at an exercise price of $28.70 per share.
The fair value of the warrant, based on the Black-Scholes valuation model was
$23.6 million on the date of issuance which has been recorded as a deferred
warrant

14



---



##### 



charge. As part of the amended agreement, i2 will pay us OEM fees of
$8.8 million over the amended term of the OEM/Reseller agreement which will be
recorded as a reduction to the deferred warrant charge and will not be recorded
as revenue.

The deferred stock compensation and warrant charge is presented as a
reduction of stockholders equity and amortized over the vesting period of the
applicable equity arrangement and is shown by expense category.

Interest Income, net

Net interest income decreased by $618,000, or 27%, to $1.6 million for the
six months ended September 30, 2003 from $2.3 million for the six months ended
September 30, 2002. During the quarter ended September 30, 2003, net interest
income decreased $214,000, or 23%, to $699,000 from $913,000 for the quarter
ended September 30, 2002. These decreases were primarily attributable to lower
interest rates on corporate paper, bonds and money market funds in the
respective period of our fiscal year 2004, compared to those in the same period
in the prior year.

Income Taxes

We have recorded a valuation allowance for the full amount of our net
deferred tax assets, as the realizability of the deferred tax assets is not
currently predictable.

LIQUIDITY AND CAPITAL RESOURCES

Historically we have financed our operations and met our capital
requirements though the sales of equity securities. Our liquidity and financial
position at September 30, 2003, showed a 3% decrease in our cash and marketable
securities, to $192.2 million and a 9% decrease in our working capital, to
$128.8 million from our positions at September 30, 2002. The decrease in
working capital is primarily due to a decrease in our short-term marketable
securities and accounts receivable balances at September 30, 2003, as compared
to September 30, 2002.

Net cash used in operating activities was $9.5 million for the six months
ended September 30, 2003, compared to $14.6 million for the six months ended
September 30, 2002. The decrease in cash used in operating activities during
the first six months of our fiscal 2004 compared to the first six months of our
fiscal year 2003, was due primarily to smaller decreases in deferred revenue,
accounts payable and accrual balances offset by higher net loss in the six months
ended September 30, 2003.

Net cash provided by investing activities was $8.1 million for the six
months ended September 30, 2003, compared to cash used in investing activities
of $20.7 million during the six months ended September 30, 2002. The increase
in cash provided by investing activities during the first six months of our
fiscal 2004 compared to the first six months of our prior fiscal year was
primarily due to the increase in the sale of marketable securities available
for sale. Capital expenditures were $1,597,000 and $1,958,000 for the six
months ended September 30, 2003 and 2002, respectively. Capital expenditures
consisted of purchases of computer hardware and software, office furniture and
equipment and leasehold improvements. We generally fund capital expenditures
through capital leases and the use of working capital. Additionally, for the
six months ended September 30, 2003, we received $1.0 million in proceeds from
the sale of a substantial portion of an investment in a private company.

Net cash used in financing activities was $449,000 for the six months
ended September 30, 2003, compared to net cash provided by financing activities
of $3.0 million during the six months ended September 30, 2002. These cash
flows primarily reflect net cash proceeds from exercises of stock options and
Employee Stock Purchase Plan common stock issuances offset by payments on
capital leases for the six months ended September 30, 2003 and 2002 and
borrowings under lease agreements for the six months ended September 30, 2002.
Net cash proceeds from exercises of stock options were $406,000 and $906,000
for the six months ended September 30, 2003 and 2002 respectively. Net cash
proceeds from ESPP common stock issuances were $1.2 million and $1.7 million
for the six months ended September 30, 2003 and 2002 respectively. Payments on
capital leases were $2.1 million for each of the six months ended September 30,
2003 and 2002. Borrowings on capital leases were $2.5 million for the six
months ended September 30, 2002.

We have a line of credit to borrow up to a maximum principal amount of
$20,000,000, of which the maturity date is being extended to October 9, 2004. Any borrowings under this
line bear interest at the banks prime rate per annum. As of September 30,
2003, we had not borrowed against this line of credit. In connection with the
line of credit, we have a letter of credit totaling $355,000 related to an
office lease. Borrowings under this line are limited to 80% of eligible
accounts receivable.

15



---



##### 



We believe that our existing working capital and our line of credit will
be sufficient to meet our operating resource expenditure requirements for at
least the next twelve months. However, we may utilize cash resources to fund
acquisitions or investments in complementary businesses, technologies or
product lines. In the event additional financing is required, we may not be
able to raise it on acceptable terms or at all.

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

You should consider the following factors when evaluating our statements
in this report and elsewhere. webMethods is subject to risks in addition to
those described below, which, at the date of this report, we may not be aware
of or which we may not consider significant. Those risks may adversely affect
our business, financial condition, results of operations or the market price of
webMethods stock.

Unanticipated fluctuations in our quarterly revenue or operating results could
significantly affect the price of our stock.

We believe that quarter-to-quarter or year-to-year comparisons of our
financial results are not necessarily meaningful indicators of our future
revenue or operating results and should not be relied on as an indication of
our future performance. If our quarterly or annual revenue or operating results
fail to meet the expectations of investors or analysts, the market price of
webMethods stock could be negatively affected. Our quarterly operating results
have varied substantially in the past and may vary substantially in the future
depending upon a number of factors, including the changes in demand for our
products and services, economic conditions, competitive pressures, amount and
timing of operating cost, the timing and amount of revenue from acquired
technology and businesses, and changes that we may make in our business,
operations and infrastructure. In addition, economic uncertainties, economic
consequences or after-effects of terrorist acts, geopolitical developments or
uncertainties, travel limitations, delays in
the availability of new products or new releases of existing products, and
other major, unanticipated events may impact our quarterly operating results.
We generally close a substantial number of license transactions in the last
month of each quarter, which makes it more difficult to gauge the level of
license revenue we will have in any quarter until near to, or after, its
conclusion. We expect to continue devoting resources to our sales and marketing
operations and our research and development activities. Our operating expenses,
which include sales and marketing, research and development and general and
administrative expenses, are based on our expectations of future revenue and
are relatively
fixed in the short term. If revenue falls below our expectations in a quarter
and we are not able to quickly reduce our spending in response, our operating
results for that quarter could be significantly below the expectations of
investors or analysts. It is possible that our revenue or operating results in
the future may be below the expectations of investors or analysts and, as a
result, the market price of webMethods stock may fall. In addition, the stock
market, particularly the stock prices of independent infrastructure software
companies, has been very volatile. This volatility is often not related to the
operating performance of the companies. From our initial public offering in
February 2000 until November 1, 2003, the closing price of webMethods stock on
the Nasdaq National Market has ranged from a high of $336.25 to a low of $4.32.

Growth of our sales may slow from time to time, causing our quarterly operating
results to fluctuate.

Due to customer demand, economic conditions, competitive pressures,
seasonal factors or major, unanticipated events, we may experience a lower
growth rate for, no growth in, or a decline in quarterly or annual revenue from
sales of our software and services in some or all of the geographic regions in
which we operate. For example, the growth rate for revenue from sales of our
software and services during summer months may be lower than at other times
during the year, particularly in European markets.

We also may experience declines in expected revenue due to patterns in the
capital budgeting and purchasing cycles of our current and prospective
customers, changes in demand for our software and services, the timing
and amount of revenue from acquired technology and business, and deferrals of
purchases due to economic uncertainties and economic consequences or after-
effects of terrorist acts, geopolitical developments or uncertainties, travel limitations or other major,
unanticipated events. These periods of slower or no growth may lead to lower
revenue, which could cause fluctuations in our quarterly operating results. In
addition, variations in sales cycles may have an impact on the timing of our
revenue, which in turn could cause our quarterly operating results to
fluctuate. To successfully sell our software and services, we generally must
educate our potential customers regarding their use and benefits, which can
require significant time and resources. Any misperception by us in the needs of
our customers and prospective customers, or any delay in sales of our software
and services could cause our revenue and operating results to vary
significantly from quarter to quarter, which could result in volatility in the
market price of webMethods stock.

16



---



##### 



Our target markets are highly competitive, and we may not be able to compete effectively.

The
markets for Web services infrastrucure solutions, integration
software, business activity monitoring software and portal technology is
rapidly changing and intensely competitive. There are a variety of methods
available to run Web services, integrate software applications, monitor
and optimize business processes and workflows and provide user access to
available data and Web services. We expect that competition will remain
intense as the number of entrants and new technologies increases. We do not
know if our target markets will widely adopt and deploy our Web
services solutions, our integration software, our business activity
monitoring software, our portal product or other solutions we offer
or have announced. If our technology, software and
solutions are not widely adopted by our target markets or if we are not able to
compete successfully against current or future competitors, our business,
operating results and financial condition may be harmed. Our current and
potential competitors include, among others, large software vendors, companies
and trading exchanges that develop their own Web services technologies,
integration solutions and business activity monitoring solutions, electronic
data interchange vendors, vendors of proprietary enterprise
application integration, vendors of portal products, and application server vendors. We also
face competition from various providers of application integration solutions
technologies to run web services and companies offering products and
services that address specific aspects of application integration or Web
services. Further, we face competition for some aspects of our
software and service offerings from major system integrators, both
independently and in conjunction with corporate in-house information technology
departments, which have traditionally been the prevalent resource for
application integration. In addition, our customers and application software
vendors with whom we currently have strategic relationships are offering
competitive solutions or may become competitors in the future. Some of our
competitors or potential competitors may have more experience developing
integration, portal or business activity monitoring software or running web
services, larger technical staffs, larger customer bases, more established
distribution channels, greater brand recognition and greater financial,
marketing and other resources than we do. Our competitors may be able to
develop products and services
that are superior to our software and services, that achieve greater customer
acceptance or that have significantly improved functionality or performance as
compared to our existing software and future software and services. In
addition, negotiating and maintaining favorable customer and strategic
relationships is critical to our business. Our competitors may be able to
negotiate strategic relationships on more favorable terms than we are able to
negotiate. Many of our competitors may also have well-established relationships
with our existing and prospective customers. Increased competition may result
in reduced margins, loss of sales or decreased market share, which in turn
could harm our business, operating results and financial condition.

We rely on strategic partnerships with software vendors, alliances with major
system integrators and other similar relationships to implement and promote our
software and, if these relationships terminate, we may lose important deals and
marketing opportunities.

We have established strategic relationships with enterprise application
software vendors and system integration partners. These strategic partners
provide us with important sales and marketing opportunities, create
opportunities to upsell our products to customers already using our software
embedded in their enterprise application products, and greatly increase our
implementation capabilities. We also have similar relationships with resellers,
distributors and other technology leaders. If our relationships with any of
these organizations were terminated or if we failed to work effectively with
our partners or to grow our base of strategic partners, resellers and
distributors, we might lose important opportunities, including sales and
marketing opportunities, and our business may suffer. In general, our partners
are not required to market or promote our software and generally are not
restricted from working with vendors of competing  software or
solutions.
Accordingly, our success will depend on their willingness and ability to devote
sufficient resources and efforts to marketing our software rather than the
products of competitors. If these relationships are not successful or if they
terminate, our revenue and operating results could be materially adversely
affected, our ability to increase our penetration of our target
markets could be impaired, we may have to devote substantially more resources
to the distribution, sales and marketing, implementation and support of our
software than we would otherwise, and our efforts may not be as effective as
those of our partners, which could harm our business.

Third-party claims that we infringe upon their intellectual property rights may
be costly to defend; trademarks or settle or could damage our business.

We cannot be certain that our software and the services do not infringe
issued patents, copyrights, trademarks or other intellectual property rights of
third-parties. Litigation regarding intellectual property rights is common in
the software industry, and we are subject to, and may be increasingly subject
to, legal proceedings and claims from time to time, including claims of alleged
infringement of intellectual property rights of third-parties by us or our
licensees concerning their use of our software products and integration
technologies and services. Although we believe that our intellectual property
rights are sufficient to allow us to market our software without incurring
liability to third-parties, third-parties may bring claims of infringement
against us. Because our software is integrated with our customers networks and
business processes, as well as other software applications, third parties may
bring claims of infringement against us, as well as our customers and other
software suppliers, if the cause of the alleged infringement cannot easily be
determined. Such claims may be with or without merit. Claims of alleged
infringement may have a material adverse effect on our

17



---



##### 



business and may
discourage potential customers from doing business with us on acceptable terms,
if at all. Litigation to defend against claims of infringement or contests of
validity may be very time-consuming and may result in substantial costs and
diversion of resources, including our managements attention to our business.
Furthermore, a party making such a claim could secure a judgment that requires
us to pay substantial damages. A judgment could also include an injunction or
other court order that could prevent us from selling our software or require
that we re-engineer some or all of our products. Our business, operating
results and financial condition could be harmed significantly if any of these
events occurred, and the price of webMethods common stock could be adversely
affected. Furthermore, former employers of our current and future employees may
assert that our employees have improperly disclosed confidential or proprietary
information to us. In addition, we have agreed, and may agree in the future, to
indemnify certain of our customers against claims that our software infringes
upon the intellectual property rights of others. We could incur substantial
costs in defending ourself and our
customers against infringement claims. In the event of a claim of infringement,
we, as well as our customers, may be required to obtain one or more licenses
from third parties, which may not be available on acceptable terms, if at all.
Defense of any lawsuit or failure to obtain any such required licenses could
harm our business, operating results and financial condition and the price of
webMethods common stock. In addition, although we carry general liability
insurance, our current insurance coverage may not apply to, and likely would
not protect us from, all liability that may be imposed under these types of
claims.

We are trying to increase our sales to the US Government and to others in the
public sector, and we may face difficulties in our attempts to procure new
contracts with them and risks unique to government contracts that may have a
detrimental impact on our business or operating results.

We are attempting to expand our customer base to include more entities and
agencies within the US Government, state, local and foreign
governments.  Developing
new business in the public sector often requires companies to develop
relationships with different agencies or entities, as well as other government
contractors. If we are unable to develop or sustain these relationships, we may
be unable to procure new contracts within the timeframe we expect, and our
business and financial results may be adversely affected. Contracting with the
US Government and other governments also requires businesses to participate in a highly competitive
bidding process to obtain new contracts. We lack substantial experience in
bidding for public sector contracts. We may be unable to bid competitively if
our software and services are improperly priced or if we are incapable of
providing our software and services at a competitive price. The bidding process
is an expensive and time-consuming endeavor that may result in a loss for
webMethods if we fail to win a contract on which we submitted a bid. Further,
some agencies within the US Government may also require some or all of our
personnel to obtain a security clearance or may require us to add features or
functionality to our software. If our key personnel are unable to obtain or
retain this clearance or if we cannot or do not provide required features or
functionality, we may be unsuccessful in our bid for some government contracts.

Contracts
with the US Government or with many state, local, and foreign governments
also frequently include provisions not found in the private sector and are
often governed by laws and regulations that do not affect private contracts.
These differences permit the public sector customer to take action not
available to customers in the private sector. This may include termination of
current contracts for convenience or due to a default. The US Government can
also suspend operations if Congress does not allocate sufficient funds, and the
US Government may allow our competitors to protest our successful bids. If any
of these events occur, they may negatively affect our business and financial
results. In order to maintain contracts with the US Government, webMethods must
also comply with many rules and regulations that may affect our relationship
with other customers. The US Government can terminate its contract with us if
we come under foreign government control or influence, may require that we
disclose our pricing data during the course of negotiations, and may require us
to prevent access to classified data. If the US Government requires us to meet
any of these demands, it could result in increased costs or an inability to
take advantage of certain opportunities that may present themselves in the
future. US Government agencies routinely investigate and audit government
contractors administrative processes. They may audit our performance and our
pricing, and review our compliance with rules and regulations. If they find
that we have improperly allocated costs, they may require us to refund those
costs or may refuse to pay us for outstanding balances related to the improper
allocation. An unfavorable audit could result in a reduction of revenue, and
may result in civil or criminal liability if the audit uncovers improper or
illegal activities. This could harm our business, financial results and
reputation.

Recent and future acquisitions
of companies or technologies may result in disruptions to our
business or the distraction of our management.

We
recently acquired three businesses and technologies, and we may
acquire or make investments in other complementary businesses and
technologies in the future. We may not be able to identify other
future suitable acquisition or investment candidates, and even if we
identify suitable candidates, may not be able to make these
acquisitions or investments on commercially acceptable terms, or at
all. With respect to our recent acquisitions and potential future
acquisitions, we may not be able to realize the benefits we expected
to achieve at the time of entering into the transaction. In such
acquisitions, we will likely face many or all of the risks inherent in
integrating corporate cultures, product lines, operations and
businesses. We will be required to train our sales, professional
services and customer support staff with respect to acquired software
products, which can detract from executing against goals in the
current period, and we may be required to modify priorities of our
product development, customer support, systems engineering and sales
organizations. Further, we may have to incur debt or issue equity
securities to pay for any future acquisitions or investments, the
issuance of which could be dilutive to our existing stockholders.

Our operating results may decline and our customers may become dissatisfied if
we do not provide professional services or if we are unable to establish and
maintain relationships with third-party implementation providers.

Customers that license our software typically engage our professional
services staff or third-party consultants to assist with support, training,
consulting and implementation. We believe that many of our software sales
depend, in part, on our ability to provide our customers with these services
and to attract and educate third-party consultants to provide similar services.
New professional services personnel and service providers require training and
education and take time to reach full productivity. Competition for qualified

18



---



##### 



personnel and service providers is intense. Our business may be harmed if we
are unable to provide
professional services to our customers and establish and maintain relationships
with third-party implementation providers.

Our software must integrate with applications made by third parties, and, if we
lose access to the programming interfaces for these applications, or if we are
unable to modify our software or develop new adapters in response to changes in
these applications, our business could suffer.

Our software uses software components called adapters to communicate with
our customers enterprise applications. Our ability to develop these adapters
is largely dependent on our ability to gain access to the application
programming interfaces, or APIs, for the applications, and we may not have
access to necessary APIs in the future. APIs are written and controlled by the
application provider. Accordingly, if an application provider becomes a
competitor by entering the integration market, it could restrict access to its
APIs for competitive reasons. Our business could suffer if we are unable to
gain access to these APIs. Furthermore, we may need to modify our software or
develop new adapters in the future as new applications or newer versions of
existing applications are introduced. If we fail to continue to develop
adapters or respond to new applications or newer versions of existing
applications, our business could suffer. We rely in part on third parties to
develop adapters necessary for the integration of applications using our
software. We cannot be certain that these companies will continue to develop
these adapters, or that, if they do not continue to do so, that we will be able
to develop these adapters internally in a timely or efficient manner. In
addition, we cannot be certain that adapters developed by third parties will
not contain undetected errors or defects, which could harm our reputation,
result in product liability or decrease the market acceptance of our products.

Our executive officers and certain key personnel are critical to our business,
and these officers and key personnel may not always remain with us.

Our success depends upon the continued service of our executive officers
and other key employees, and none of these officers or key employees is bound
by an employment agreement for any specific term. If we lose the services of
one or more of our executive officers or key employees,  our business, operating results and financial condition could be
harmed. In particular, Phillip Merrick, our Chairman of the Board and Chief
Executive Officer, would be particularly difficult to replace. Our future
success will also depend in large part on our ability to attract and retain
experienced technical, sales, marketing and management personnel.

If our customers do not renew their product support and maintenance agreements,
we may lose a recurring revenue stream, which could harm our operating results.

Many of our customers subscribe for software support and maintenance
services, which we recognize over the term of those support and maintenance
agreements. If a significant portion of those customers chose not to continue
subscribing for product support and maintenance, our recurring revenue from
those services would be adversely affected, which could harm our business,
operating results and financial condition.

We may not be able to increase market awareness and sales of our software if we
do not maintain our sales and distribution capabilities.

We need to maintain and further develop our direct and indirect sales and
distribution efforts, both domestically and internationally, in order to
increase market awareness and sales of our software and the related services we
offer. Our software requires a sophisticated sales effort targeted at multiple
departments within an organization. Competition for qualified sales and
marketing personnel is intense, and we might not be able to hire and retain
adequate numbers of such personnel. Our competitors have attempted to hire
employees away from us, and we expect that they will continue such attempts in
the future. We also plan to expand our relationships with system integrators,
enterprise software vendors and other third-party resellers to further develop
our indirect sales channel. As we continue to develop our indirect sales
channel, we will need to manage potential conflicts between our direct sales
force and third-party reselling efforts, which may impact our business and
operating results.

We intend to continue expanding our international sales efforts, and our
inability to do so could harm our business and operating results.

We have been, and intend to continue, expanding our international sales
efforts. We have limited experience in marketing, selling and supporting our
software and services abroad. Expansion of our international operations will
require a significant amount of attention from our management and substantial
financial resources. If we are unable to continue expanding our international
operations successfully and in a timely manner, our business and operating
results could be harmed. In addition, doing business

19



---



##### 



internationally involves
additional risks, particularly: the difficulties and costs of staffing and
managing foreign operations; unexpected changes in regulatory requirements,
taxes, trade laws and tariffs; differing intellectual property rights;
differing labor regulations; and changes in a specific countrys or regions
political or economic conditions.

We currently do not engage in any currency hedging transactions. Our
foreign sales generally are invoiced in the local currency, and, as we expand
our international operations or if there is continued volatility in exchange
rates, our exposure to gains and losses in foreign currency transactions may
increase when we determine that foreign operations are expected to repay
intercompany debt in the foreseeable future. Moreover, the costs of doing
business abroad may increase as a result of adverse exchange rate fluctuations.
For example, if the United States dollar declines in value relative to a local
currency and we are funding operations in that country from our U.S.
operations, we could be required to pay more for salaries, commissions, local
operations and marketing expenses, each of which is paid in local currency. In
addition, exchange rate fluctuations, currency devaluations or economic crises
may reduce the ability of our prospective customers to purchase our software
and services.

If we experience delays in developing our software, or if our software contains
defects, we could lose customers and revenue.

We expect that the rapid evolution of integration software and standards
and web services technologies and protocols, as well as general technology
trends such as changes in or introductions of operating systems or enterprise
applications, will require us to adapt our software to remain competitive. Our
software could become obsolete, unmarketable or less desirable to prospective
customers if we are unable to adapt to new technologies or standards. Many
serious defects are frequently found during the period immediately following
introduction of new software or enhancements to existing software. Internal
quality assurance testing and customer testing may reveal product performance
issues or desirable feature enhancements that could lead us to postpone the
release of new versions of our software. The reallocation of resources
associated with any postponement could cause delays in the development and
release of future enhancements to our currently available software and could
damage the reputation of our software in the marketplace. Although we attempt
to resolve all errors that we believe would be considered serious by our
customers, our software is not error-free. Undetected errors or performance
problems may be discovered in the future, and known errors that we consider
minor may be considered serious by our customers. This could result in lost
revenue or delays in customer deployment and would be detrimental to our
reputation, which could harm our business, operating results and financial
condition. If our software experiences performance problems, we may have to
increase our product development costs and divert our product development
resources to address the problems. In addition, because our customers depend on
our software for their critical systems and business functions, any
interruptions could cause our customers to initiate product liability suits
against us.

Because our software could interfere with the operations of our customers
other software applications, we may be subject to potential product liability
and warranty claims by these customers, which may be time consuming, costly to
defend and may not be adequately covered by insurance.

Our software is integrated with our customers networks and software
applications and is often used for mission critical applications. Errors,
defects, other performance problems or failure to provide support could result
in financial or other damages to our customers. Customers could seek damages
for losses from us, which, if successful, could have a material adverse effect
on our business, operating results or financial condition. In addition, the
failure of our software to perform to customer expectations could give rise to
warranty claims. Although our license agreements typically contain provisions
designed to limit our
exposure to potential product liability claims, existing or future laws or
unfavorable judicial decisions could negate these limitation of liability
provisions. Although we have not experienced any product liability claims to
date, sale and support of our software entail the risk of such claims. The
integration of our software with our customers networks and software
applications increases the risk that a customer may bring a lawsuit against
several suppliers if an integrated computer system fails and the cause of the
failure cannot easily be determined. Even if our software is not at fault, a
product liability claim brought against us, even if not successful, could be
time consuming and costly to defend and could harm our reputation. In addition,
although we carry general liability insurance, our current insurance coverage
would likely be insufficient to protect us from all liability that may be
imposed under these types of claims.

We are a relatively young
company and have a relatively limited operating history with
which to evaluate our  business and the prospects of achieving our
anticipated growth and of maintaining sustained profitability.

We commenced operations in September 1996. Active Software, with which we
completed a merger in August 2000, was incorporated in September 1995. We have
been operating as a combined company since August 2000. In addition,
we have recently acquired businesses and technologies with limited
operating histories. If we do not generate
sufficient revenue from our business to fund operations, our growth could be
limited unless we are willing to incur operating losses that may be substantial
and are able to fund those operating losses from our available assets or, if
necessary, from the sale of additional capital through public or private equity
or debt financings. If we are unable to grow as planned, our chances of
maintaining sustained profitability and

20



---



##### 



the anticipated or forecasted results of operations could be reduced, which, in
turn, could have a material adverse effect on the market price of webMethods
stock.

Our penetration of the integration software market and the growth of our
business achieved in our relatively limited operating history is not necessarily
indicative of our ability in the future to continue to penetrate our
target markets and to grow our business as we anticipate. Our software is complex and
generally involves significant capital expenditures by our customers. We often
have to devote substantial resources to educate prospective customers about the
benefits of our software. Our efforts to educate potential customers may not
result in our software being accepted by the potential customer or achieving
market acceptance. In addition, many of these prospective customers have made
significant investments in internally developed or custom systems and would
incur significant costs in switching to third-party software such as ours.
Furthermore, even if our software is effective, our potential customers may not
choose it for technical, cost, support, competitive, economic or other reasons.
If the market for our software fails to grow or grows more slowly than we
anticipate, or if our penetration of our target markets and the
growth of our business is less or slower than we anticipate, our business could
suffer, and our ability to achieve and maintain profitability and the
anticipated or forecasted results of operations could be reduced, which, in
turn, could have a material adverse effect on the market price of webMethods
stock.

We may not have sufficient resources available to us in the future to take
advantage of certain opportunities.

In the future, we may not have sufficient resources available to us to
take advantage of growth, product development or marketing opportunities. We
may need to raise additional funds in the future through public or private debt
or equity financings in order to: take advantage of opportunities, including
more rapid international expansion or acquisitions of complementary businesses
or technologies; develop new software or services; or respond to competitive
pressures. Additional financing needed by us in the future may not be available
on terms favorable to us, if at all. If adequate funds are not available, not
available on a timely basis, or are not available on acceptable terms, we may
not be able to take advantage of opportunities, develop new software or
services or otherwise respond to unanticipated competitive pressures. In such
case, our business, operating results and financial condition could be harmed.

If we are unable to protect our intellectual property, we may lose a valuable
asset, experience reduced market share, or incur costly litigation to protect
our rights.

Our success depends, in part, upon our proprietary technology and other
intellectual property rights. To date, we have relied primarily on a
combination of copyright, trade secret, trademark and patent laws, and
nondisclosure and other contractual restrictions on copying and distribution to
protect our proprietary technology. We have one patent and several pending
patent applications for technology related to our software, but we cannot
assure you that this patent is valid or that these applications will be
successful. A small number of our agreements with customers and system
integrators contain provisions regarding the rights of third parties to obtain
the source code for our software, which may limit our ability to protect our
intellectual property rights in the future. Despite our efforts to protect our
proprietary rights, unauthorized parties may copy aspects of our software and
obtain and use information that we regard as proprietary. In addition, other
parties may breach confidentiality agreements or other protective contracts we
have entered into, and we may not be able to enforce our rights in the event of
these breaches. Furthermore, we expect to continue increasing our international
operations in the future, and the laws of certain foreign countries may not
protect our intellectual property rights to the same extent as do the laws of
the United States.

Our means of protecting our intellectual property rights in the United
States or abroad may not be adequate to fully protect our intellectual property
rights. Litigation to enforce our intellectual property rights or protect our
trade secrets could result in substantial costs, may not result in timely
relief and may not be successful. Any inability to protect our intellectual
property rights could seriously harm our business, operating results and
financial condition.

21



---



##### 



Because some of our software products incorporate technology licensed from, or
provided by, third parties, the loss of our right to use that technology could
harm our business.

Some of our software products contain technology that is licensed from, or
provided by, third parties. Any significant interruption in the supply or
support of any of that third-party software could adversely affect our sales,
unless and until we can replace the functionality provided by the third-party
software. Because some of our software incorporates software developed and
maintained by third parties, we depend on these third parties to deliver and
support reliable products, enhance our current software, develop new software
on a timely and cost-effective basis and respond to emerging industry standards
and other technological changes. In other instances we provide third-party
software with our current software and offer support for the third party
software, and we depend on these third-parties to deliver reliable products,
provide underlying product support and respond to emerging industry standards
and other technological changes. The failure of these third parties to meet
these criteria could harm our business.

Because market participants in some markets have adopted industry specific
technologies, we may need to expend significant resources in order to address
specific markets.

Our strategy is to continue developing our integration software to be
broadly applicable to many industries. However, in some markets, market
participants have adopted core technologies that are specific to their markets.
For example, many companies in the financial services industries have adopted
industry-specific protocols for the interchange of information. In order to
successfully sell our software to companies in these markets, we may need to
expand or enhance our software to adapt to these industry-specific
technologies, which could be costly and require the diversion of engineering
resources.

We adopted a shareholder rights plan in October 2001, and previously
implemented certain provisions in our certificate of incorporation and bylaws,
that may have anti-takeover effects.

Our Board of Directors adopted a shareholder rights plan and declared a
dividend distribution of one right for each outstanding share of webMethods
stock. Each right, when exercisable, entitles the registered holder to purchase
certain securities at a specified purchase price, subject to adjustment. The
rights plan may have the anti-takeover effect of causing substantial dilution
to a person or group that attempts to acquire webMethods on terms not approved
by our Board of Directors. The existence of the rights plan could limit the
price that certain investors might be willing to pay in the future for shares
of webMethods stock and could discourage, delay or prevent a merger or
acquisition of webMethods, Inc. that stockholders may consider favorable. In
addition, provisions of the current certificate of incorporation and bylaws of
webMethods, Inc., as well as Delaware corporate law, could make it more
difficult for a third-party to acquire us without the support of our Board of
Directors, even if doing so would be beneficial to our stockholders.

22



---



##### 



ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to a variety of risks, including changes in interest rates
affecting the return on our investments and foreign currency fluctuations. We
have established policies and procedures to manage our exposure to fluctuations
in interest rates and foreign currency exchange rates.

Interest rate risk.We maintain our funds in money market accounts,
corporate bonds, commercial paper, Treasury notes, and agency notes. Our
exposure to market risk due to fluctuations in interest rates relates primarily
to our interest earnings on our cash deposits. These securities are subject to
interest rate risk inasmuch as their fair value will fall if market interest
rates increase. If market interest rates were to increase immediately and
uniformly by 10% from the levels prevailing as of September 30, 2003, the fair
value of the portfolio would not decline by a material amount. We do not use
derivative financial instruments to mitigate risks. However, we do have an
investment policy that would allow us to invest in short-term and long-term
investments such as money market instruments and corporate debt securities. Our
policy attempts to reduce such risks by typically limiting the maturity date of
such securities to no more than twenty-four months with a maximum average
maturity to our whole portfolio of such investments at twelve months, placing
our investments with high credit quality issuers and limiting the amount of
credit exposure with any one issuer.

Foreign currency exchange rate risk.Our exposure to market risk due to
fluctuations in foreign currency exchange rates relates primarily to the
intercompany balances with our subsidiaries located in Australia, England,
France, Germany, Japan, the Netherlands, Korea, Hong Kong and Singapore.
Transaction gains or losses have not been significant in the past, and there is
no hedging activity on foreign currencies. We would not experience a material
foreign exchange loss based on a hypothetical 10% adverse change in the price
of the euro, Great Britain pound, Singapore dollar, Australian dollar, or yen
against the U.S. dollar. Consequently, we do not expect that a reduction in the
value of such accounts denominated in foreign currencies resulting from even a
sudden or significant fluctuation in foreign exchange rates would have a direct
material impact on our financial position, results of operations or cash flows.

Notwithstanding the foregoing, the direct effects of interest rate and
foreign currency exchange rate fluctuations on the value of certain of our
investments and accounts, and the indirect effects of fluctuations in foreign
currency could have a material adverse effect on our business, financial
condition and results of operations. For example, international demand for our
products is affected by foreign currency exchange rates. In addition, interest
rate fluctuations may affect the buying patterns of our customers. Furthermore,
interest rate and currency exchange rate fluctuations have broad influence on
the general condition of the U.S. foreign and global economics, which could
materially adversely affect our business, financial condition results of
operations and cash flows.

ITEM 4. CONTROLS AND PROCEDURES

As of September 30, 2003, webMethods management, including our Chief
Executive Officer and Chief Financial Officer, have conducted an evaluation of
the effectiveness of disclosure controls and procedures pursuant to Exchange
Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that our disclosure controls and
procedures are effective to ensure that information we are required to disclose
in reports that we file or submit under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms. There
have been no significant changes in internal controls, or in factors that could
significantly affect internal controls, during the quarter ended
September 30, 2003 that has materially affected, or is reasonably
likely to materially affect, WebMethods internal control over
financial reporting.

23



---



##### 



PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On November 30, 2001, a purported class action lawsuit was filed in the
Southern District of New York naming webMethods, several of its executive
officers at the time of our initial public offering and the managing
underwriters of our initial public offering as defendants. The amended
complaint alleges, among other things, that webMethods initial public offering
registration statement and final prospectus contained material
misrepresentations and omissions related in part to certain commissions
allegedly solicited and received by the underwriters, and tie-in arrangements
allegedly demanded by the underwriters, in connection with their allocation of
shares in our initial public offering, and that those commissions and
arrangements were not disclosed to the public after webMethods initial public
offering. The amended complaint also alleges that false analysts reports were
issued. The amended complaint seeks unspecified damages on behalf of a
purported class of purchasers of webMethods common stock between February 10,
2000 and December 6, 2000. This case has been consolidated as part of In Re
Initial Public Offering Securities Litigation (SDNY). We have considered and
agreed to enter into a proposed settlement offer with representatives of the
plaintiffs in the consolidated proceeding, and believe that any liability on
behalf of webMethods that may accrue under that settlement offer would be
covered by our insurance policies. Until that settlement is fully effective, we
intend to defend against the amended complaint vigorously.

From time to time, the Company is involved in other disputes and
litigation in the normal course of business.

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



| | (a) |  | The 2003 Annual Meeting of Stockholders of the Company was held
on August 26, 2003.
| | --- |  | -----------------------------------------------------------------------------------
|
| | (b) |  | Election of Directors:                                                             



| | (i) |  | The following nominees were elected to hold office as
Class I directors of the Company until 2006:
| | --- |  | --------------------------------------------------------------------------------------------------



| | R. James Green
William A. Halter
Robert Vasan
| | ---------------------------------------------



| | (ii) |  | Incumbent Class II directors whose term expires in 2004 are as follows:
| | ---- |  | -----------------------------------------------------------------------



| | James P. Gauer
Jack L. Lewis
Gene Riechers
| | ------------------------------------------



| | (iii) |  | Incumbent Class III directors whose term expires in 2005 are as follows:
| | ----- |  | ------------------------------------------------------------------------



| | Gary J. Fernandes
Jerry J. Jasinowski
Phillip Merrick
| | -----------------------------------------------------



| | (c) |  | The following additional matter was voted upon at the 2003
Annual Meeting of Stockholders of the Company:                                                   
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | The ratification of the appointment of PricewaterhouseCoopers LLP as
the Companys independent public accountants for the fiscal year ending
March 31, 2004:

|               |  |  |            | 
|-------------- |  |  | ---------- | 
|Votes For:     |  |  | 46,598,901 | 
|Votes Against: |  |  | 1,219,398  | 
|Abstentions:   |  |  | 91,078     | 

24



---



##### 



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a)  Exhibits.

|        |  |                                                                                                                                       
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                       
|Number  |  | Description                                                                                                                           
|        |  |                                                                                                                                       
|2.1(1)  |  | Agreement and Plan of Merger dated as of May 20, 2000, by
and among webMethods, Inc., Wolf Acquisition, Inc. and
Active Software, Inc.
|        |  |                                                                                                                                       
|3.1(2)  |  | Fifth Amended and Restated Certificate of Incorporation
of webMethods, Inc., as amended                                               
|        |  |                                                                                                                                       
|3.2(3)  |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                       
|        |  |                                                                                                                                       
|4.1(3)  |  | Specimen certificate for shares of webMethods Common Stock                                                                            
|        |  |                                                                                                                                       
|4.2(4)  |  | Rights Agreement dated as of October 18, 2001 between
webMethods, Inc. and American Stock Transfer & Trust
Company.                   
|        |  |                                                                                                                                       
|10.1(3) |  | Second Amended and Restated Investor Rights Agreement                                                                                 
|        |  |                                                                                                                                       
|10.2(5) |  | webMethods, Inc. Amended and Restated Stock Option Plan                                                                               
|        |  |                                                                                                                                       
|10.3(3) |  | Employee Stock Purchase Plan                                                                                                          
|        |  |                                                                                                                                       
|10.4(3) |  | Indemnification Agreement entered into between
webMethods, Inc. and each of its directors and executive
officers                      
|        |  |                                                                                                                                       
|31.1    |  | *Rule 13a-14(a) Certification of Chief Executive Officer                                                                              
|        |  |                                                                                                                                       
|31.2    |  | *Rule 13a-14(a) Certification of Chief Financial Officer                                                                              
|        |  |                                                                                                                                       
|32.1    |  | *#Section 1350 Certification of Chief Executive Officer                                                                               
|        |  |                                                                                                                                       
|32.2    |  | *#Section 1350 Certification of Chief Financial Officer                                                                               



|(1) |  | Incorporated by reference to webMethods Registration Statement on Form S-4, as amended (File No. 333-39572).              
|--- |  | ---------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Incorporated by reference to webMethods Annual Report on Form 10-K for the year ended March 31, 2001 (File No.
001-15681).
|   
|(3) |  | Incorporated by reference to webMethods Registration Statement on Form S-1, as amended (File No. 333-91309).              
|   
|(4) |  | Incorporated by reference to webMethods Registration Statement on Form 8-A (File No. 001-15681)                           
|   
|(5) |  | Incorporated by reference to webMethods Annual Report on Form 10-K for the year ended March 31, 2002 (File No.
001-15681).
|   
|*   |  | Filed herewith.                                                                                                            
|   
|#   |  | This item is furnished as an exhibit to this report but is not filed with the Securities and Exchange Commission.          

(b)  Reports on Form 8-K.The following reports on Form 8-K have been filed
by webMethods, Inc. since the beginning of its fiscal quarter on July 1, 2003:

|                 |  |          |  |                                       |  |  |  | 
|---------------- |  | -------- |  | ------------------------------------- |  |  |  | 
|Date of Report   |  | Item No. |  | Item Reported                         |  |  |  | 
|                 |  |          |  |                                       |  |  |  | 
|July 3, 2003     |  | 7,12     |  | Press release dated July 3, 2003.    
|July 21, 2003    |  | 7,12     |  | Press release dated July 21, 2003.   
|October 13, 2003 |  | 5,7      |  | Press release dated October 13, 2003.
|October 21, 2003 |  | 7,12     |  | Press release dated October 21, 2003.

25



---



##### 



SIGNATURES

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

|                        |  |                              
|----------------------- |  | -----------------------------
|                        |  | WEBMETHODS, INC              
|                        |  |                              
|Date: November 12, 2003 |  | By: /s/ PHILLIP MERRICK      
|                        |  |                              
|                        |  | Phillip Merrick              
|                        |  | Chairman of the Board and    
|                        |  | Chief Executive Officer      
|                        |  |                              
|Date: November 12, 2003 |  | By: /s/ MARY DRIDI           
|                        |  |                              
|                        |  | Mary Dridi                   
|                        |  | Chief Financial Officer      
|                        |  | (Principal Financial Officer)

26