##### 









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 
|          
|           |  | Quarterly Period Ended September 30, 2005                                                   
|          
|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
    Incorporation or Organization)                                  |  | (I.R.S. Employer
    Identification No.)
|                                                                                                   
|3877 Fairfax Ridge Road,
    South Tower, Fairfax, Virginia(Address of Principal Executive Offices) |  | 22030(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





þ o


þ o


o þ












---



##### 










WEBMETHODS, INC.


QUARTERLY REPORT ON FORM 10-Q


TABLE OF CONTENTS


|                                                                                                                                                                  |  |                                                                                           |  |   
|----------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | --
|Part I                                                                                                                                                            |  | Financial Information                                                                     |  |   
|Item 1                                                                                                                                                            |  | Financial Statements                                                                      |  |   
|Condensed Consolidated Financial
    Statements                                                                                                                   |  |                                                                                          
|Condensed Consolidated Balance Sheets (unaudited) as of
    September 30, 2005 and March 31, 2005                                                                 |  | 3                                                                                        
|Condensed Consolidated Statements of
    Operations and Comprehensive Income or Loss
    (unaudited)  Three and six months ended
    September 30, 2005 and 2004 |  | 4                                                                                        
|Condensed Consolidated Statements of Cash
    Flows (unaudited)  Six months ended
    September 30, 2005 and 2004                                                |  | 5                                                                                        
|Notes to Condensed Consolidated Financial
    Statements (unaudited)                                                                                              |  | 6                                                                                        
|Item 2                                                                                                                                                            |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations |  | 9 
|Item 3                                                                                                                                                            |  | Quantitative and Qualitative Disclosures
    About Market Risk                            |  | 30
|Item 4                                                                                                                                                            |  | Controls and Procedures                                                                   |  | 31
|Part II                                                                                                                                                           |  | Other Information                                                                         |  |   
|Item 1                                                                                                                                                            |  | Legal Proceedings                                                                         |  | 32
|Item 4                                                                                                                                                            |  | Submission of Matters to a Vote of Security
    Holders                                   |  | 32
|Item 6                                                                                                                                                            |  | Exhibits                                                                                  |  | 33



2



---



##### 






PART I


FINANCIAL INFORMATION





ITEM 1:     FINANCIAL
STATEMENTS


WEBMETHODS, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS


(UNAUDITED)


|                                         |                                                                                                                               |                                            |        |          |           |  |        |          |         | 
|---------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | --------- |  | ------ | -------- | ------- | 
|                                         |                                                                                                                               | September 30,                              |        |          | March 31, | 
|                                         |                                                                                                                               | 2005                                       |        |          | 2005      | 
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | (In thousands)                             |       
|ASSETS                                  
|Current assets:                          |                                                                                                                               |                                            |        |          |           |  |        |         
|                                         | Cash and cash equivalents                                                                                                     |                                            | $      | 89,130   |           |  | $      | 57,209   |        
|                                         | Marketable securities available for sale                                                                                      |                                            |        | 58,891   |           |  |        | 78,332   |        
|                                         | Accounts receivable, net of allowance of $887 and $1,862                                                                      |                                            |        | 41,213   |           |  |        | 47,326   |        
|                                         | Prepaid expenses and other current assets                                                                                     |                                            |        | 6,219    |           |  |        | 6,401    |        
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | Total current assets                       |        |          | 195,453   |  |        |          | 189,268 | 
|Marketable securities available for sale |                                                                                                                               |                                            |       |          |           |  | 14,513 |         
|Property and equipment, net              |                                                                                                                               |                                            | 10,762 |          |           |  | 10,342 |         
|Goodwill                                 |                                                                                                                               |                                            | 46,704 |          |           |  | 46,704 |         
|Intangibles assets, net                  |                                                                                                                               |                                            | 7,192  |          |           |  | 8,390  |         
|Other assets                             |                                                                                                                               |                                            | 4,686  |          |           |  | 6,127  |         
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | Total assets                               |        | $        | 264,797   |  |        | $        | 275,344 | 
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                        
|LIABILITIES AND STOCKHOLDERS EQUITY    
|Current liabilities:                     |                                                                                                                               |                                            |        |          |           |  |        |         
|                                         | Accounts payable                                                                                                              |                                            | $      | 7,835    |           |  | $      | 8,673    |        
|                                         | Accrued expenses                                                                                                              |                                            |        | 12,431   |           |  |        | 16,506   |        
|                                         | Accrued salaries and commissions                                                                                              |                                            |        | 9,381    |           |  |        | 12,219   |        
|                                         | Deferred revenue                                                                                                              |                                            |        | 39,847   |           |  |        | 43,055   |        
|                                         | Current portion of capital lease obligations                                                                                  |                                            |        | 406      |           |  |        | 475      |        
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | Total current liabilities                  |        |          | 69,900    |  |        |          | 80,928  | 
|                                         | Capital lease obligations, net of current portion                                                                             |                                            |        | 113      |           |  |        | 139      |        
|                                         | Other long-term liabilities                                                                                                   |                                            |        | 3,133    |           |  |        | 3,374    |        
|                                         | Long-term deferred revenue                                                                                                    |                                            |        | 4,714    |           |  |        | 6,371    |        
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | Total liabilities                          |        |          | 77,860    |  |        |          | 90,812  | 
|                                         |                                                                                                                               |                                            |        |          |           | 
|Commitments and contingencies            |                                                                                                                               |                                            |        |          |           |  |        |         
|Stockholders equity:                    |                                                                                                                               |                                            |        |          |           |  |        |         
|                                         | Common stock, $0.01 par value; 500,000,000 shares
    authorized; 53,653,038 and 53,346,623 shares issued and
    outstanding |                                            |        | 537      |           |  |        | 533      |        
|                                         | Additional paid-in capital                                                                                                    |                                            |        | 526,442  |           |  |        | 524,487  |        
|                                         | Deferred warrant charge                                                                                                       |                                            |        | (1,649   | )         |  |        | (2,480   | )      
|                                         | Accumulated deficit                                                                                                           |                                            |        | (338,180 | )         |  |        | (340,224 | )      
|                                         | Accumulated other comprehensive gain (loss)                                                                                   |                                            |        | (213     | )         |  |        | 2,216    |        
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | Total stockholders equity                 |        |          | 186,937   |  |        |          | 184,532 | 
|                                         |                                                                                                                               |                                            |        |          |           | 
|                                         |                                                                                                                               | Total liabilities and stockholders equity |        | $        | 264,797   |  |        | $        | 275,344 | 
|                                         |                                                                                                                               |                                            |        |          |           | 



3



---



##### 



WEBMETHODS, INC.





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND


COMPREHENSIVE INCOME OR LOSS


(UNAUDITED)


|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |            |        |  
|------------------------------------------------------------ | -------------------------------------------------- | ------------------------------------------------------- | ------ | ---------- | ---------------- | - | ------ | ---------- | ------ | - | ------ | ---------- | ------ | - | ------- | ---------- | ------ | -
|                                                             |                                                    | Three Months Ended                                      |        |            | Six Months Ended |  
|                                                             |                                                    | September 30,                                           |        |            | September 30,    |  
|                                                             |                                                    |                                                         |        |            |                  |  
|                                                             |                                                    | 2005                                                    |        |            | 2004             |   |        | 2005       |        |   | 2004   |           
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|                                                             |                                                    | (In thousands, except share and per share data)         |       
|Revenue:                                                     |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |           
|                                                             | License                                            |                                                         | $      | 19,390     |                  |   | $      | 23,851     |        |   | $      | 37,857     |        |   | $       | 38,657     |       
|                                                             | Professional services                              |                                                         |        | 11,326     |                  |   |        | 12,077     |        |   |        | 23,009     |        |   |         | 24,601     |       
|                                                             | Maintenance                                        |                                                         |        | 18,452     |                  |   |        | 14,838     |        |   |        | 36,037     |        |   |         | 29,445     |       
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|                                                             |                                                    | Total revenue                                           |        |            | 49,168           |   |        |            | 50,766 |   |        |            | 96,903 |   |         |            | 92,703 |  
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Cost of revenue:                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |           
|                                                             | Amortization of intangibles                        |                                                         |        | 599        |                  |   |        | 599        |        |   |        | 1,198      |        |   |         | 1,198      |       
|                                                             | License                                            |                                                         |        | 271        |                  |   |        | 245        |        |   |        | 485        |        |   |         | 865        |       
|                                                             | Professional services and maintenance              |                                                         |        | 13,481     |                  |   |        | 14,280     |        |   |        | 27,035     |        |   |         | 28,553     |       
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|                                                             |                                                    | Total cost of revenue                                   |        |            | 14,351           |   |        |            | 15,124 |   |        |            | 28,718 |   |         |            | 30,616 |  
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Gross profit                                                 |                                                    |                                                         | 34,817 |            |                  |   | 35,642 |            |        |   | 68,185 |            |        |   | 62,087  |           
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Operating expenses:                                          |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |           
|                                                             | Sales and marketing                                |                                                         |        | 17,051     |                  |   |        | 20,587     |        |   |        | 34,326     |        |   |         | 42,362     |       
|                                                             | Research and development                           |                                                         |        | 10,126     |                  |   |        | 10,820     |        |   |        | 21,244     |        |   |         | 21,870     |       
|                                                             | General and administrative                         |                                                         |        | 5,401      |                  |   |        | 4,868      |        |   |        | 11,615     |        |   |         | 9,941      |       
|                                                             | Restructuring costs                                |                                                         |        | 431        |                  |   |        | 2,756      |        |   |        | 719        |        |   |         | 2,756      |       
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|                                                             |                                                    | Total operating expenses                                |        |            | 33,009           |   |        |            | 39,031 |   |        |            | 67,904 |   |         |            | 76,929 |  
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Operating income (loss)                                      |                                                    |                                                         | 1,808  |            |                  |   | (3,389 | )          |        |   | 281    |            |        |   | (14,842 | )         
|Other income (expense)                                       |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |           
|                                                             | Interest income                                    |                                                         |        | 1,019      |                  |   |        | 532        |        |   |        | 1,979      |        |   |         | 1,085      |       
|                                                             | Interest expense                                   |                                                         |        | (46        | )                |   |        | (29        | )      |   |        | (63        | )      |   |         | (56        | )     
|                                                             | Other income (expense)                             |                                                         |        | 20         |                  |   |        | (116       | )      |   |        | 232        |        |   |         | (4         | )     
|                                                             | Impairment of equity investment in private company |                                                         |        |           |                  |   |        | (1,057     | )      |   |        |           |        |   |         | (1,057     | )     
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Income (loss) before income taxes                            |                                                    |                                                         | 2,801  |            |                  |   | (4,059 | )          |        |   | 2,429  |            |        |   | (14,874 | )         
|                                                             |                                                    | Provision for income taxes                              |        |            | 243              |   |        |            | 65     |   |        |            | 385    |   |         |            | 69     |  
|Net income (loss)                                            |                                                    | $                                                       | 2,558  |            |                  | $ | (4,124 | )          |        | $ | 2,044  |            |        | $ | (14,943 | )         
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Basic and diluted net income (loss) per common share         |                                                    | $                                                       | 0.05   |            |                  | $ | (0.08  | )          |        | $ | 0.04   |            |        | $ | (0.28   | )         
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Weighted average shares used in computing per share amounts: |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |           
|                                                             | Basic                                              |                                                         |        | 53,609,637 |                  |   |        | 53,088,527 |        |   |        | 53,492,483 |        |   |         | 52,958,538 |       
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|                                                             | Diluted                                            |                                                         |        | 54,304,756 |                  |   |        | 53,088,527 |        |   |        | 53,854,784 |        |   |         | 52,958,538 |       
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Comprehensive income (loss):                                 |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |           
|                                                             | Net income (loss)                                  |                                                         | $      | 2,558      |                  |   | $      | (4,124     | )      |   | $      | 2,044      |        |   | $       | (14,943    | )     
|                                                             | Other comprehensive income (loss):                 |                                                         |        |            |                  |   |        |            |        |   |        |            |        |   |         |            |       
|                                                             |                                                    | Unrealized (loss) gain on securities available for sale |        |            | (2               | ) |        |            | 111    |   |        |            | 137    |   |         |            | (318   | )
|                                                             |                                                    | Foreign currency cumulative translation adjustment      |        |            | (455             | ) |        |            | 354    |   |        |            | (2,565 | ) |         |            | (276   | )
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           
|Total comprehensive income (loss)                            |                                                    | $                                                       | 2,101  |            |                  | $ | (3,659 | )          |        | $ | (384   | )          |        | $ | (15,537 | )         
|                                                             |                                                    |                                                         |        |            |                  |   |        |            |        |   |        |           



4



---



##### 



WEBMETHODS, INC.





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)


|                                                                                  |                                                                                                                   |                  |        |        |      |   |         |         |  
|--------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------- | ---------------- | ------ | ------ | ---- | - | ------- | ------- | -
|                                                                                  |                                                                                                                   | Six Months Ended |       
|                                                                                  |                                                                                                                   | September 30,    |       
|                                                                                  |                                                                                                                   |                  |       
|                                                                                  |                                                                                                                   | 2005             |        |        | 2004 |  
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|                                                                                  |                                                                                                                   | (In thousands)   |       
|Cash flows from operating activities:                                             |                                                                                                                   |                  |        |        |      |   |         |        
|                                                                                  | Net income (loss)                                                                                                 |                  | $      | 2,044  |      |   | $       | (14,943 | )
|                                                                                  | Adjustments to reconcile net income (loss) to net cash provided
    by (used in) operating activities:            |                  |        |        |      |   |         |         |  
|                                                                                  | Depreciation and amortization                                                                                     |                  |        | 2,776  |      |   |         | 3,243   |  
|                                                                                  | (Recovery of) provision for doubtful accounts                                                                     |                  |        | (376   | )    |   |         | 241     |  
|                                                                                  | Amortization of deferred stock compensation related to employee
    stock options and non-employee stock warrants |                  |        | 1,352  |      |   |         | 1,322   |  
|                                                                                  | Amortization of acquired intangibles                                                                              |                  |        | 1,198  |      |   |         | 1,198   |  
|                                                                                  | Amortization of deferred rent                                                                                     |                  |        | (229   | )    |   |         |        |  
|                                                                                  | Impairment of equity investment in private company                                                                |                  |        |       |      |   |         | 1,057   |  
|Increase (decrease) in cash resulting from changes in assets and
    liabilities: |                                                                                                                   |                  |        |        |      |   |         |        
|                                                                                  | Accounts receivable                                                                                               |                  |        | 5,514  |      |   |         | 952     |  
|                                                                                  | Prepaid expenses and other current assets                                                                         |                  |        | 85     |      |   |         | (1,598  | )
|                                                                                  | Other assets                                                                                                      |                  |        | 1,315  |      |   |         | 980     |  
|                                                                                  | Accounts payable                                                                                                  |                  |        | (523   | )    |   |         | (1,866  | )
|                                                                                  | Accrued expenses and other liabilities                                                                            |                  |        | (3,875 | )    |   |         | (1,851  | )
|                                                                                  | Accrued salaries and commissions                                                                                  |                  |        | (2,613 | )    |   |         | 149     |  
|                                                                                  | Deferred revenue                                                                                                  |                  |        | (3,725 | )    |   |         | 911     |  
|                                                                                  | Other liabilities                                                                                                 |                  |        | (73    | )    |   |         |        |  
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Net cash provided by (used in) operating activities                               |                                                                                                                   |                  | 2,870  |        |      |   | (10,205 | )      
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Cash flows from investing activities:                                             |                                                                                                                   |                  |        |        |      |   |         |        
|                                                                                  | Purchases of property and equipment                                                                               |                  |        | (3,039 | )    |   |         | (2,660  | )
|                                                                                  | Net maturities of marketable securities available for sale                                                        |                  |        | 34,091 |      |   |         | 874     |  
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|                                                                                  | Net cash provided by (used in) investing activities                                                               |                  |        | 31,052 |      |   |         | (1,786  | )
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Cash flows from financing activities:                                             |                                                                                                                   |                  |        |        |      |   |         |        
|                                                                                  | Short-term borrowings                                                                                             |                  |        |       |      |   |         | 3,533   |  
|                                                                                  | Payments on short-term borrowings                                                                                 |                  |        |       |      |   |         | (4,284  | )
|                                                                                  | Payments on capital leases                                                                                        |                  |        | (336   | )    |   |         | (547    | )
|                                                                                  | Proceeds from exercise of stock options and stock issued under
    the ESPP                                       |                  |        | 1,438  |      |   |         | 1,882   |  
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Net cash provided by financing activities                                         |                                                                                                                   |                  | 1,102  |        |      |   | 584     |        
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Effect of exchange rate on cash and cash equivalents                              |                                                                                                                   |                  | (3,103 | )      |      |   | (473    | )      
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Net increase (decrease) in cash and cash equivalents                              |                                                                                                                   |                  | 31,921 |        |      |   | (11,880 | )      
|Cash and cash equivalents at beginning of period                                  |                                                                                                                   |                  | 57,209 |        |      |   | 75,462  |        
|                                                                                  |                                                                                                                   |                  |        |        |      |  
|Cash and cash equivalents at end of period                                        |                                                                                                                   | $                | 89,130 |        |      | $ | 63,582  |        
|                                                                                  |                                                                                                                   |                  |        |        |      |  



5



---



##### 



WEBMETHODS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)


1.     BASIS OF PRESENTATION






|   |                                   
|-- | ----------------------------------
|2. | PRO FORMA STOCK-BASED COMPENSATION





|                                                                                      |  |                                       |        |   |                  |   |         |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ---------------- | - | ------- | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                      |  | Three Months Ended                    |        |   | Six Months Ended |  
|                                                                                      |  | September 30,                         |        |   | September 30,    |  
|                                                                                      |  |                                       |        |   |                  |  
|                                                                                      |  | 2005                                  |        |   | 2004             |   |         | 2005 |  |   | 2004   |  
|                                                                                      |  |                                       |        |   |                  |   |         |      |  |   |        |  
|                                                                                      |  | (In thousands, except per share data) |       
|Net income (loss) attributable to common stockholders,
    as reported                |  | $                                     | 2,558  |   |                  | $ | (4,124  | )    |  | $ | 2,044  |   |  | $ | (14,943 | )
|Add: Stock-based compensation expense determined under the
    intrinsic value method |  |                                       | 30     |   |                  |   |        |      |  |   | 30     |   |  |   |        |  
|Less: Stock-based compensation expense determined under fair
    value method         |  |                                       | (4,759 | ) |                  |   | (9,173  | )    |  |   | (8,787 | ) |  |   | (19,615 | )
|                                                                                      |  |                                       |        |   |                  |   |         |      |  |   |        |  
|Net loss attributable to common stockholders, pro forma                               |  | $                                     | (2,171 | ) |                  | $ | (13,297 | )    |  | $ | (6,713 | ) |  | $ | (34,558 | )
|                                                                                      |  |                                       |        |   |                  |   |         |      |  |   |        |  
|Basic and diluted net income (loss) per common share,
    as reported                 |  | $                                     | 0.05   |   |                  | $ | (0.08   | )    |  | $ | 0.04   |   |  | $ | (0.28   | )
|Basic and diluted net loss per common share, pro forma                                |  | $                                     | (0.04  | ) |                  | $ | (0.25   | )    |  | $ | (0.13  | ) |  | $ | (0.65   | )



|   |                                            
|-- | -------------------------------------------
|3. | COMPUTATION OF NET INCOME OR LOSS PER SHARE



6



---



##### 



WEBMETHODS, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                                                                  
|-- | -----------------------------------------------------------------
|4. | SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
    (UNAUDITED)

|                                             |                                                                  |                |    |     |      |   |    |      |  
|-------------------------------------------- | ---------------------------------------------------------------- | -------------- | -- | --- | ---- | - | -- | ---- | -
|                                             |                                                                  | Six Months     |   
|                                             |                                                                  | Ended          |   
|                                             |                                                                  | September 30,  |   
|                                             |                                                                  |                |   
|                                             |                                                                  | 2005           |    |     | 2004 |  
|                                             |                                                                  |                |    |     |      |  
|                                             |                                                                  | (In thousands) |   
|Cash paid during the period for interest     |                                                                  | $              | 63 |     |      | $ | 67 |     
|                                             |                                                                  |                |    |     |      |  
|Non-cash investing and financing activities: |                                                                  |                |    |     |      |   |    |     
|                                             | Equipment purchased under capital lease                          |                | $  | 270 |      |   | $  |     |  
|                                             |                                                                  |                |    |     |      |  
|                                             | Change in net unrealized gain or (loss) on marketable securities |                | $  | 137 |      |   | $  | (318 | )
|                                             |                                                                  |                |    |     |      |  



|   |                    
|-- | -------------------
|5. | SEGMENT INFORMATION



|             |  |                    |        |  |                  |   |        |      |  |   |        |  |  |   |        | 
|------------ |  | ------------------ | ------ |  | ---------------- | - | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|             |  | Three Months Ended |        |  | Six Months Ended |  
|             |  | September 30,      |        |  | September 30,    |  
|             |  |                    |        |  |                  |  
|Revenue      |  | 2005               |        |  | 2004             |   |        | 2005 |  |   | 2004   | 
|             |  |                    |        |  |                  |   |        |      |  |   |        | 
|             |  | (In thousands)     |       
|Americas     |  | $                  | 30,862 |  |                  | $ | 32,540 |      |  | $ | 61,030 |  |  | $ | 58,090 | 
|EMEA         |  |                    | 12,110 |  |                  |   | 10,513 |      |  |   | 22,919 |  |  |   | 18,286 | 
|Japan        |  |                    | 2,745  |  |                  |   | 4,869  |      |  |   | 5,316  |  |  |   | 9,665  | 
|Asia Pacific |  |                    | 3,451  |  |                  |   | 2,844  |      |  |   | 7,638  |  |  |   | 6,662  | 
|             |  |                    |        |  |                  |   |        |      |  |   |        | 
|Total        |  | $                  | 49,168 |  |                  | $ | 50,766 |      |  | $ | 96,903 |  |  | $ | 92,703 | 
|             |  |                    |        |  |                  |   |        |      |  |   |        | 

|                  |  |                |        |  |           |   |        | 
|----------------- |  | -------------- | ------ |  | --------- | - | ------ | 
|                  |  | As of          |        |  | As of     |  
|                  |  | September 30,  |        |  | March 31, |  
|Long Lived Assets |  | 2005           |        |  | 2005      |  
|                  |  |                |        |  |           |  
|                  |  | (In thousands) |       
|Americas          |  | $              | 65,778 |  |           | $ | 67,572 | 
|EMEA              |  |                | 1,558  |  |           |   | 1,852  | 
|Japan             |  |                | 1,295  |  |           |   | 1,509  | 
|Asia Pacific      |  |                | 713    |  |           |   | 630    | 
|                  |  |                |        |  |           |  
|Total             |  | $              | 69,344 |  |           | $ | 71,563 | 
|                  |  |                |        |  |           |  



|   |                                  
|-- | ---------------------------------
|6. | RESTRUCTURING AND RELATED CHARGES





7



---



##### 



WEBMETHODS, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)












|                                                    |  |                 |     |   |              |   |       |             |           |   |          |   |  |       |      |   |  |   |       |  
|--------------------------------------------------- |  | --------------- | --- | - | ------------ | - | ----- | ----------- | --------- | - | -------- | - |  | ----- | ---- | - |  | - | ----- | -
|                                                    |  | Excess          |     |   |              |   |       |             | Severance |   |          |  
|                                                    |  | Facilities      |     |   | Excess       |   |       | Excess      |           |   | And      |   |  |      
|                                                    |  | Santa Clara, CA |     |   | Facilities   |   |       | Facilities  |           |   | Related  |   |  |      
|                                                    |  | and Fairfax, VA |     |   | Berkeley, CA |   |       | Fairfax, VA |           |   | Benefits |   |  | Total |     
|                                                    |  |                 |     |   |              |   |       |             |           |   |          |   |  |       |     
|Balance at March 31, 2005                           |  | $               | 534 |   |              | $ | 1,007 |             |           | $ | 2,900    |   |  | $     |     |   |  | $ | 4,441 |  
|                                                    |  |                 |     |   |              |   |       |             |           |   |          |   |  |       |     
|First quarter fiscal 2006 charges                   |  |                 |    |   |              |   |      |             |           |   |         |   |  |       | 288  |   |  |   | 288   |  
|Cash payments made in first quarter of fiscal 2006  |  |                 | (43 | ) |              |   | (91   | )           |           |   | (124     | ) |  |       | (246 | ) |  |   | (504  | )
|Second quarter fiscal 2006 charges                  |  |                 |    |   |              |   |      |             |           |   |         |   |  |       | 431  |   |  |   | 431   |  
|Cash payments made in second quarter of fiscal 2006 |  |                 | (43 | ) |              |   | (82   | )           |           |   | (546     | ) |  |       | (264 | ) |  |   | (935  | )
|                                                    |  |                 |     |   |              |   |       |             |           |   |          |   |  |       |     
|Balance at September 30, 2005                       |  | $               | 448 |   |              | $ | 834   |             |           | $ | 2,230    |   |  | $     | 209  |   |  | $ | 3,721 |  
|                                                    |  |                 |     |   |              |   |       |             |           |   |          |   |  |       |     

7.     BORROWINGS








8



---



##### 








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



OVERVIEW


Background


tm




9



---



##### 







| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | eliminating significant costs from the organizations
    information technology environment,                              
|
| |  | automating and streamlining interactions with their customers
    and suppliers,                                           
|
| |  | becoming more competitive by capturing more market share in
    terms of increased revenue from new and existing customers,
|
| |  | gaining more timely access to information to make better
    decisions about the business, and                             
|
| |  | allowing staff to focus their attention on higher value business
    activities.                                           









Critical Accounting Policies and Estimates




10



---



##### 









| |                    
| | -------------------
| | Revenue Recognition







| |                                
| | -------------------------------
| | Allowance for Doubtful Accounts





| |                      
| | ---------------------
| | Business Combinations





11



---



##### 









| |                               
| | ------------------------------
| | Goodwill and Intangible Assets





| |                                             
| | --------------------------------------------
| | Acquired In-process Research and Development





| |                         
| | ------------------------
| | Foreign Currency Effects





| |                            
| | ---------------------------
| | Accounting for Income Taxes



12



---



##### 





| |                                  
| | ---------------------------------
| | Restructuring and Related Charges





| |                             
| | ----------------------------
| | Litigation and Contingencies



RESULTS OF OPERATIONS




|                         |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |   |        |   |         |    |  |  |     |   
|------------------------ |  | -------------------------------- | ------ | ---------- | ------------------------------ | - | ------ | ------ | ---------- |  | ---- | -- |  | ---- | ------ | - | ------ | - | ------- | -- |  |  | --- | --
|                         |  | Three Months Ended September 30, |        |            | Six Months Ended September 30, |  
|                         |  |                                  |        |            |                                |  
|                         |  |                                  |        | Percentage |                                |   |        |        | Percentage | 
|                         |  | 2005                             |        |            | 2004                           |   |        | Change |            |  | 2005 |    |  | 2004 |        |   | Change |  
|                         |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |   |        |  
|                         |  | ($ in thousands)                 |       
|Total revenue            |  | $                                | 49,168 |            |                                | $ | 50,766 |        |            |  | (3   | )% |  | $    | 96,903 |   |        | $ | 92,703  |    |  |  | 5   | % 
|Gross profit             |  |                                  | 34,817 |            |                                |   | 35,642 |        |            |  | (2   | )% |  |      | 68,185 |   |        |   | 62,087  |    |  |  | 10  | % 
|% of total revenue       |  |                                  | 71     | %          |                                |   | 70     | %      |            |  |      |    |  |      | 70     | % |        |   | 67      | %  |  |  |     |   
|Total operating expenses |  |                                  | 33,009 |            |                                |   | 39,031 |        |            |  | (15  | )% |  |      | 67,904 |   |        |   | 76,929  |    |  |  | (12 | )%
|% of total revenue       |  |                                  | 67     | %          |                                |   | 77     | %      |            |  |      |    |  |      | 70     | % |        |   | 83      | %  |  |  |     |   
|Operating income (loss)  |  |                                  | 1,808  |            |                                |   | (3,389 | )      |            |  | *    |    |  |      | 281    |   |        |   | (14,842 | )  |  |  | *   |   
|% of total revenue       |  |                                  | 4      | %          |                                |   | (7     | )%     |            |  |      |    |  |      |       | % |        |   | (16     | )% |  |  |     |   
|Net income (loss)        |  | $                                | 2,558  |            |                                | $ | (4,124 | )      |            |  | *    |    |  | $    | 2,044  |   |        | $ | (14,943 | )  |  |  | *   |   
|% of total revenue       |  |                                  | 5      | %          |                                |   | (8     | )%     |            |  |      |    |  |      | 2      | % |        |   | (16     | )% |  |  |     |   






|  |                
|- | ---------------
|* | Not applicable.





13



---



##### 





Revenue




|                      |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |   |        |  |  |  |    |   
|--------------------- |  | -------------------------------- | ------ | ---------- | ------------------------------ | - | ------ | ------ | ---------- |  | ---- | -- |  | ---- | ------ |  | ------ | - | ------ |  |  |  | -- | --
|                      |  | Three Months Ended September 30, |        |            | Six Months Ended September 30, |  
|                      |  |                                  |        |            |                                |  
|                      |  |                                  |        | Percentage |                                |   |        |        | Percentage | 
|                      |  | 2005                             |        |            | 2004                           |   |        | Change |            |  | 2005 |    |  | 2004 |        |  | Change |  
|                      |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |  
|                      |  | ($ in thousands)                 |       
|License               |  | $                                | 19,390 |            |                                | $ | 23,851 |        |            |  | (19  | )% |  | $    | 37,857 |  |        | $ | 38,657 |  |  |  | (2 | )%
|Professional services |  |                                  | 11,326 |            |                                |   | 12,077 |        |            |  | (6   | )% |  |      | 23,009 |  |        |   | 24,601 |  |  |  | (6 | )%
|Maintenance           |  |                                  | 18,452 |            |                                |   | 14,838 |        |            |  | 24   | %  |  |      | 36,037 |  |        |   | 29,445 |  |  |  | 22 | % 
|                      |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |  
|Total revenue         |  | $                                | 49,168 |            |                                | $ | 50,766 |        |            |  | (3   | )% |  | $    | 96,903 |  |        | $ | 92,703 |  |  |  | 5  | % 
|                      |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |  



|              |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |   |        |  |  |  |     |   
|------------- |  | -------------------------------- | ------ | ---------- | ------------------------------ | - | ------ | ------ | ---------- |  | ---- | -- |  | ---- | ------ |  | ------ | - | ------ |  |  |  | --- | --
|              |  | Three Months Ended September 30, |        |            | Six Months Ended September 30, |  
|              |  |                                  |        |            |                                |  
|              |  |                                  |        | Percentage |                                |   |        |        | Percentage | 
|              |  | 2005                             |        |            | 2004                           |   |        | Change |            |  | 2005 |    |  | 2004 |        |  | Change |  
|              |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |  
|              |  | ($ in thousands)                 |       
|Americas      |  | $                                | 30,862 |            |                                | $ | 32,540 |        |            |  | (5   | )% |  | $    | 61,030 |  |        | $ | 58,090 |  |  |  | 5   | % 
|EMEA          |  |                                  | 12,110 |            |                                |   | 10,513 |        |            |  | 15   | %  |  |      | 22,919 |  |        |   | 18,286 |  |  |  | 25  | % 
|Japan         |  |                                  | 2,745  |            |                                |   | 4,869  |        |            |  | (44  | )% |  |      | 5,316  |  |        |   | 9,665  |  |  |  | (45 | )%
|Asia Pacific  |  |                                  | 3,451  |            |                                |   | 2,844  |        |            |  | 21   | %  |  |      | 7,638  |  |        |   | 6,662  |  |  |  | 15  | % 
|              |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |  
|Total revenue |  | $                                | 49,168 |            |                                | $ | 50,766 |        |            |  | (3   | )% |  | $    | 96,903 |  |        | $ | 92,703 |  |  |  | 5   | % 
|              |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |  |        |  





14



---



##### 









Gross Profit




|                                             |  |               |     |  |               |  |     |      |  |  |      |  |  |  |     | 
|-------------------------------------------- |  | ------------- | --- |  | ------------- |  | --- | ---- |  |  | ---- |  |  |  | --- | 
|                                             |  | Three Months  |     |  | Six Months    | 
|                                             |  | Ended         |     |  | Ended         | 
|                                             |  | September 30, |     |  | September 30, | 
|                                             |  |               |     |  |               | 
|                                             |  | 2005          |     |  | 2004          |  |     | 2005 |  |  | 2004 | 
|                                             |  |               |     |  |               |  |     |      |  |  |      | 
|License margin                               |  |               | 96% |  |               |  | 96% |      |  |  | 96%  |  |  |  | 95% | 
|Professional services and maintenance margin |  |               | 55% |  |               |  | 47% |      |  |  | 54%  |  |  |  | 47% | 
|Gross margin                                 |  |               | 71% |  |               |  | 70% |      |  |  | 70%  |  |  |  | 67% | 



15



---



##### 







Operating Expenses




|                           |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |   |        |   |        |   |  |  |     |   
|-------------------------- |  | -------------------------------- | ------ | ---------- | ------------------------------ | - | ------ | ------ | ---------- |  | ---- | -- |  | ---- | ------ | - | ------ | - | ------ | - |  |  | --- | --
|                           |  | Three Months Ended September 30, |        |            | Six Months Ended September 30, |  
|                           |  |                                  |        |            |                                |  
|                           |  |                                  |        | Percentage |                                |   |        |        | Percentage | 
|                           |  | 2005                             |        |            | 2004                           |   |        | Change |            |  | 2005 |    |  | 2004 |        |   | Change |  
|                           |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |   |        |  
|                           |  | ($ in thousands)                 |       
|Operating expenses:        |  |                                  |        |            |                                |   |        |        |            |  |      |    |  |      |        |   |        |   |        |   |  |  |     |   
|Sales and marketing        |  | $                                | 17,051 |            |                                | $ | 20,587 |        |            |  | (17  | )% |  | $    | 34,326 |   |        | $ | 42,362 |   |  |  | (19 | )%
|% of Total revenue         |  |                                  | 35     | %          |                                |   | 41     | %      |            |  |      |    |  |      | 35     | % |        |   | 46     | % |  |  |     |   
|Research and development   |  |                                  | 10,126 |            |                                |   | 10,820 |        |            |  | (6   | )% |  |      | 21,244 |   |        |   | 21,870 |   |  |  | (3  | )%
|% Total revenue            |  |                                  | 21     | %          |                                |   | 21     | %      |            |  |      |    |  |      | 22     | % |        |   | 24     | % |  |  |     |   
|General and administrative |  |                                  | 5,401  |            |                                |   | 4,868  |        |            |  | 11   | %  |  |      | 11,615 |   |        |   | 9,941  |   |  |  | 17  | % 
|% of Total revenue         |  |                                  | 11     | %          |                                |   | 10     | %      |            |  |      |    |  |      | 12     | % |        |   | 11     | % |  |  |     |   
|Restructuring charges      |  |                                  | 431    |            |                                |   | 2,756  |        |            |  | (84  | )% |  |      | 719    |   |        |   | 2,756  |   |  |  | (74 | )%
|% of Total revenue         |  |                                  | 1      | %          |                                |   | 5      | %      |            |  |      |    |  |      | 1      | % |        |   | 3      | % |  |  |     |   
|Total operating expenses   |  | $                                | 33,009 |            |                                | $ | 39,031 |        |            |  | (15  | )% |  | $    | 67,904 |   |        | $ | 76,929 |   |  |  | (12 | )%
|% of Total revenue         |  |                                  | 67     | %          |                                |   | 77     | %      |            |  |      |    |  |      | 70     | % |        |   | 83     | % |  |  |     |   







16



---



##### 









17



---



##### 





Interest Income




Interest Expense




Other Income (Expense), Net




Income Taxes








LIQUIDITY AND CAPITAL RESOURCES






18



---



##### 













RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS




19



---



##### 



FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS






| |                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our quarterly revenue  especially the amount of
    license revenue we recognize in a quarter  and
    operating results could fluctuate materially, which could
    significantly affect the market price of webMethods common
    stock.





| |   |                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | changes in demand for our software products and services;                                                                                                                                                                                                                                                             
|
| |  | the timing and terms of large transactions with customers;                                                                                                                                                                                                                                                            
|
| |  | the spending environment for business integration and
    optimization solutions;                                                                                                                                                                                                                                     
|
| |  | competitive pressures;                                                                                                                                                                                                                                                                                                
|
| |  | fluctuations in the revenue and license revenue of our
    geographic regions;                                                                                                                                                                                                                                        
|
| |  | our ability to execute on our business strategy and sales
    strategies within the timeframes we anticipate;                                                                                                                                                                                                         
|
| |  | the number of our quota bearing sales representatives, their
    experience with our solutions, software products and sales
    processes and their capability to utilize our solution-selling
    approach;                                                                                                          
|
| |  | the timing and amount of revenue from acquired technologies or
    businesses;                                                                                                                                                                                                                                        
|
| |  | the amount and timing of operating expenses and the success of
    attempts to increase expense efficiency and, for purposes of
    operating results determined in accordance with accounting
    principals generally accepted in the United States, the
    timing and amount of non-recurring or non-cash charges;
|
| |  | delays in the availability of new products or new releases of
    existing products;                                                                                                                                                                                                                                  
|
| |  | costs of legal compliance, including compliance with the
    Sarbanes-Oxley Act of 2002 and regulatory requirements and
    investigating allegations that may be made or resolving pending
    or threatened legal claims; and                                                                                       
|
| |  | changes that we may make in our business, operations and
    infrastructure.                                                                                                                                                                                                                                          



20



---



##### 





| |                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail accurately to forecast our future total
    revenue, license revenue or operating results, we may not
    satisfy the expectations of investors or securities
    analysts.







| |                                                                                                                                                                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The market price of webMethods common stock
    fluctuates as a result of factors other than our quarterly total
    revenue, license revenue and operating results, including
    actions taken by or performance of our competitors, estimates
    and recommendations of securities analysts, industry volatility
    and changes to accounting rules.





| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the overall volatility of the stock market, particularly the
    stock prices of software and technology companies;                                   
|
| |  | fluctuation in the levels of total revenue, license revenue and
    operating results of competitors;                                                 
|
| |  | changes in securities analysts estimates, recommendations
    or expectations with respect to webMethods business,
    common stock or our industry;
|
| |  | rapid developments, consolidation and technology changes within
    our industry; and                                                                 
|
| |  | changes to accounting rules.                                                                                                                          

21



---



##### 







| |                                                                            
| | ---------------------------------------------------------------------------
| | Our markets are highly competitive, and we may not compete
    effectively.







| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | Economic conditions could adversely affect our revenue
    growth and cause us not to achieve our forecasts of license
    revenue and total revenue.



22



---



##### 







| |                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on strategic alliances with major system
    integrators and other similar relationships to promote and
    implement our software.





| |                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Before the current fiscal year, we had a history of
    operating losses, and our failure to achieve and sustain
    profitability could impact our prospect of achieving our growth
    targets and have a material adverse effect on the market price
    of webMethods common stock.





| |                                                                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Sarbanes-Oxley Act of 2002 requires that we undertake
    periodic evaluations of our internal control over financial
    reporting, which may identify material weaknesses that could
    harm our reputation and impact the market price of
    webMethods common stock.



23



---



##### 







| |                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our disclosure controls and procedures and our internal
    control over financial reporting may not be effective to detect
    all errors or to detect and deter wrongdoing, fraud or improper
    activities in all instances.





| |                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to attract and retain key executive officers
    and other key personnel who are essential to our business, our
    ability to execute effectively on our business strategy or our
    results of operations or financial condition may be adversely
    affected.





| |                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------
| | Third-party claims that we infringe upon their
    intellectual property rights may be costly to defend and could
    damage our business.



24



---



##### 









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





25



---



##### 





| |                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our business strategy contemplates possible future
    acquisitions of companies or technologies that may result in
    disruptions to our business, integration difficulties, increased
    debt or contingent liabilities, dilution to our stockholders or
    other adverse effects on future financial results.





| |                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Treating stock options and employee stock purchase plan
    participation as a compensation expense could significantly
    impair our ability to return to and sustain profitability on a
    GAAP basis, and may have an adverse impact on our ability to
    attract and retain key personnel.





| |                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to adapt and enhance our software
    products to meet rapid technological changes, to provide desired
    product interfaces or to conform to new industry standards, we
    could lose partners, customers and future revenue
    opportunities.



26



---



##### 







| |                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our business may be adversely impacted if we do not
    provide professional services to implement our solutions or if
    we are unable to establish and maintain relationships with
    third-party implementation providers.





| |                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may face product liability claims, damage to the
    reputation of our software and a loss of revenue if our software
    products fail to perform as intended or contain significant
    defects.





| |                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------
| | Costs of legal investigations and regulatory compliance
    matters may increase our operating expenses and impact our
    operating results.



27



---



##### 





| |                                                                                                    
| | ---------------------------------------------------------------------------------------------------
| | Our financial statements may in the future be impacted by
    improper activities of our personnel.





| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | Our international sales efforts could subject us to
    greater or unique uncertainties and additional risk.







| |                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because our software could interfere with the operations
    of our partners and customers other network and
    software applications, we may be subject to potential product
    liability and warranty claims by these partners and
    customers.



28



---



##### 







| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may not have sufficient resources available to us in
    the future to take advantage of certain opportunities,
    potentially harming our operating results and financial
    condition.





| |                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Some provisions of the Delaware General Corporation Law,
    our certificate of incorporation and our bylaws, as well as our
    stockholder rights plan, may deter potential acquisition bids,
    discourage changes in our management or Board of Directors and
    have anti-takeover effects.






ITEM 3.     QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK




Interest rate risk.


29



---



##### 





Foreign currency exchange rate risk.







ITEM 4.     CONTROLS AND
PROCEDURES


Evaluation of Disclosure Controls and Procedures.






Changes in Internal Control over Financial Reporting.


30



---



##### 






PART II


OTHER INFORMATION





ITEM 1.     LEGAL
PROCEEDINGS









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




|                     |  |                    |            |  |                |  |         | 
|-------------------- |  | ------------------ | ---------- |  | -------------- |  | ------- | 
|Nominee              |  | Votes For Election |            |  | Votes Withheld | 
|                     |  |                    |            |  |                | 
|David Mitchell       |  |                    | 49,056,285 |  |                |  | 361,887 | 
|Jerry J. Jasinowski  |  |                    | 48,997,846 |  |                |  | 420,327 | 
|Vincent J. Mullarkey |  |                    | 49,082,379 |  |                |  | 335,793 | 



31



---



##### 






ITEM 6.     EXHIBITS.


|        |    |             |  |                                                                                                                           
|------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1(1)       |  | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                               
|        | 3  | .2(2)       |  | Amended and Restated Bylaws of webMethods, Inc.                                                                           
|        | 4  | .1(3)       |  | Specimen certificate for shares of webMethods, Inc. Common Stock                                                          
|        | 4  | .2(4)       |  | Rights Agreement dated as of October 18, 2001 between
    webMethods, Inc. and American Stock Transfer & Trust
    Company
|        | 10 | .2(5)       |  | webMethods, Inc. Amended and Restated Stock Option Plan, as
    Amended                                                   
|        | 10 | .3(3)       |  | Employee Stock Purchase Plan                                                                                              
|        | 10 | .4(3)       |  | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors                             
|        | 10 | .5(6)       |  | Executive Agreement entered into between webMethods, Inc. and
    certain of its executive officers                       
|        | 10 | .6(7)       |  | Form of Stock Option Agreement for stock option grants to
    employees or officers other than California residents       
|        | 10 | .7(8)       |  | Form of Stock Option Agreement for stock option grants to
    directors                                                   
|        | 10 | .8(7)       |  | Form of notice of grant of stock option                                                                                   
|        | 10 | .9*         |  | Deferred Compensation Plan for Directors, as amended                                                                      
|        | 10 | .10(8)      |  | Consulting Agreement dated October 3, 2004 between Phillip
    Merrick and webMethods, Inc.                               
|        | 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 Form 10-K for
    the year ended March 31, 2002 
     (File No. 1-15681).            
|   
|(2) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended December 31, 2004 
     (File No. 1-15681). 
|   
|(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. 1-15681).                           
|   
|(5) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2003 
     (File No. 1-15681).            
|   
|(6) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended June 30, 2004 
     (File No. 1-15681).     
|   
|(7) | Incorporated by reference to webMethods Form 8-K
    dated October 2, 2004 (File No. 1-15681).                               
|   
|(8) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended September 30, 2004 
     (File No. 1-15681).



| |   |                
| | - | ---------------
| | * | Filed herewith.



| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| | # | This item is furnished as an exhibit to this report but is
    not filed with the Securities and Exchange Commission.

32



---



##### 



SIGNATURES






| |                 
| | ----------------
| | WEBMETHODS, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ DAVID MITCHELL

| |                                      
| | -------------------------------------
| |                                      
| | David Mitchell                       
| | President and Chief Executive Officer





| |     |                   
| | --- | ------------------
| | By: | /s/ MARK WABSCHALL

| |                                                  
| | -------------------------------------------------
| |                                                  
| | Mark Wabschall                                   
| | Senior Vice President and Chief Financial Officer



33



---



##### 



INDEX TO EXHIBITS


|        |    |             |  |                                                                                                                           
|------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1(1)       |  | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                               
|        | 3  | .2(2)       |  | Amended and Restated Bylaws of webMethods, Inc.                                                                           
|        | 4  | .1(3)       |  | Specimen certificate for shares of webMethods, Inc. Common Stock                                                          
|        | 4  | .2(4)       |  | Rights Agreement dated as of October 18, 2001 between
    webMethods, Inc. and American Stock Transfer & Trust
    Company
|        | 10 | .2(5)       |  | webMethods, Inc. Amended and Restated Stock Option Plan, as
    Amended                                                   
|        | 10 | .3(3)       |  | Employee Stock Purchase Plan                                                                                              
|        | 10 | .4(3)       |  | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors                             
|        | 10 | .5(6)       |  | Executive Agreement entered into between webMethods, Inc. and
    certain of its executive officers                       
|        | 10 | .6(7)       |  | Form of Stock Option Agreement for stock option grants to
    employees or officers other than California residents       
|        | 10 | .7(8)       |  | Form of Stock Option Agreement for stock option grants to
    directors                                                   
|        | 10 | .8(7)       |  | Form of notice of grant of stock option                                                                                   
|        | 10 | .9*         |  | Deferred Compensation Plan for Directors, as amended                                                                      
|        | 10 | .10(8)      |  | Consulting Agreement dated October 3, 2004 between Phillip
    Merrick and webMethods, Inc.                               
|        | 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 Form 10-K for
    the year ended March 31, 2002 
     (File No. 1-15681).            
|   
|(2) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended December 31, 2004 
     (File No. 1-15681). 
|   
|(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. 1-15681).                           
|   
|(5) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2003 
     (File No. 1-15681).            
|   
|(6) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended June 30, 2004 
     (File No. 1-15681).     
|   
|(7) | Incorporated by reference to webMethods Form 8-K
    dated October 2, 2004 (File No. 1-15681).                               
|   
|(8) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended September 30, 2004 
     (File No. 1-15681).



| |   |                
| | - | ---------------
| | * | Filed herewith.



| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| | # | This item is furnished as an exhibit to this report but is not
    filed with the Securities and Exchange Commission.