##### 



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 1934For the quarterly period ended
    September 30, 2006ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF
    THE SECURITIES EXCHANGE ACT OF 1934For the transition period
    from          to   Commission File Number 1-15681
      webMethods, Inc.
 (Exact name of Registrant as
    Specified in its Charter)
  Delaware

54-1807654(State or Other Jurisdiction
    of

(I.R.S. EmployerIncorporation or
    Organization)

Identification No.)3877 Fairfax Ridge
    Road,

22030South Tower, Fairfax,
    Virginia

(Zip Code)(Address of Principal Executive
    Offices)   (703) 460-2500
 (Registrants telephone
    number, including area code)
  Securities registered pursuant to Section 12(b) of the
    Act:
 Common Stock, $0.01 par value, together with related
    Preferred Stock Purchase Rights
  Securities registered pursuant to Section 12(g) of the
    Act:
 None
  þ o
  Rule 12b-2
 o þ o
  Rule 12b-2 o þ




---



##### 



WEBMETHODS,
    INC.
  QUARTERLY
    REPORT ON
    FORM 10-Q
  TABLE OF
    CONTENTS
  PART I
    FINANCIAL INFORMATIONItem 1.


Financial
    Statements


3Condensed
    Consolidated Balance Sheets (unaudited) as of September 30,
    2006 and March 31, 2006


3Condensed
    Consolidated Statements of Operations and Comprehensive Income
    (Loss) (unaudited) for the three and six months ended
    September 30, 2006 and 2005


4Condensed
    Consolidated Statements of Cash Flows (unaudited) for the six
    months ended September 30, 2006 and 2005


5Notes to Condensed
    Consolidated Financial Statements (unaudited)


6Item 2.


Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


23Item 3.


Quantitative and
    Qualitative Disclosures About Market Risk


36Item 4.


Controls and
    Procedures


37PART II
    OTHER INFORMATIONItem 1.


Legal
    Proceedings


38Item 1A.


Risk
    Factors


38Item 4.


Submission of
    Matters to a Vote of Security Holders


38Item 6.


Exhibits


38   2




---



##### 



PART I 
    FINANCIAL INFORMATION  ITEM 1:
    FINANCIAL
    STATEMENTS  WEBMETHODS,
    INC.
  CONDENSED
    CONSOLIDATED BALANCE SHEETS
  September 30,


March 31,2006


2006(Unaudited)(In thousands)ASSETSCurrent assets:Cash and cash equivalents

$
91,086


$
82,371Marketable securities available
    for sale


44,682



79,943Accounts receivable, net of
    allowance of $941 and $652


42,096



64,298Deferred income tax assets, net


219



138Prepaid expenses and other current
    assets


6,509



6,830Total current assets


184,592



233,580Marketable securities available
    for sale


1,994



Property and equipment, net


9,790



10,274Goodwill


76,192



46,704Intangible assets, net


18,633



5,993Long-term deferred income tax
    assets, net


2,053



1,961Other assets


5,159



4,299Total assets

$
298,413


$
302,811LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
9,563


$
7,323Accrued expenses


15,716



10,866Accrued salaries and commissions


10,798



12,694Deferred revenue


45,183



59,168Current portion of capital lease
    obligations


114



259Total current liabilities


81,374



90,310Capital lease obligations, net of
    current portion






10Other long-term liabilities


3,647



3,941Long-term deferred revenue


2,026



1,772Total liabilities


87,047



96,033Commitments and contingenciesStockholders equity:Common stock, $0.01 par
    value; 500,000 shares authorized; 55,737 and
    54,479 shares issued and outstanding


557



545Additional paid-in capital


543,364



529,972Deferred stock compensation






(357
)Accumulated deficit


(332,058
)


(322,202
)Accumulated other comprehensive
    loss


(497
)


(1,180
)Total stockholders equity


211,366



206,778Total liabilities and
    stockholders equity

$
298,413


$
302,811    3




---



##### 



WEBMETHODS,
    INC.
  CONDENSED
    CONSOLIDATED STATEMENTS OF OPERATIONS
 AND
    COMPREHENSIVE INCOME (LOSS)
  Three Months Ended


Six Months EndedSeptember 30,


September 30,2006


2005


2006


2005(Unaudited)(In thousands, except per share data)Revenue:License

$
16,541


$
19,390


$
29,178


$
37,857Professional services


13,286



11,326



26,438



23,009Maintenance


20,963



18,452



41,180



36,037Total revenue


50,790



49,168



96,796



96,903Cost of revenue:Amortization of intangibles


736



599



1,335



1,198License


459



271



783



485Professional services


12,679



10,008



24,832



20,307Maintenance


3,239



3,473



6,436



6,728Total cost of revenue


17,113



14,351



33,386



28,718Gross profit


33,677



34,817



63,410



68,185Operating expenses:Sales and marketing


19,027



17,051



38,515



34,326Research and development


11,523



10,126



22,499



21,244General and administrative


7,409



5,401



14,538



11,615In-process research and development


1,170







1,170



Restructuring costs






431







719Total operating expenses


39,129



33,009



76,722



67,904Operating (loss) income


(5,452
)


1,808



(13,312
)


281Interest income


1,841



1,019



3,642



1,979Interest expense


(23
)


(46
)


(30
)


(63
)Other (expense) income


(222
)


20



268



232(Loss) income before income taxes

$
(3,856
)

$
2,801


$
(9,432
)

$
2,429Provision for income taxes


196



243



424



385Net (loss) income

$
(4,052
)

$
2,558


$
(9,856
)

$
2,044Basic and diluted net (loss)
    income per common share

$
(0.07
)

$
0.05


$
(0.18
)

$
0.04Shares used in computing basic net
    (loss) income per share


55,600



53,610



55,295



53,492Shares used in computing diluted
    net (loss) income per share


55,600



54,305



55,295



53,855Comprehensive loss:Net (loss) income

$
(4,052
)

$
2,558


$
(9,856
)

$
2,044Other comprehensive (loss) income:Unrealized gain (loss) on
    securities available for sale


108



(2
)


156



137Foreign currency cumulative
    translation adjustment


116



(455
)


527



(2,565
)Total comprehensive (loss) income

$
(3,828
)

$
2,101


$
(9,173
)

$
(384
)    4




---



##### 



WEBMETHODS,
    INC.
  CONDENSED
    CONSOLIDATED STATEMENTS OF CASH FLOWS
  Six Months EndedSeptember 30,2006


2005(Unaudited)(In thousands)Cash flows from operating
    activities:Net (loss) income

$
(9,856
)

$
2,044Adjustments to reconcile net
    (loss) income to net cash provided by operating activities:Depreciation and amortization


2,589



2,776Provision for (recovery of)
    doubtful accounts and revenue allowance


570



(376
)Deferred tax asset


(74
)


Stock-based compensation for
    employees and directors


5,533



30In-process research and development


1,170



Amortization of deferred warrant
    charge






1,322Amortization of acquired
    intangibles


1,335



1,198Amortization of deferred rent


(229
)


(229
)Increase (decrease) in cash
    resulting from changes in assets and liabilities:Accounts receivable


23,325



5,514Prepaid expenses and other current
    assets


362



85Other non-current assets


(3,191
)


1,315Accounts payable


344



(523
)Accrued expenses and other
    liabilities


4,699



(3,875
)Accrued salaries and commissions


(2,581
)


(2,613
)Deferred revenue


(14,824
)


(3,725
)Long-term deferred revenue and
    other non-current liabilities


157



(73
)Net cash provided by operating
    activities


9,329



2,870Cash flows from investing
    activities:Business acquisition and
    technology purchase, net of cash acquired


(40,019
)


Purchases of property and equipment


(1,903
)


(3,039
)Changes in restricted cash


247



Proceeds from maturities of
    marketable securities available for sale


56,615



62,038Purchases of marketable securities
    available for sale


(23,192
)


(27,947
)Net cash (used in) provided by
    investing activities


(8,252
)


31,052Cash flows from financing
    activities:Payments on capital leases


(157
)


(336
)Proceeds from exercise of stock
    options


6,266



829Proceeds from ESPP common stock
    issuances


1,109



609Net cash provided by financing
    activities


7,218



1,102Effect of exchange rate on cash
    and cash equivalents


420



(3,103
)Net increase in cash and cash
    equivalents


8,715



31,921Cash and cash equivalents at
    beginning of period


82,371



57,209Cash and cash equivalents at end
    of period

$
91,086


$
89,130    5




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
  1.
    ORGANIZATION
    AND BASIS OF PRESENTATION  Form 10-Q
    Form 10-Q Form 10-K
  2.
    SUMMARY
    OF SIGNIFICANT ACCOUNTING POLICIES  Adoption
    of New Accounting Standards
  Stock-Based
    Compensation
         6




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  paid-in
      Recently
    Issued Accounting Pronouncements
  Fair
    Value Measurements
    Considering
    the Effects of Prior Year Misstatements When Quantifying
    Misstatements in Current Year Financial Statements
   7




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Transition
    Election Related to Accounting for the Tax Effects of
    Share-Based Payment Awards
  No. FAS 123R-3,
  Accounting
    for Uncertainty in Income Taxes
    Income
    Statement Classification of Taxes Collected from
    Customers
  No. 06-03, (EITF 06-03). EITF 06-03 EITF 06-03 EITF 06-03
  3.
    MARKETABLE
    SECURITIES    Purchase/


Gross


Gross





Cash andAmortized


Unrealized


Unrealized


Aggregate


Cash


Short-Term


Long-TermAs of September 30, 2006

Cost


Gains


Losses


Fair Value


Equivalents


Investments


Investments(In thousands)Commercial paper

$
7,719


$



$
(4
)

$
7,715


$
2,287


$
5,428


$
Corporate bonds


47,701



8







47,709



7,961



39,254



494Treasury coupons


1,499



1







1,500











1,500Money market funds


27,518











27,518



27,518







Total

$
84,437


$
9


$
(4
)

$
84,442


$
37,766


$
44,682


$
1,994   8




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Purchase/


Gross





Cash andAmortized


Unrealized


Aggregate


Cash


Short-Term


Long-TermAs of March 31, 2006

Cost


Losses


Fair Value


Equivalents


Investments


Investments(In thousands)Taxable municipal auction rate
    securities

$
9,850


$



$
9,850


$



$
9,850


$
Corporate bonds


82,217



(163
)


82,054



11,961



70,093



Money market funds


30,137







30,137



30,137







Total

$
122,204


$
(163
)

$
122,041


$
42,098


$
79,943


$
     other-than-temporary, other-than-temporary,
  FAS 115-1 FAS 124-1, Other-Than-Temporary available-for-sale
  Less Than 12 Months


Greater Than 12 Months


TotalGross





Gross





GrossUnrealized





Unrealized





UnrealizedFair Value


Losses


Fair Value


Losses


Fair Value


Losses(In thousands)Commercial paper

$
5,428


$
(4
)

$



$



$
5,428


$
(4
)   other-than-temporarily
    4.
    STOCK-BASED
    COMPENSATION  Stock
    Incentive Plan
   9




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        out-of-the-money
    Weighted AverageWeighted


RemainingAverage


Contractual Life


AggregateStock Options


Exercise Price


(Years)


Intrinsic ValueOutstanding, March 31, 2006


18,198,486


$
10.56Granted


2,795,345



7.61Exercised


(1,029,296
)


6.09Forfeited


(845,304
)


6.44Expired


(555,476
)


13.16Outstanding, September 30,
    2006


18,563,755


$
10.48



7.39


$
14,080,981Options exercisable


11,262,462


$
12.84






$
6,560,425   (in-the-money
   10




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      OutstandingWeighted Average





Options ExercisableRemaining


Weighted





WeightedNumber of


Contractual Life


Average





AverageRange of Exercise Price

Shares


(in years)


Exercise Price


Number of Shares


Exercise Price$ 0.11 to $  5.89


4,849,010



8.30


$
5.28



1,995,969


$
4.825.93
    to    7.71


3,870,578



8.31



6.99



1,219,654



6.897.77
    to   9.54


3,745,575



7.51



8.56



2,277,168



8.819.62
    to   14.36


5,245,011



6.29



12.10



4,916,090



12.2516.07 to 115.75


853,581



4.28



54.26



853,581



54.26$ 0.11 to $115.75


18,563,755



7.39


$
10.48



11,262,462


$
12.84   in-the-money.
  Employee
    Stock Purchase Plan
     11




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
         12




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Valuation
    and Expense Information under SFAS 123R
    Three Months Ended


Six Months EndedSeptember 30,


September 30,Employee Stock-Based Compensation Included in:

2006


2005


2006


2005(In thousands)Cost of revenue:Professional services

$
337


$
4


$
661


$
4Maintenance


95



2



204



2Stock-based compensation expense
    included in cost of revenue


432



6



865



6Operating expenses:Sales and marketing


875



9



1,723



9Research and development


701



10



1,380



10General and administrative


827



5



1,565



5Stock-based compensation expense
    included in operating expenses


2,403



24



4,668



24Total stock-based compensation
    expense related to stock-based equity awards

$
2,835


$
30


$
5,533


$
30           13




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Three Months Ended


Six Months EndedSeptember 30,


September 30,2006


2005


2006


2005Stock option grants:Risk free interest rate


4.8
%


4.0
%


4.9
%


4.0
%Expected lives in years


4.69



4.0



4.69



4.0Expected volatility


69.3
%


74.3
%


69.2
%


75.2
%Dividend yield


0.0
%


0.0
%


0.0
%


0.0
%ESPP:Risk free interest rate


4.6
%


4.0
%


4.6
%


4.0
%Expected lives in years


1.3



1.3



1.3



1.3Expected volatility


38.4
%


54.7
%


38.4
%


54.7
%Dividend yield


0.0
%


0.0
%


0.0
%


0.0
%     Three Months Ended


Six Months EndedSeptember 30,


September 30,2006


2005


2006


2005Weighted-average grant date fair
    value of options granted

$
4.55


$
3.44


$
4.71


$
3.38Weighted-average fair value of
    employee stock purchase rights

$
3.32


$
2.22


$
3.32


$
2.22   catch-up
 14




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Three Months Ended


Six Months EndedSeptember 30,


September 30,2005


2005(In thousands except per share data)Net income, as reported

$
2,558


$
2,044Add: Stock-based compensation
    expense determined under the intrinsic value method


30



30Less: Stock-based compensation
    expense determined under fair value method

$
(4,759
)

$
(8,787
)Net loss, pro forma

$
(2,171
)

$
(6,713
)Basic and diluted net income per
    common share, as reported

$
0.05


$
0.04Basic and diluted net loss per
    common share, pro forma

$
(0.04
)

$
(0.13
)     5.
    EMPLOYEE
    BENEFIT PLAN    6.
    COMPUTATION
    OF NET LOSS PER SHARE      Three Months


Six MonthsEnded


EndedSeptember 30,


September 30,2006


2005


2006


2005(In thousands, except per share amounts)Net (loss) income

$
(4,052
)

$
2,558


$
(9,856
)

$
2,044Weighted-average common stock
    shares used to compute basic net loss per share


55,600



53,610



55,295



53,492Effect of dilutive common stock
    equivalents






695







362Weighted-average common stock
    shares used in computing diluted net income per common share


55,600



54,305



55,295



53,854Basic and diluted net (loss)
    income per share

$
(0.07
)

$
0.05


$
(0.18
)

$
0.04  15




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Six Months EndedThree Months Ended September 30,


September 30,2006


2005


2006


2005(In thousands)Anti-dilutive weighted-average
    common stock shares


15,437



368



14,608



537   7.
    SUPPLEMENTAL
    DISCLOSURES OF CASH FLOW INFORMATION  Six Months EndedSeptember 30,2006


2005(In thousands)Non-cash investing and financing
    activities:Change in net unrealized (loss)
    gain on marketable securities

$
(156
)

$
137   Supplemental
    schedule of noncash investing activities:    Fair value of assets acquired

$
44,399In process research and development


1,170Cash paid, net of cash acquired


(40,019
)Cash hold back included in
    accounts payable


(1,235
)Liabilities incurred in connection
    with direct acquisition costs


(2,528
)Stock option plan assumed


(866
)Liabilities assumed

$
921   8.
    SEGMENT
    INFORMATION     16




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Three Months


Six MonthsEnded


EndedSeptember 30,


September 30,Revenue

2006


2005


2006


2005(In thousands)Americas

$
33,537


$
30,862


$
62,247


$
61,030EMEA


11,981



12,110



22,773



22,919Japan


2,003



2,745



4,177



5,316Asia Pacific


3,269



3,451



7,599



7,638Total

$
50,790


$
49,168


$
96,796


$
96,903   As of


As ofSeptember 30,


March 31,Long Lived Assets

2006


2006(In thousands)Americas

$
10,805


$
10,981EMEA


1,363



1,393Japan


1,190



1,132Asia Pacific


1,437



843Total

$
14,795


$
14,349   9.
    RESTRUCTURING
    COSTS      11-year
   17




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      ExcessFacilitiesSanta Clara,


Excess


ExcessCA and


Facilities


FacilitiesFairfax, VA


Berkeley, CA


Fairfax, VA


Total(In thousands)Balance at March 31, 2006

$
166


$
747


$
1,250


$
2,163Cash payments made in the first
    quarter of fiscal year 2007


(55
)


(91
)


(225
)


(371
)Cash payments made in the second
    quarter of fiscal year 2007


(33
)


(94
)


(170
)


(297
)Balance at September 30, 2006

$
78


$
562


$
855


$
1,495     10.
    BORROWINGS        11.
    BUSINESS
    COMBINATION AND PURCHASE OF TECHNOLOGY  Business
    acquisition
   18




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Infravio(In thousands)Cash and cash equivalents

$
368Accounts receivable


384Other current assets


257Property and equipment


114Accounts payable


(281
)Accrued expenses


(479
)Deferred revenue


(73
)In-process research and development


1,170Developed technology


7,670Tradename


490Customer relationships


80Non-compete agreements


810Goodwill


29,488Total cash purchase price

$
39,998    19




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
          Three Months


Six MonthsEnded


EndedSeptember 30,


September 30,2006


2005


2006


2005(Unaudited)


(Unaudited)(in thousands, except per share data)Pro forma revenue

$
51,059


$
49,745


$
96,890


$
97,136Pro forma net loss


(4,462
)


(1,148
)


(11,360
)


(2,546
)Pro forma net loss per
    share  basic and diluted

$
(0.08
)

$
(0.02
)

$
(0.21
)

$
(0.05
)   Acquisition
    of technology
     20




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Goodwill
    and intangible assets
        As of September 30, 2006


As of March 31, 2006Gross








GrossCarrying


Accumulated





Carrying


AccumulatedAmount


Amortization


Net Amount


Amount


Amortization


Net Amount(in thousands)Developed technology

$
23,552


$
(6,818
)

$
16,734


$
11,152


$
(5,572
)

$
5,580Tradename


490



(1
)


489











Customer relationships


938



(503
)


435



833



(420
)


413Non-compete agreements


810



(1
)


809











Assembled workforce


170



(4
)


166











$
25,960


$
(7,327
)

$
18,633


$
11,985


$
(5,992
)

$
5,993    Weighted-averageAmortizationPeriod(in years)Developed technology


5Tradename


5Customer relationships


4Non-compete agreements


1.5Assembled workforce


54.8  21




---



##### 



WEBMETHODS,
    INC.
  NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Amortization ofAs of September 30, 2006:

Intangibles(In thousands)2007

$
5,6542008


5,2782009


2,6122010


2,6122011


2,477$
18,633   12.
    COMMITMENTS
    AND CONTINGENCIES      13.
    RELATED-PARTY
    TRANSACTIONS   22




---



##### 



ITEM 2.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  FORWARD-LOOKING
    STATEMENTS
  Form 10-Q
  
    projections of revenue, costs or expense, margins, income or
    loss, earnings or loss per share, capital expenditures, cash
    requirements or other financial items, effective tax rate,
    sufficiency of working capital and projections regarding the
    market for our software and services;
    statements of our plans, objectives or expectations, including
    the development or enhancement of software, development and
    continuation of strategic partnerships and alliances,
    contributions to revenue by our business partners,
    implementation and effect of sales and marketing initiatives,
    future financial results, future financial results within
    geographic or specific markets and the allocation of resources
    to those markets, predictions of the timing and type of customer
    or market reaction to sales and marketing initiatives, the
    ability to control expenses, anticipated cost savings or expense
    reduction strategies, future hiring, business strategy and the
    execution on it and actions by customers and competitors;
    statements of future economic performance or economic
    conditions, the continuation of patterns identified as trends or
    seasonal occurrences or the impact of recent or anticipated
    changes in accounting standards;
    statements of our plans for remediation of a material weakness,
    or other changes, in our internal controls over financial
    reporting; and
    assumptions underlying any of the foregoing.  Form 10-K.
  INTRODUCTION
  Form 10-Q
  
    Overview.  This section provides a general
    description of our business and the performance indicators that
    management uses in assessing our financial condition and results
    of operations.
    Results of Operations.  This section provides
    an analysis of our results of operations for the three and six
    months ended September 30, 2006 and 2005.
    Liquidity and Capital Resources.  This section
    provides an analysis of our cash flows for the three and six
    months ended September 30, 2006, and a discussion of our
    capital requirements and the resources available to us to meet
    those requirements. 23




---



##### 




    Critical accounting policies.  This section
    discusses accounting policies that are considered important to
    our financial condition and results of operations, require
    significant judgment and require estimates on the part of
    management in application.  OVERVIEW
    Second
    Quarter Fiscal 2007 Review
               24




---



##### 



Recent
    Developments
     25




---



##### 



Stock-Based
    Compensation
    Three Months Ended


Six Months EndedSeptember 30,


September 30,Employee Stock-Based Compensation Included in:

2006


2005


2006


2005(In thousands)Cost of revenue:Professional services

$
337


$
4


$
661


$
4Maintenance


95



2



204



2Stock-based compensation expense
    included in cost of revenue


432



6



865



6Operating expenses:Sales and marketing


875



9



1,723



9Research and development


701



10



1,380



10General and administrative


827



5



1,565



5Stock-based compensation expense
    included in operating expenses


2,403



24



4,668



24Total stock-based compensation
    expense related to stock-based equity awards

$
2,835


$
30


$
5,533


$
30   out-of-the-money
 26




---



##### 



RESULTS
    OF OPERATIONS
    Three Months Ended


Six Months EndedSeptember 30,


September 30,2006


2005


% Change


2006


2005


% Change(In thousands)


(In thousands)Total revenue

$
50,790


$
49,168



3
%

$
96,796


$
96,903



0
%Total cost of revenue


17,113



14,351



19
%


33,386



28,718



16
%% of total revenue


34
%


29
%






34
%


30
%Gross profit


33,677



34,817



(3
)%


63,410



68,185



(7
)%% of total revenue


66
%


71
%






66
%


70
%Total operating expenses


39,129



33,009



19
%


76,722



67,904



13
%% of total revenue


77
%


67
%






79
%


70
%Operating (loss) income


(5,452
)


1,808



N/A



(13,312
)


281



N/A% of total revenue


(11
)%


4
%






(14
)%


0
%Net (loss) income


(4,052
)


2,558



N/A



(9,856
)


2,044



N/A% of total revenue


(8
)%


5
%






(10
)%


2
%         Revenue
    Three Months Ended September 30,


Six Months Ended September 30,2006


2005


% Change


2006


2005


% Change(In thousands)License

$
16,541


$
19,390



(15
)%

$
29,178


$
37,857



(23
)%Professional services


13,286



11,326



17
%


26,438



23,009



15
%Maintenance


20,963



18,452



14
%


41,180



36,037



14
%Total revenue

$
50,790


$
49,168



3
%

$
96,796


$
96,903



0
%  27




---



##### 



Three Months Ended September 30,


Six Months Ended September 30,2006


2005


% Change


2006


2005


% Change(In thousands)Americas

$
33,537


$
30,862



9
%

$
62,247


$
61,030



2
%EMEA


11,981



12,110



(1
)%


22,773



22,919



(1
)%Japan


2,003



2,745



(27
)%


4,177



5,316



(21
)%Asia Pacific


3,269



3,451



(5
)%


7,599



7,638



(1
)%Total revenue

$
50,790


$
49,168



3
%

$
96,796


$
96,903



0
%       License
    Revenue
    Professional
    Services Revenue
    Maintenance
    Revenue
   28




---



##### 



Cost of
    Revenue
    Three Months Ended September 30,


Six Months Ended September 30,2006


2005


% Change


2006


2005


% Change(In thousands)Amortization of Intangibles

$
736


$
599



23
%

$
1,335


$
1,198



11
%% of License Revenue


4
%


3
%






5
%


3
%Cost of License Revenue


459



271



69
%


783



485



61
%% of License Revenue


3
%


1
%






3
%


1
%Cost of Professional Services
    Revenue


12,679



10,008



27
%


24,832



20,307



22
%% of Professional Services Revenue


95
%


88
%






94
%


88
%Cost of Maintenance Revenue


3,239



3,473



(7
)%


6,436



6,728



(4
)%% of Maintenance Revenue


15
%


19
%






16
%


19
%Total cost of revenue


17,113



14,351



19
%


33,386



28,718



16
%% of Total revenue


34
%


29
%






34
%


30
%          29




---



##### 



Operating
    Expenses
    Three Months Ended September 30,


Six Months Ended September 30,2006


2005


% Change


2006


2005


% Change(In thousands)


(In thousands)Operating Expenses:Sales and marketing

$
19,027


$
17,051



12
%

$
38,515


$
34,326



12
%% of total revenue


37
%


35
%






40
%


35
%Research and development


11,523



10,126



14
%


22,499



21,244



6
%% of total revenue


23
%


21
%






23
%


22
%General and administrative


7,409



5,401



37
%


14,538



11,615



25
%% of total revenue


15
%


11
%






15
%


12
%In-process research and development


1,170







N/A



1,170







N/A% of total revenue


2
%


0
%






1
%


0
%Restructuring costs






431



(100
)%






719



(100
)%% of total revenue


0
%


1
%






0
%


1
%Total operating expenses


39,129



33,009



19
%


76,722



67,904



13
%% of total revenue


77
%


67
%






79
%


70
%  30




---



##### 



31




---



##### 



Interest
    income
    Interest
    expense
    Other
    (expense) income, net
   32




---



##### 



Income
    taxes
          LIQUIDITY
    AND CAPITAL RESOURCES
  Cash
    Flows
         33




---



##### 



Liquidity
    Requirements
  Debt
    financing
        Liquidity
    Outlook
      Off
    Balance Sheet Arrangements
    CRITICAL
    ACCOUNTING POLICIES AND ESTIMATES
      Form 10-K
 34




---



##### 



Stock-Based
    Compensation
        paid-in-capital
     35




---



##### 



Recently
    Issued Accounting Pronouncements
  Fair
    Value Measurements
    Considering
    the Effects of Prior Year Misstatements When Quantifying
    Misstatements in Current Year Financial Statements
    Transition
    Election Related to Accounting for the Tax Effects of
    Share-Based Payment Awards
  No. FAS 123R-3,
  Accounting
    for Uncertainty in Income Taxes
    Income
    Statement Classification of Taxes Collected from
    Customers
  No. 06-03, (EITF 06-03). EITF 06-03 EITF 06-03 EITF 06-03
 36




---



##### 



ITEM 3.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  Form 10-K
  ITEM 4.
    CONTROLS
    AND PROCEDURES  Evaluation of Disclosure Controls and
    Procedures. Rule 13a-15(e)
    Rule 13a-15 Form 10-Q.
  Form 10-Q Form 10-Q
  Material Weakness in Internal Control Over Financial
    Reporting. Form 10-K
    Material Weakness Remediation Plans.
  
    Implementing formal procedures to evaluate the continued
    profitability of each of our subsidiaries on a quarterly basis
    in order to determine the income tax benefit of reducing the
    valuation allowances on net operating loss carryforwards and
    other deferred tax assets. 37




---



##### 




    Implementing formal procedures to monitor net deferred tax
    assets relating to goodwill and intangible assets of companies
    that we acquire.
    Evaluating the implementation of a new tax accounting and
    reporting system and improve our procedures with respect to
    communicating, documenting, and reconciling the detailed
    components of income tax assets and liabilities of each of our
    subsidiaries.
    Expanding staffing and resources, including the continued use of
    external consultants, and provide training on income tax
    accounting and reporting.  Changes in Internal Control Over Financial
    Reporting.
 PART II



OTHER
    INFORMATION  ITEM 1.
    LEGAL
    PROCEEDINGS    ITEM 1A.
    RISK
    FACTORS  Form 10-K
  ITEM 4.
    SUBMISSION
    OF MATTERS TO A VOTE OF SECURITY HOLDERS.    Nominee

Votes For Election


Votes WithheldR. James Green


49,298,886



1,340,327Peter Gyenes


48,082,163



2,557,050William V. Russell


47,644,589



2,994,624       ITEM 6.
    EXHIBITS   38




---



##### 



SIGNATURES
    WEBMETHODS, INC.
  By:
    /s/  DAVID
    MITCHELL         By:
    /s/  MARK
    WABSCHALL  
     By:
    /s/  JOHN
    ANDARY  
     By:
    /s/  MICHAEL
    KRONE  
   39




---



##### 



EXHIBIT INDEX
  ExhibitNumber

Description2
.1

Agreement and Plan of Merger,
    dated as of September 8, 2006, by and among webMethods,
    Inc., Iowa Acquisition Corp., Infravio, Inc., certain holders of
    capital stock of Infravio with respect to certain provisions
    only, and Mary Coleman in her capacity as Shareholders
    Representative (filed as Exhibit 2.1 to the
    Registrants Current Report on
    Form 8-K
    filed November 3, 2006 and incorporated herein by this
    reference)3
.1

Fifth Amended and Restated
    Certificate of Incorporation of webMethods, Inc., as amended
    (filed as Exhibit 3.1 to the Registrants Annual
    Report on
    Form 10-K
    for year ended March 31, 2001 and incorporated herein by
    this reference)3
.2

Second Amended and Restated Bylaws
    of webMethods, Inc. (filed as Exhibit 3.2 to the
    Registrants Quarterly Report on
    Form 10-Q
    for the three months ended December 31, 2004 and
    incorporated herein by this reference)4
.1

Specimen certificate for shares of
    webMethods, Inc. Common Stock (Filed as Exhibit 4.2 to
    Registrants Registration Statement on
    Form S-1,
    as amended (File
    No. 333-91309)
    and incorporated herein by this reference)4
.2

Rights Agreement dated as of
    October 18, 2001 between webMethods, Inc. and American
    Stock Transfer & Trust Company (filed as
    Exhibit 4.1 to the Registrants Registration Statement
    on
    Form 8-A
    (File
    No. 000-33329)
    and incorporated herein by this reference)10
.1

webMethods, Inc. Employee Stock
    Purchase Plan, as amended (filed as Exhibit 4.5 to the
    Registrants Registration Statement on
    Form S-8
    (File
    No. 333-136261)
    and incorporated herein by this reference)10
.2

webMethods, Inc. 2006 Omnibus
    Stock Incentive Plan (the 2006 Plan) (filed as
    Exhibit 10.1 to the Registrants Current Report on
    Form 8-K
    filed September 5, 2006 and incorporated herein by this
    reference)10
.3

Form of Stock Option Agreement for
    option grants under the 2006 Plan to employees or officers other
    than California residents (filed as Exhibit 10.2 to the
    Registrants Current Report on
    Form 8-K
    filed September 5, 2006 and incorporated herein by this
    reference)10
.4

Form of Director Stock Option
    Agreement for option grants under the 2006 Plan to directors
    (filed as Exhibit 10.3 to the Registrants Current
    Report on
    Form 8-K
    filed September 5, 2006 and incorporated herein by this
    reference)10
.5

Form of Deferred Shares Award
    Agreement for deferred share awards under the 2006 Plan to
    directors (filed as Exhibit 10.4 to the Registrants
    Current Report on
    Form 8-K
    filed September 5, 2006 and incorporated herein by this
    reference)10
.6

Services Agreement between
    webMethods, Inc. and John J. Andary (filed herewith)31
.1

Certifications of Chief Executive
    Officer, Chief Financial Officer, principal financial officer
    and Chief Accounting Officer pursuant to
    Rule 13a  14(a) as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002 (filed
    herewith)32
.1

Certifications of Chief Executive
    Officer, Chief Financial Officer, principal financial officer
    and Chief Accounting Officer pursuant to 18 U.S.C.
    Section 1350 as adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002 (filed herewith)  40