##### 



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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______

FORM 10-Q

(MARK ONE)

|     |  |                                                                                         
|---- |  | ----------------------------------------------------------------------------------------
|[X]  |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 
|     |  |                                                                                         
|     |  | FOR THE THREE MONTHS ENDED JUNE 30, 2002                                                
|     |  |                                                                                         
|     |  | OR                                                                                      
|     |  |                                                                                         
|[  ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 001-15681
______

WEBMETHODS, INC.

(Exact Name of Registrant as Specified in its Charter)

|                                         |  |                    
|---------------------------------------- |  | -------------------
|DELAWARE                                 |  | 54-1807654         
|(State or other jurisdiction of          |  | (I.R.S. Employer   
|incorporation or organization)           |  | Identification No.)
|                                         |  |                    
|3930 PENDER DRIVE, FAIRFAX, VIRGINIA     |  | 22030              
|(Address of principal executive offices) |  | (Zip Code)         

Registrants Telephone Number, Including Area Code: (703) 460-2500
______

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

As of August 7, 2002, 50,915,830 shares of the registrants Common Stock,
par value $.01 per share, were issued and outstanding.



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1



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##### 



WEBMETHODS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED JUNE 30, 2002
TABLE OF CONTENTS

|        |  |                                                                                     
|------- |  | ------------------------------------------------------------------------------------
|Part I  |  | Financial Information                                                               
|Item 1  |  | Financial Statements                                                                
|        |  | Condensed Consolidated Financial Statements                                         
|        |  | Condensed Consolidated Balance Sheets as of                                         
|        |  | June 30, 2002 (unaudited) and March 31, 2002                                        
|        |  | Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited) -
|        |  | Three months ended June 30, 2002 and 2001                                           
|        |  | Condensed Consolidated Statements of Cash Flows (unaudited) -                       
|        |  | Three months ended June 30, 2002 and 2001                                           
|        |  | Notes to Condensed Consolidated Financial Statements (unaudited)                    
|Item 2  |  | Managements Discussion and Analysis of Financial                                   
|        |  | Condition and Results of Operations                                                 
|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk                          
|       
|Part II |  | Other Information                                                                   
|Item 1. |  | Legal Proceedings                                                                   
|Item 2  |  | Changes in Securities and Use of Proceeds                                           
|Item 6  |  | Exhibits and Reports on Form 8-K                                                    
|        |  | (a) Exhibits                                                                        
|        |  | (b) Reports on Form 8-K                                                             

2



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##### 



PART I
FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

WEBMETHODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS



|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |          |         | 
|---------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | --------------------------------- | ------- | --------- | ------ | -------- | ------- | 
|                                         |                                                                                                                       |                                            |        | JUNE 30,                          |         | MARCH 31,
|                                         |                                                                                                                       |                                            |        | 2002                              |         | 2002     
|                                         |                                                                                                                       |                                            |        |                                   |         |          
|                                         |                                                                                                                       |                                            |        | unaudited                         |         |           |        |         
|                                         |                                                                                                                       |                                            |        | (In thousands, except share data)
|ASSETS                                   |                                                                                                                       |                                            |        |                                   |         |           |        |         
|Current assets:                          |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         | Cash and cash equivalents                                                                                             |                                            | $      | 118,492                           |         |           | $      | 98,497   |        
|                                         | Marketable securities available for sale                                                                              |                                            |        | 83,365                            |         |           |        | 113,345  |        
|                                         | Accounts receivable, net of allowance of $3,585 and
$3,685                                                            |                                            |        | 40,555                            |         |           |        | 46,417   |        
|                                         | Prepaid expenses and other current assets                                                                             |                                            |        | 8,234                             |         |           |        | 7,516    |        
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         |                                                                                                                       | Total current assets                       |        |                                   | 250,646 |           |        |          | 265,775 | 
|Property and equipment, net              |                                                                                                                       |                                            | 15,993 |                                   |         |           | 17,181 |         
|Marketable securities available for sale |                                                                                                                       |                                            | 5,174  |                                   |         |           |       |         
|Goodwill and acquired intangibles, net   |                                                                                                                       |                                            | 29,838 |                                   |         |           | 29,838 |         
|Other assets                             |                                                                                                                       |                                            | 10,702 |                                   |         |           | 11,269 |         
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         |                                                                                                                       | Total assets                               |        | $                                 | 312,353 |           |        | $        | 324,063 | 
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY     |                                                                                                                       |                                            |        |                                   |         |           |        |         
|Current liabilities:                     |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         | Accounts payable                                                                                                      |                                            | $      | 10,876                            |         |           | $      | 15,105   |        
|                                         | Accrued expenses                                                                                                      |                                            |        | 15,337                            |         |           |        | 16,170   |        
|                                         | Accrued salaries and commissions                                                                                      |                                            |        | 11,232                            |         |           |        | 15,594   |        
|                                         | Deferred revenue                                                                                                      |                                            |        | 39,005                            |         |           |        | 37,298   |        
|                                         | Current portion of capital lease obligations                                                                          |                                            |        | 5,023                             |         |           |        | 2,699    |        
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         |                                                                                                                       | Total current liabilities                  |        |                                   | 81,473  |           |        |          | 86,866  | 
|                                         | Capital lease obligations, net of current portion and
other                                                           |                                            |        | 1,284                             |         |           |        | 1,765    |        
|                                         | Long term deferred revenue                                                                                            |                                            |        | 13,141                            |         |           |        | 19,888   |        
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         |                                                                                                                       | Total liabilities                          |        |                                   | 95,898  |           |        |          | 108,519 | 
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|Commitments and contingencies            |                                                                                                                       |                                            |        |                                   |         |           |        |         
|Stockholders equity:                    |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         | Common stock, $0.01 par value; 500,000,000 shares
authorized; 50,800,194 and 50,477,383 shares issued and
outstanding |                                            |        | 508                               |         |           |        | 505      |        
|                                         | Additional paid-in capital                                                                                            |                                            |        | 512,623                           |         |           |        | 510,281  |        
|                                         | Deferred stock compensation and warrant charge                                                                        |                                            |        | (13,753                           | )       |           |        | (14,875  | )      
|                                         | Accumulated deficit                                                                                                   |                                            |        | (282,986                          | )       |           |        | (279,864 | )      
|                                         | Accumulated other comprehensive gain (loss)                                                                           |                                            |        | 63                                |         |           |        | (503     | )      
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         |                                                                                                                       | Total stockholders equity                 |        |                                   | 216,455 |           |        |          | 215,544 | 
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         
|                                         |                                                                                                                       | Total liabilities and stockholders equity |        | $                                 | 312,353 |           |        | $        | 324,063 | 
|                                         |                                                                                                                       |                                            |        |                                   |         |           |        |         

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

3



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##### 



WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

|                                                              |         |   |                                          |                                                         |  |                                                 |            |        |  |        |         |  
|------------------------------------------------------------- | ------- | - | ---------------------------------------- | ------------------------------------------------------- |  | ----------------------------------------------- | ---------- | ------ |  | ------ | ------- | -
|                                                              |         |   |                                          |                                                         |  | THREE MONTHS ENDED JUNE 30,                    
|                                                              |         |   |                                          |                                                         |  |                                                
|                                                              |         |   |                                          |                                                         |  | 2002                                            |            | 2001  
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          |                                                         |  | (in thousands, except share and per share data)
|Revenue:                                                      |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              | License |   | $                                        | 28,669                                                  |  |                                                 | $          | 36,804 | 
|                                                              |         |   | Professional services                    |                                                         |  | 8,202                                           |            |        |  | 9,691  |        
|                                                              |         |   | Maintenance                              |                                                         |  | 10,810                                          |            |        |  | 8,902  |        
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          | Total revenue                                           |  |                                                 | 47,681     |        |  |        | 55,397  |  
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Cost of revenue:                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   | License                                  |                                                         |  | 135                                             |            |        |  | 701    |        
|                                                              |         |   | Professional services and maintenance:   |                                                         |  |                                                 |            |        |  |        |        
|                                                              |         |   |                                          | Stock based compensation                                |  |                                                 | 76         |        |  |        | 192     |  
|                                                              |         |   |                                          | Other professional services and maintenance costs       |  |                                                 | 10,267     |        |  |        | 12,399  |  
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          | Total cost of revenue                                   |  |                                                 | 10,478     |        |  |        | 13,292  |  
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Gross profit                                                  |         |   | 37,203                                   |                                                         |  |                                                 | 42,105     |       
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Operating expenses:                                           |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   | Sales and marketing:                     |                                                         |  |                                                 |            |        |  |        |        
|                                                              |         |   |                                          | Stock based compensation and warrant charge             |  |                                                 | 970        |        |  |        | 1,232   |  
|                                                              |         |   |                                          | Other sales and marketing costs                         |  |                                                 | 24,310     |        |  |        | 30,200  |  
|                                                              |         |   | Research and development:                |                                                         |  |                                                 |            |        |  |        |        
|                                                              |         |   |                                          | Stock based compensation                                |  |                                                 | 19         |        |  |        | 3,490   |  
|                                                              |         |   |                                          | Other research and development costs                    |  |                                                 | 12,279     |        |  |        | 13,299  |  
|                                                              |         |   | General and administrative:              |                                                         |  |                                                 |            |        |  |        |        
|                                                              |         |   |                                          | Stock based compensation                                |  |                                                 | 21         |        |  |        | 87      |  
|                                                              |         |   |                                          | Other general and administrative costs                  |  |                                                 | 4,065      |        |  |        | 5,904   |  
|                                                              |         |   | Amortization of goodwill and intangibles |                                                         |  |                                                |            |        |  | 10,508 |        
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          | Total operating expenses                                |  |                                                 | 41,664     |        |  |        | 64,720  |  
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Operating loss                                                |         |   | (4,461                                   | )                                                       |  |                                                 | (22,615    | )     
|Interest income, net                                          |         |   | 1,339                                    |                                                         |  |                                                 | 2,677      |       
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          | Net loss                                                |  | $                                               | (3,122     | )      |  | $      | (19,938 | )
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Basic and diluted net loss per share                          |         | $ | (0.06                                    | )                                                       |  | $                                               | (0.41      | )     
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Shares used in computing basic and diluted net loss per share |         |   | 50,564,625                               |                                                         |  |                                                 | 48,839,735 |       
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|Comprehensive loss:                                           |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          | Net loss                                                |  | $                                               | (3,122     | )      |  | $      | (19,938 | )
|                                                              |         |   |                                          | Other comprehensive loss:                               |  |                                                 |            |        |  |        |         |  
|                                                              |         |   |                                          | Unrealized gain (loss) on securities available for sale |  |                                                 | 30         |        |  |        | (104    | )
|                                                              |         |   |                                          | Foreign currency cumulative translation adjustment      |  |                                                 | 536        |        |  |        | 46      |  
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       
|                                                              |         |   |                                          | Total comprehensive loss                                |  | $                                               | (2,556     | )      |  | $      | (19,996 | )
|                                                              |         |   |                                          |                                                         |  |                                                 |            |       

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

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WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                                                              |                                                                                                               |   |         |                             |   |      |         |         |   | 
|----------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------- | - | ------- | --------------------------- | - | ---- | ------- | ------- | - | 
|                                                                              |                                                                                                               |   |         | THREE MONTHS ENDED JUNE 30,
|                                                                              |                                                                                                               |   |         |                            
|                                                                              |                                                                                                               |   |         | 2002                        |   | 2001
|                                                                              |                                                                                                               |   |         |                             |   |     
|                                                                              |                                                                                                               |   |         | (in thousands)             
|Cash flows from operating activities:                                         |                                                                                                               |   |         |                             |   |      |         |        
|                                                                              | Net loss                                                                                                      |   | $       | (3,122                      | ) |      | $       | (19,938 | )
|                                                                              | Adjustments to reconcile net loss to net
cash used in operating activities:                                   |   |         |                             |   |      |         |         |  
|                                                                              | Depreciation and amortization                                                                                 |   |         | 2,305                       |   |      |         | 1,833   |  
|                                                                              | Provision for allowance for doubtful accounts                                                                 |   |         | 129                         |   |      |         | 1,320   |  
|                                                                              | Amortization of deferred stock compensation related to employee stock options and
non-employee stock warrants |   |         | 1,086                       |   |      |         | 5,001   |  
|                                                                              | Amortization of goodwill and intangibles                                                                      |   |         |                            |   |      |         | 10,508  |  
|Increase (decrease) in cash resulting from
changes in assets and liabilities: |                                                                                                               |   |         |                             |   |      |         |        
|                                                                              | Accounts receivable                                                                                           |   |         | 7,084                       |   |      |         | 6,055   |  
|                                                                              | Prepaid expenses and other current assets                                                                     |   |         | (558                        | ) |      |         | 934     |  
|                                                                              | Other non-current assets                                                                                      |   |         | 639                         |   |      |         | (463    | )
|                                                                              | Accounts payable                                                                                              |   |         | (4,654                      | ) |      |         | 486     |  
|                                                                              | Accrued expenses                                                                                              |   |         | (1,068                      | ) |      |         | (978    | )
|                                                                              | Accrued salaries and commissions                                                                              |   |         | (3,744                      | ) |      |         | (843    | )
|                                                                              | Accrued ESPP                                                                                                  |   |         | (885                        | ) |      |         | (2,331  | )
|                                                                              | Deferred revenue                                                                                              |   |         | (6,093                      | ) |      |         | (2,763  | )
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Net cash used in operating activities                                         |                                                                                                               |   | (8,881  | )                           |   |      | (1,179  | )      
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Cash flows from investing activities:                                         |                                                                                                               |   |         |                             |   |      |         |        
|                                                                              | Purchases of property and equipment                                                                           |   |         | (921                        | ) |      |         | (1,908  | )
|                                                                              | Net sales (purchases) of marketable securities available
for sale                                             |   |         | 24,833                      |   |      |         | (37,210 | )
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|                                                                              | Net cash provided by (used in) investing activities                                                           |   |         | 23,912                      |   |      |         | (39,118 | )
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Cash flows from financing activities:                                         |                                                                                                               |   |         |                             |   |      |         |        
|                                                                              | Borrowings under leasing agreements                                                                           |   |         | 2,500                       |   |      |         |        |  
|                                                                              | Payments on capital leases                                                                                    |   |         | (653                        | ) |      |         | (717    | )
|                                                                              | Proceeds from exercise of stock options and
stock issued under the ESPP                                       |   |         | 2,381                       |   |      |         | 5,454   |  
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Net cash provided by financing activities                                     |                                                                                                               |   | 4,228   |                             |   |      | 4,737   |        
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Effect of exchange rate on cash and cash equivalents                          |                                                                                                               |   | 736     |                             |   |      | 143     |        
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Net increase (decrease) in cash and cash equivalents                          |                                                                                                               |   | 19,995  |                             |   |      | (35,417 | )      
|Cash and cash equivalents at beginning of period                              |                                                                                                               |   | 98,497  |                             |   |      | 109,713 |        
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        
|Cash and cash equivalents at end of period                                    |                                                                                                               | $ | 118,492 |                             |   | $    | 74,296  |        
|                                                                              |                                                                                                               |   |         |                             |   |      |         |        

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

5



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

1. BASIS OF PRESENTATION

The accompanying consolidated financial
statements of webMethods, Inc. and its subsidiaries (collectively, the
Company) have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). This Quarterly Report on Form 10-Q should be read in conjunction
with the Companys Annual Report on Form 10-K for the year ended March 31, 2002. Certain information and
footnote disclosures which are normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to  SEC rules and regulations. The
information reflects all normal and recurring adjustments which, in the opinion of management, are necessary
for a fair presentation of the financial position of the Company, and its results of operations for the interim
periods set forth herein. The results for the three months ended June 30, 2002 are not necessarily indicative
of the results to be expected for the full year or any future period.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires that all business combinations initiated after
June 30, 2002 be accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that intangible assets
with finite useful lives be amortized and that goodwill and intangible assets
with indefinite lives will not be amortized, but will rather be tested at least
annually for impairment. Under the provisions of SFAS No. 142, any impairment
loss identified upon adoption of this standard is recognized as a cumulative
effect of a change in accounting principle. Any impairment loss incurred
subsequent to initial adoption of SFAS No. 142 is recorded as a charge to
current period earnings. In the event the Company acquires goodwill subsequent
to June 30, 2002 it will not be amortized. The Company adopted SFAS No. 142 on
April 1, 2002 and, at that time, stopped amortizing goodwill that resulted from
business combinations completed prior to the adoption of SFAS No. 141.

The following table
presents the impact of SFAS No. 142 on net loss and net
loss per share had SFAS No. 142 been in effect for the three months ended June 30,
2001 (in thousands, except share and per share amounts):

|                               |  |                    |            |      |  |   |            |  
|------------------------------ |  | ------------------ | ---------- | ---- |  | - | ---------- | -
|                               |  | Three months ended
|                               |  | June 30,          
|                               |  |                   
|                               |  | 2002               |            | 2001
|                               |  |                    |            |     
|Net loss                       |  | $                  | (3,122     | )    |  | $ | (19,938    | )
|Adjustments:                   |  |                    |            |      |  |   |            |  
|Amortization of
goodwill       |  |                    |           |      |  |   | 10,352     |  
|                               |  |                    |            |      |  |   |            |  
|Adjusted net
loss              |  | $                  | (3,122     | )    |  | $ | (9,586     | )
|                               |  |                    |            |      |  |   |            |  
|Weighted average
shares-basic  |  |                    | 50,564,625 |      |  |   | 48,839,735 |  
|                               |  |                    |            |      |  |   |            |  
|Adjusted basic and diluted EPS |  | $                  | (0.06      | )    |  | $ | (0.20      | )
|Reported basic and diluted EPS |  | $                  | (0.06      | )    |  | $ | (0.41      | )

There was no impairment recorded for the three months ended June 30, 2002.

In June 2002, the Financial Accounting Standards Board issued
SFAS No. 146 Accounting for Costs Associated with Exit or Disposal Activities. This standard is effective for exit or disposal
activities that are initiated after December 31, 2002. The adoption of this standard is not expected to have
a material effect on the Companys financial position or results of operations.

3. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

|                                             |                                                                |   |                             |    |      |   |     |       |  
|-------------------------------------------- | -------------------------------------------------------------- | - | --------------------------- | -- | ---- | - | --- | ----- | -
|                                             |                                                                |   | Three months ended June 30,
|                                             |                                                                |   |                            
|                                             |                                                                |   | 2002                        |    | 2001
|                                             |                                                                |   |                             |    |     
|                                             |                                                                |   | (in thousands)             
|Cash paid during the period for interest     |                                                                | $ | 107                         |    |      | $ | 122 |      
|                                             |                                                                |   |                             |    |      |   |     |      
|Non-cash investing and financing activities: |                                                                |   |                             |    |      |   |     |      
|                                             | Equipment purchased under capital lease                        |   | $                           | 27 |      |   | $   | 1,934 |  
|                                             |                                                                |   |                             |    |      |   |     |      
|                                             | Change in net unrealized gain or loss on marketable securities |   | $                           | 30 |      |   | $   | (104  | )
|                                             |                                                                |   |                             |    |      |   |     |      

6



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##### 



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

4. SEGMENT INFORMATION

The Company conducts operations worldwide
and is primarily managed on a geographic basis with those geographic segments being
the Americas, Europe and Asia Pacific region. Revenue is primarily attributable to the
region in which the contract is signed and the product is deployed. Information regarding
geographic areas is as follows:

|             |       |      |                    |        |  |   |        |        | 
|------------ | ----- | ---- | ------------------ | ------ |  | - | ------ | ------ | 
|             |       |      | THREE MONTHS ENDED
|             |       |      | JUNE 30,          
|             |       |      |                   
|REVENUE      |       | 2002 |                    | 2001  
|             |       |      |                    |       
|             |       |      | (in thousands)    
|Americas     |       | $    | 32,824             |        |  | $ | 40,366 |       
|Europe       |       |      | 9,230              |        |  |   | 10,810 |       
|Asia Pacific |       |      | 5,627              |        |  |   | 4,221  |       
|             |       |      |                    |        |  |   |        |       
|             | Total |      | $                  | 47,681 |  |   | $      | 55,397 | 
|             |       |      |                    |        |  |   |        |       

|                  |       |      |                |        |           |   |        |        | 
|----------------- | ----- | ---- | -------------- | ------ | --------- | - | ------ | ------ | 
|                  |       |      | AS OF          |        | AS OF    
|                  |       |      | JUNE 30,       |        | MARCH 31,
|LONG LIVED ASSETS |       | 2002 |                | 2002  
|                  |       |      |                |       
|                  |       |      | (in thousands)
|Americas          |       | $    | 53,350         |        |           | $ | 55,360 |       
|Europe            |       |      | 1,539          |        |           |   | 1,555  |       
|Asia Pacific      |       |      | 1,644          |        |           |   | 1,373  |       
|                  |       |      |                |        |           |   |        |       
|                  | Total |      | $              | 56,533 |           |   | $      | 58,288 | 
|                  |       |      |                |        |           |   |        |       

During the quarter ended September 30, 2001, the Company recorded a
restructuring charge of $7.2 million, consisting of $2.5 million for headcount
reductions, $4.0 million for consolidations of facilities, and $700,000 of
other related restructuring charges. These restructuring charges were taken to
align the Companys cost structure with changing market conditions. The
restructuring plan resulted in headcount reduction of approximately 150
employees or 14% of the workforce. The Company reduced the number of facilities
by closing excess field offices and consolidating several California facilities
into two locations. As of June 30, 2002 and March 31, 2002, respectively,
$2.8 million and $3.0 million of restructuring charge remained unpaid. This
portion primarily relates to rent on the excess facilities and will be paid
over the remaining rental periods.

6. SUBSEQUENT EVENT

Subsequent to June 30, 2002, the Company renewed its line of credit
agreement with a bank increasing its maximum borrowing amount from $10,000,000 to $20,000,000 with a
maturity date of October 10, 2003.

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

Readers are advised that this report contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those indicated by the
forward-looking statements. Statements using the words believes,
anticipates, plans, expects, intends, may, will, should,
estimates, predicts, continue and similar expressions are intended to
identify forward-looking statements. Examples of forward-looking statements
include, but are not limited to, (i) projections of revenue, costs or expense,
margins, income or loss, earnings or loss per share, capital expenditures, cash
requirements or other financial items and projections regarding the market for
integration software, (ii) statements of the plans or objectives of the Company
or its management, including the development or enhancement of software,
development and continuation of strategic partnerships and alliances,
implementation and effect of sales and marketing initiatives by the Company,
focus on geographic or specific vertical markets and allocation of resources to
them, predictions of the timing and type of customer or market reaction to
those initiatives, the ability to control expenses, future hiring, the Companys
business strategy and the execution on it, and actions by customers and
competitors, (iii) statements of future economic performance or economic
conditions and (iv) statements of assumptions underlying other statements or
statements about the Company or its business.

This report also identifies important factors that could cause actual
results to differ materially from those indicated by the forward-looking
statements. These risks and uncertainties include those factors discussed in
this Item under the caption Factors that May Affect Future
Operating Results. Forward-looking statements are beyond the ability of
the Company to control, and in many cases, the Company cannot predict what
factors may cause actual results to differ from those indicated by the
forward-looking statements. The Company disclaims any obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.

7



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##### 

OVERVIEW

Background

We are a leading provider of software and services for comprehensive
end-to-end integration solutions. We develop and deliver software products and
provide related services that give large organizations the ability, seamlessly
and in real-time, to integrate disparate information resources, to connect
customers, vendors and business partners with the organization and its
employees, to view and manage the connected information resources, data,
business processes and human workflows and to provide Enterprise Web Services.
By deploying the webMethods integration platform, customers can reduce costs,
create new revenue opportunities, strengthen relationships with customers,
vendors and business partners, substantially increase supply chain efficiencies
and streamline internal business processes.

In August 2000, webMethods acquired Active Software, Inc. (Active) in a
transaction that was accounted for as a pooling of interests.

Overview of First Quarter of Fiscal 2003

Our revenue for the first quarter ended June 30,
 2002 was $47.7 million,
a decrease of 14% compared to the quarter ended June 30, 2001. We decreased our
net loss to $3.1 million in the quarter ended June 30, 2002 from $19.9 million
from the quarter ended June 30, 2001 primarily due to a reduction in goodwill
amortization of $10.5 million resulting from the adoption of SFAS No. 142 (see
Recently Issued Accounting Pronouncements) and a reduction in cost of revenue and
operating expenses, partially offset by a decrease in revenue and interest
income.

License revenue decreased by 22% in
the quarter ended June 30, 2002
compared to the quarter ended June 30, 2001, reflecting the
reduction in information technology spending associated with the economic slowdown and the extension
of sales cycles for enterprise software sales.
Our
professional services revenue decreased in the quarter ended June 30, 2002,
compared to the quarter ended June 30, 2001 primarily due to an increase in the
number of customer implementations performed by system integrators, a decrease
in our billable consultants, and, to a lesser extent, an increase in the self-sufficiency of our customers to perform their
own implementations. Maintenance revenue grew in the quarter ended June 30, 2002, reflecting
the increase in our customer base and the cumulative effect of maintenance
contracts, which are recognized as revenue ratably over the term of the
contract.

We have continued to focus on cost management while continuing to expand and service
our customer base. Our cost of revenue and our operating expenses
totaled $52.1 million and were 23% lower than the
quarter ended June 30, 2001 after excluding amortization of goodwill and intangibles. This decrease was primarily due to lower
headcount and sales related expenses and a reduction in deferred stock charges. In July 2001, we reduced our headcount by
approximately 150 people or 14% from our June 30, 2001 headcount of 1,067. As
of June 30, 2002 our headcount was 899.

We sell our integration platform to Global 2000 customers through our
direct sales force augmented by system integrators, our relationships with
application software partners, and to a lesser extent, resellers. We license
our software to customers under either a renewable term or a perpetual license.
As of June 30, 2002, we had over 850 customers and as of June 30, 2001 we had
over 700 customers. Existing customers accounted for more than 50% of our revenue in the
quarter ended June 30, 2002 as a result of their expanded use of our software.
No customer accounted for more than 10% of our total revenue in quarters ended
June 30, 2002 and 2001.

We believe one of our competitive differentiators is
our strong
partnerships with application software companies and system integrators. Under
our partnerships with application software vendors, the partner may resell or
embed our software with their applications under limited use licenses for a
license or royalty fee. Leading enterprise application software vendors with
whom we have strong relationships include BroadVision, i2 Technologies, J.D.
Edwards, Lawson Software, SAP AG and Siebel Systems. Our application and system
integrator partners actively assist us in selling the full webMethods
integration platform to their customers, making us the logical choice for
enterprise-wide integration initiatives. We believe our partners influenced,
directly or indirectly, a substantial portion of our license revenue during the
quarter ended June 30, 2002, and we expect this leverage to continue. Under
certain partnership arrangements, we may share license fees derived from joint
selling opportunities with our partner. In other partnership arrangements, we
may pay a sales assistance fee to a partner who performs or assists in certain
sales activities, and that fee usually is paid once payment from the joint
customer of license fees is received.

Our focus on customer success and
satisfaction has resulted in an increasing number of referenceable customers,

8



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##### 



and a substantial portion of our license revenue in the quarter ended June
30, 2002 came from our existing customers. We strive to provide the most
comprehensive integration platform available, and will continue to invest to
ensure an advantageous positioning relative to our competition resulting in
recognized industry and technology leadership and increasing market share.

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

We enter into arrangements, which may include the sale of licenses of our
software, professional services and maintenance or various combinations of each
element. We recognize revenue based on Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended and modified by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions. SOP 98-9 modified SOP 97-2 by requiring revenue to be
recognized using the residual method if certain conditions are met. Revenue
is recognized based on the residual method when an agreement has been signed by
both parties, the fees are fixed or determinable, collection of the fees is
probable, delivery of the product has occurred, vendor specific objective
evidence of fair value exists for any undelivered element, and no other
significant obligations remain. Revenue allocated to the undelivered elements
is deferred using vendor-specific objective evidence of fair value of the
elements and the remaining portion of the fee is allocated to the delivered
elements (generally the software license).

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

Allowance for Doubtful Accounts

We maintain allowances for doubtful
accounts for estimated losses which
may result from the inability of our customers to make required payments to us.
These allowances are established through analysis of the credit worthiness of customers
and collectability of receivables by using information such as
credit reports from
third parties, published or publicly available financial information, customer
specific experience including payment practices and history, inquiries, and
other financial information from our customers. The use of different estimates
or assumptions could produce materially different allowance balances. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.

Valuation of Private Company Equity Investments

We record an investment impairment charge when we believe an investment in
corporate debt securities or in equity securities of private companies has declined
in value and that such a decline is other than temporary. The determination of
the value of the investments is based on information provided to us from the
private companies such as audited financial statements, valuations based on
recent sales of equity, projections, representations by management, and third
party valuations if available. Future adverse changes in market conditions or
poor operating results of the underlying companies could result in losses or a
perceived inability to recover the carrying

9



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##### 



value of the investments that may not be reflected in an investments
current carrying value, thereby possibly requiring an impairment charge in the
future.

Goodwill and Indefinite Lived Intangible Assets

Under SFAS No. 142, which we adopted on April 1, 2002, all of our goodwill
will be associated with our corporate reporting unit as we do not have multiple
reporting units. On an annual basis we will evaluate whether an impairment of
the goodwill may exist by comparing the book value of our outstanding common
stock to the market value of our outstanding common stock. If the market value
exceeds the book value, impairment does not exist. If the market value is less
than the book value, we will evaluate whether the condition is other than
temporary based primarily on fluctuations in our stock price. If we determine
that the condition is other than temporary, we will record an impairment equal
to the excess book value. See Recently Issued Accounting Pronouncements, for
more information.

Accounting for Income Taxes

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

RESULTS OF OPERATIONS

The following table summarizes the results of our operations for the fiscal quarters ended June 30, 2002 and 2001 (all percentages are calculated using the
underlying data in thousands):

|                         |  |          |        |            |  |                  |       |    |  |  |         |   
|------------------------ |  | -------- | ------ | ---------- |  | ---------------- | ----- | -- |  |  | ------- | --
|
|                         |  | June 30, |        | Percentage |  | June 30,        
|                         |  | 2002     |        | Change     |  | 2001            
|                         |  |          |        |            |  |                 
|                         |  |          |        |            |  | ($ in thousands) |       |    |  | 
|Total revenue            |  |          | 47,681 |            |  |                  | (13.9 | )% |  |  | 55,397  |   
|Gross Profit             |  |          | 37,203 |            |  |                  | (11.6 | )% |  |  | 42,105  |   
|% of total revenue       |  |          | 78.0   | %          |  |                  |       |    |  |  | 76.0    | % 
|Total operating expenses |  |          | 41,664 |            |  |                  | (35.6 | )% |  |  | 64,720  |   
|% of total revenue       |  |          | 87.4   | %          |  |                  |       |    |  |  | 116.8   | % 
|Operating loss           |  |          | (4,461 | )          |  |                  | (80.3 | )% |  |  | (22,615 | ) 
|% of total revenue       |  |          | (9.4   | )%         |  |                  |       |    |  |  | (40.8   | )%
|Net loss                 |  |          | (3,122 | )          |  |                  | (84.3 | )% |  |  | (19,938 | ) 
|% of total revenue       |  |          | (6.5   | )%         |  |                  |       |    |  |  | (36.0   | )%

During the quarter ended June 30, 2002, total revenue declined 14% from
the quarter ended June 30, 2001, to $47.7 million reflecting the continued
global economic slowdown and decline in information technology spending.
Our net loss of $3.1 million for the quarter ended June 30, 2002 decreased $16.8 million
from the quarter ended June 30, 2001, due primarily to the cessation of amortization of goodwill and
intangibles as well as decreased operating expenses and cost of revenue. This
decrease was partially offset by lower revenue and interest
income.

Revenue

The following table summarizes the Companys revenue for fiscal quarters ended June 30, 2002 and 2001:

|                      |  |          |        |            |  |                  |       |    |  |   |        | 
|--------------------- |  | -------- | ------ | ---------- |  | ---------------- | ----- | -- |  | - | ------ | 
|                      |  | June 30, |        | Percentage |  | June 30,        
|                      |  | 2002     |        | Change     |  | 2001            
|                      |  |          |        |            |  |                 
|                      |  |          |        |            |  | ($ in thousands) |       |    |  |  
|License               |  | $        | 28,669 |            |  |                  | (22.1 | )% |  | $ | 36,804 | 
|Professional services |  |          | 8,202  |            |  |                  | (15.4 | )% |  |   | 9,691  | 
|Maintenance           |  |          | 10,810 |            |  |                  | 21.4  | %  |  |   | 8,902  | 
|                      |  |          |        |            |  |                  |       |    |  |   |        | 
|Total revenue         |  | $        | 47,681 |            |  |                  | (13.9 | )% |  | $ | 55,397 | 
|                      |  |          |        |            |  |                  |       |    |  |   |        | 

10



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##### 



The following table summarizes the Companys net revenue by geographic
region for the fiscal quarters ended June 30, 2002 and 2001:



|              |  |          |        |            |  |                  |       |    |  |   |        | 
|------------- |  | -------- | ------ | ---------- |  | ---------------- | ----- | -- |  | - | ------ | 
|              |  | June 30, |        | Percentage |  | June 30,        
|              |  | 2002     |        | Change     |  | 2001            
|              |  |          |        |            |  |                 
|              |  |          |        |            |  | ($ in thousands) |       |    |  |  
|Americas      |  | $        | 32,824 |            |  |                  | (18.7 | )% |  | $ | 40,366 | 
|Europe        |  |          | 9,230  |            |  |                  | (14.6 | )% |  |   | 10,810 | 
|Asia Pacific  |  |          | 5,627  |            |  |                  | 33.3  | %  |  |   | 4,221  | 
|              |  |          |        |            |  |                  |       |    |  |   |        | 
|Total revenue |  | $        | 47,681 |            |  |                  | (13.9 | )% |  | $ | 55,397 | 
|              |  |          |        |            |  |                  |       |    |  |   |        | 

Total revenue decreased by 14%, to $47.7 million for the quarter ended

June 30, 2002, due to a decrease in license revenue and to a lesser extent a
decrease in professional services revenue, which was partially offset by an
increase in maintenance revenue.

In the quarter ended June 30, 2002, revenue from the Americas declined 19%
to $32.8 million due primarily to the reduction in information technology
spending associated with the economic slowdown and the extension of sales
cycles for enterprise software sales. International revenue decreased slightly
from $15.0 million to $14.9 million primarily due to the economic slowdown partially
offset by increased sales capacity and the increased customer base.
International revenue accounted for 31% of our total revenue in the quarter
ended June 30, 2002, as compared to 27% in the quarter ended June 30,
2001.

License revenue decreased by $8.1 million
to $28.7 million in the quarter
ended June 30, 2002 from the quarter ended June 30, 2001 due to a
decline in license revenue in the
Americas and Europe attributable to the global economic slowdown and decrease in technology spending.
That decline in license revenue
was partially offset by an increase in Asia Pacific license revenue. Asia Pacific revenue
increased in the quarter ended June 30, 2002, as a result of our expanded
direct sales capacity in Asia Pacific.

Professional services revenue decreased 15% to $8.2 million in the
quarter ended June 30, 2002 from the quarter ended June 30, 2001. This decrease in professional services revenue
reflects the increase in system integrator led customer implementations, a
decrease in our billable consultants and, to a lesser extent, an increase in the self
sufficiency of our customers to do their own implementations.

Maintenance revenue increased 21% to $10.8 million in the quarter ended June 30,
2002 from the quarter ended June 30, 2001. This increase is due primarily to the increase in
customers licensing our software, and the cumulative effect of agreements for
post-contract maintenance and support which are recognized as revenue ratably
over the term of the agreement.

Gross Profit

The following table summarizes the Companys gross profit by type of revenue, excluding stock based compensation:

|                                      |          |               |          |  |  |      |  
|------------------------------------- | -------- | ------------- | -------- |  |  | ---- | -
|                                      |          | Quarter Ended
|                                      |         
|                                      | June 30, |               | June 30,
|                                      | 2002     |               | 2001    
|                                      |          |               |         
|License                               |          | 99.5          | %        |  |  | 98.1 | %
|Professional services and maintenance |          | 46.0          | %        |  |  | 33.3 | %
|Total revenue                         |          | 78.2          | %        |  |  | 76.4 | %

We improved our total gross profit, excluding stock based compensation, to
78% in the quarter ended June 30, 2002 from 76% in the quarter ended
June 30, 2001. This improvement was due to a reduction
in our cost of licenses as well as improvements in our professional services
and maintenance margin.

Our cost of license revenue consists of royalties for products licensed
from third parties. Our gross profit on license revenue was 99% and  98% in
fiscal 2002 and 2001, respectively. The improvement in license gross
profit is due to our licensing of less royalty bearing products, and, to a
lesser extent, to the end of the amortization period under certain third
party contracts.

Our cost of professional services and maintenance consists of costs
related to internal professional services and support personnel,

11



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##### 



and subcontractors hired to provide implementation and support services.
Our gross profit on maintenance and services, excluding stock based
compensation, was 46% and  33% in the quarters ended June 30, 2002 and 2001, respectively.

The improvement in total gross profit
in the quarter ended June 30, 2002 is primarily due to
an increase in maintenance revenue and a decrease in the cost of professional
services and maintenance. The cost of professional services and maintenance,
excluding stock based compensation, in the quarter ended June 30, 2002,
decreased $2.1 million primarily due to a decrease in the number of
professional services  personnel, decreased use of
subcontractors and lower travel expenses, partially offset by an increase in the
number of technical support employees.

Operating Expenses

The following table presents certain information regarding webMethods
operating expenses during the fiscal quarters ended June 30, 2002 and 2001:

|                                            |  |          |        |            |  |                      |        |    |  |  |        |  
|------------------------------------------- |  | -------- | ------ | ---------- |  | -------------------- | ------ | -- |  |  | ------ | -
|                                            |  |          |        |            |  | Fiscal Quarter Ended
|                                            |  |         
|                                            |  | June 30, |        | Percentage |  | June 30,             |       
|                                            |  | 2002     |        | Change     |  | 2001                
|                                            |  |          |        |            |  |                     
|                                            |  |          |        |            |  | ($ in thousands)    
|Operating Expenses:                         |  |          |        |            |  |                      |        |    |  |  |        |  
|Sales and marketing*                        |  |          | 24,310 |            |  |                      | (19.5  | )% |  |  | 30,200
|% of total revenue                          |  |          | 51.0   | %          |  |                      |        |    |  |  | 54.5   | %
|Research and development*                   |  |          | 12,279 |            |  |                      | (7.7   | )% |  |  | 13,299 |  
|% of total revenue                          |  |          | 25.8   | %          |  |                      |        |    |  |  | 24.0   | %
|General and administrative*                 |  |          | 4,065  |            |  |                      | (31.1  | )% |  |  | 5,904 
|% of total revenue                          |  |          | 8.5    | %          |  |                      |        |    |  |  | 10.7   | %
|Stock based compensation and warrant
charge |  |          | 1,010  |            |  |                      | (79.0  | )% |  |  | 4,809  |  
|% of total revenue                          |  |          | 2.1    | %          |  |                      |        |    |  |  | 8.7    | %
|Amortization of goodwill and
intangibles    |  |          |       |            |  |                      | (100.0 | )% |  |  | 10,508 |  
|% of total revenue                          |  |          | 0.0    | %          |  |                      |        |    |  |  | 19.0   | %
|Operating expense                           |  |          | 41,664 |            |  |                      | (35.6  | )% |  |  | 64,720
|% of total revenue                          |  |          | 87.4   | %          |  |                      |        |    |  |  | 116.8  | %



---

|* |  | Excludes stock based compensation and warrant charge.
|- |  | -----------------------------------------------------

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

In July 2001, we took decisive actions to reduce our operating expenses to
realign our cost structure to address the changing market conditions caused by
the slowing of the global economy and technology spending. As part of this
action, we reduced our headcount by 14% or 150 employees through a reduction in
force, closed excess sales offices and consolidated our California facilities
into two locations. The headcount reductions were across all departments with
the exception of customer support. Since the restructuring, we have reduced
our quarterly operating expenses, excluding stock based
compensation and warrant charge, and amortization of goodwill and intangibles,
by 18% from $49.4 million in the quarter ended June 30,
2001, to $40.7 million in the quarter ended June 30, 2002.

12



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##### 



Sales and marketing expense, excluding stock based compensation and
warrant charge, was 51% and  55% of total revenue in the quarters ended
June 30, 2002 and  2001, respectively. In the quarter ended June 30, 2002,
sales and marketing expense decreased to $24.3 million from $30.2 million in
the quarter ended June 30, 2001. This decrease was primarily due to a decrease
in the number of sales and marketing employees, commission expense, marketing
programs expense, and recruiting expense.

Research and development expense, excluding stock based compensation, was
$12.3 million and  $13.3 million which represents 26% and  24%
of total revenue in the quarters ended June 30, 2002 and  2001,
respectively. In the quarter
ended June 30, 2002, research and development expense, excluding stock based
compensation, decreased $1.0 million from the quarter ended June 30, 2001 primarily due to a decrease in the number of
research and development personnel. This decrease was partially offset by
higher third party development expenses.

General and administrative expense, excluding stock based compensation, as
a percentage of total revenue was 9% and  11% for the quarters ended June
30, 2002 and  2001, respectively. In the quarter ended June 30, 2002,
general and administrative expense, excluding stock based compensation,
decreased $1.8 million from the quarter ended June 30, 2001, to $4.1 million.
This decrease is primarily due to a decrease in the provision for doubtful
accounts due to the improved quality and aging of our accounts receivable and
to a lesser extent by a decrease in the number of employees in the general and
administrative areas. This decrease was partially offset by increased corporate
insurance expense.

Stock based compensation and warrant charge was $1.1 million and $5.0 million
in the quarters ended June 30, 2002 and 2001, respectively, of which $76,000 and $192,000, respectively, was included in cost of
sales. Deferred stock based compensation and warrant charge was recorded for
the following transactions:



| |                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i) In connection with the grant of stock options to employees and
non-employee directors during the quarters ended March 31, 2000 and 1999, we
recorded aggregate unearned compensation of $15.5 million, representing the
difference between the deemed fair value of our common stock at the date of
grant and the exercise price of such options.



| |                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (ii) As a result of the acquisitions of Translink Software, Inc.,
Premier Software Technology, Inc. and Alier, Inc., we recorded a deferred
stock compensation charge of $27.9 million related to restricted stock issued
to stockholders of the acquired companies.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (iii) In March 2001 we entered into an OEM/Reseller agreement with i2
Technologies (i2) and issued a warrant which, as amended, permits i2 to
purchase 710,000 shares of our common stock at an exercise price of $28.70
per share. The fair value of the warrant was based on the Black-Scholes
valuation model was $23.6 million on the date of issuance which has been
recorded as a deferred warrant charge. As part of the agreement, i2 will pay
us OEM fees of $10.0 million over the term of the OEM/Reseller agreement
which will be recorded as a reduction to the deferred warrant charge and will
not be recorded as revenue.

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

We recorded goodwill and intangible assets in connection with the
acquisition of Premier and Translink in fiscal 2001 and Alier in fiscal 2000.
The estimated useful life of the goodwill and the acquired
intangibles during the quarter ended June 30, 2001 was three years for trained and acquired assembled workforce, one
year for license agreements, two years for non-compete agreements, three

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years for goodwill and four years for favorable lease terms.
We recorded $10.5 million of amortization of goodwill and acquired intangibles in the quarter ended June 30, 2001.
Amortization of the goodwill and acquired intangibles ceased on April 1, 2002
upon our adoption of SFAS No. 142 (see Recently Issued Accounting Pronouncements
for more information).

Interest income, net

Net interest income decreased by approximately $1.4 million or 52% to $1.3
million for the quarter ended June 30, 2002 from $2.7 million for the quarter
ended June 30, 2001. This decrease was primarily attributable to lower interest
rates on corporate paper, bonds and money market funds in the quarter ended
June 30, 2002, compared to those in the same period in the prior year.

Income taxes

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

LIQUIDITY AND CAPITAL RESOURCES

The following table presents selected financial statistics and information
for each of the two quarters ended June 30, 2002 and 2001:

|                                                     |            |   |                |         |          |   |         |         | 
|---------------------------------------------------- | ---------- | - | -------------- | ------- | -------- | - | ------- | ------- | 
|                                                     |            |   | June 30,       |         | June 30,
|                                                     |            |   | 2002           |         | 2001    
|                                                     |            |   |                |         |         
|                                                     |            |   | (in thousands)
|Cash, marketable securities and long term marketable |            |   |                |         |          |   |         |        
|                                                     | securities |   | $              | 207,031 |          |   | $       | 208,080 | 
|Working capital                                      |            | $ | 169,173        |         |          | $ | 161,970 |        

Historically we have financed our operations and met our capital
requirements though the sales of equity securities. Our liquidity and financial
position at June 30, 2002, showed a 1% decrease in our cash and investments and
a 4% increase in our working capital from our positions at June 30, 2001. The
increase in working capital is primarily due to an
increase in our cash and cash equivalents partially offset by increases in accounts payable and accrued expenses balances
at June 30, 2002, as compared to June 30, 2001.

Net cash used in operating activities was $8.9 million and $1.2 million in
the quarters ended June 30, 2002 and 2001, respectively. The increase in net
cash used in operating activities from 2001 to 2002 was due primarily to larger
decreases in our deferred revenue, accounts payable and accrued salaries and
commissions for the quarter ended June 30, 2002 compared to decreases in the quarter ended June 30, 2001.

Net cash provided by investing activities in the
quarter ended June 30,
2002 was $23.9 million, which was primarily due to maturity of
short-term  marketable
securities the proceeds of which were invested into cash and cash
equivalents due to the current low interest rate environment. This increase in net cash provided by investing activities
was partially offset by purchases of property and equipment. During the quarter ended June 30, 2001, we used $39.1 million of
net cash in investing activities, which was primarily due to the purchase of marketable securities and, to a lesser
extent, from the purchases of property and equipment. Capital expenditures were
$921,000 and $1.9 million in the quarters ended June 30, 2002 and 2001,
respectively. Capital expenditures consisted of purchases of operating
resources to manage operations, including computer hardware and software,
office furniture and equipment and leasehold improvements. We generally fund capital
expenditures either through capital leases and the
use of working capital.

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Net cash provided by financing activities was $4.2 million and $4.7
million in the quarters ended June 30, 2002 and 2001, respectively. These cash
flows primarily reflect net cash proceeds from exercises of stock
option and ESPP purchases in the quarters ended June 30, 2002
and 2001 and borrowings under lease agreements in the quarter ended
June 30, 2002.

Subsequent to June 30, 2002, we renewed and
expanded our line of credit to borrow up to a maximum principal amount of
$20,000,000 with a maturity date of October 10, 2003.
Any borrowings under this line bear interest at the banks prime rate per
annum and are limited to 80% of eligible accounts receivable. As of June 30, 2002,
we had not borrowed against this line of credit. In
connection with the line of credit, we have a letter of credit totaling
$355,000 related to an office lease.

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

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

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

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

We believe that quarter-to-quarter or year-to-year comparisons of our
financial results are not necessarily meaningful indicators of our future
revenue or operating results and should not be relied on as an indication of
our future performance. If our quarterly or annual revenue or operating results
fail to meet the expectations of investors or analysts, the market price of
webMethods stock could be negatively affected. Our quarterly operating results
have varied substantially in the past and may vary substantially in the future
depending upon a number of factors, including the changes in demand for our
products and services, economic conditions, competitive pressures, amount and
timing of operating costs and changes that we may make in our business,
operations and infrastructure. In addition, uncertainties and economic
after-effects of terrorist acts or other major, unanticipated events may impact
our quarterly operating results. In our fiscal 2002, we closed a substantial
number of license transactions in the last month of each quarter, which makes
it more difficult to gauge the level of license revenue we will have in any
quarter until near to, or after, its conclusion. We expect to continue devoting
resources to our sales and marketing operations and our research and
development activities. Our operating expenses, which include sales and
marketing, research and development and general and administrative expenses,
are based on our expectations of future revenue and are relatively fixed in the
short term. If revenue falls below our expectations in a quarter and we are not
able to quickly reduce our spending in response, our operating results for that
quarter could be significantly below the expectations of investors or analysts.
It is possible that our revenue or operating results in the future may be below
the expectations of investors or analysts and, as a result, the market price of
webMethods stock may fall. In addition, the stock market, particularly
the stock prices of infrastructure software companies, has been very
volatile. This volatility is often not related to the operating performance of
the companies. From our initial public offering in February 2000 until August 1,
2002, the closing price of webMethods stock on The Nasdaq National Market has
ranged from a high of $308.06 to a low of $6.32.

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

Due to customer demand, economic conditions, competitive pressures or
seasonal factors, we may experience a lower growth rate for, no growth in, or a
decline in quarterly or annual revenue from sales of our software and services.
For example, the growth rate for revenue from sales of our software and
services during summer months may be slower than at other times during year,
particularly in European markets. We also may experience declines in expected
revenue due to patterns in the capital budgeting and purchasing cycles of our
current and prospective customers, changes in demand for our software and
services and deferrals of purchases due to uncertainties and economic
after-effects of terrorist acts or other major, unanticipated events. These
periods of slower or no growth may lead to lower revenue, which could cause
fluctuations in our quarterly operating results. In addition, variations in
sales cycles may have an impact on the timing of our revenue, which in turn
could cause our quarterly operating results to fluctuate. To successfully sell
our software and services, we generally must educate our potential customers
regarding their use and benefits, which can require significant time and
resources. Any delay in sales of our software and services could cause our
revenue and operating results to vary significantly from quarter to quarter,
which could result in volatility in the market price of webMethods stock.

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The integration software and web services markets are highly competitive, and
we may not be able to compete effectively.

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

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

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

Our ability to expand our business and increase our revenue may be impaired and
we may lose important sales and marketing opportunities if we cannot maintain
our relationship with our strategic partners and add similar relationships with
other application software vendors, major systems integrators and resellers.

We currently have a number of strategic partners who provide leading
enterprise application software products, many of whom embed our software
directly into their application products. We also have strategic alliances with
major systems integrators. These strategic partners provide us with important
sales and marketing opportunities, leverage our direct sales force, create
opportunities to upsell our products to customers already using our software
embedded in their enterprise application products, and greatly increase our
implementation capabilities. If our relationships with any of these
organizations were impaired, if a significant number of our strategic partners
decide to compete against us in providing integration solutions or if our
competitors developed similar relationships with our strategic partners, we
might lose important opportunities, including sales and marketing
opportunities, and we may not be able to increase our penetration of the market
for integration software, which could have a material adverse effect on our
business, financial condition, revenue, operating results and the price of
webMethods stock.

In addition, if we are unable to develop additional
strategic relationships with other application software vendors, major systems
integrators or other technology leaders, we may not be able to increase our penetration of the market for integration software, increase our revenue or
expand our business in accordance with our business strategy, which could have
a material adverse effect on our business prospects, financial condition and
price of webMethods stock.

We are trying to increase our sales to the US Government and to others in the
public sector, and we may face difficulties in our attempts to procure new
contracts with them.

We are attempting to expand our customer base to include more entities and
agencies within the US Government and state and local governments. Developing
new business in the public sector often requires companies to develop
relationships with different agencies or entities, as well as other government
contractors. If we are unable to develop or sustain these relationships, we may
be unable to procure new contracts within the timeframe we expect, and our
business and financial results may be adversely affected. Contracting with the
US Government also requires businesses to participate in a highly competitive
bidding process to obtain new contracts. We are a young company, and we lack
substantial experience in bidding for public sector contracts. We may be unable
to bid competitively if our software and services are improperly priced or if
we are incapable of providing our software and services at a competitive price.
The bidding process is an expensive and time-consuming endeavor that may result
in a loss for webMethods if we fail to win a contract on which we submitted a
bid. Furthermore, some agencies within the US Government may also require some
or all of our personnel to obtain a security clearance. If our key personnel
are unable to obtain or retain this clearance, we may be unsuccessful in our
bid for some government contracts. The US Government may choose to change the
way it procures new contracts, and it may adopt new rules or regulations
governing contracts such as cost accounting standards. If these changes were
implemented, they could cause our costs to increase and may make it difficult
or impossible for us to obtain new contracts or keep any existing contracts
when they expire and are subject to renewal.

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Contracting with the US Government or state and local governments is very
different from contracting in the private sector, and these differences could
have a detrimental effect on our operating results.

Contracts with the US Government or with many state and local governments
frequently include provisions not found in the private sector and are often
governed by laws and regulations that do not affect private contracts. These
differences permit the public sector customer to take action not available to
customers in the private sector. This may include termination of current
contracts for convenience or due to a default. If a public sector customer
cancels a contract for convenience, which can occur if need for a
product changes, we may only be able to collect costs for work done prior
to the termination of the contract. If the public sector customer cancels
because of default, we may only be able to collect revenue for work we have
completed, and we may be forced to pay any costs the public sector customer
incurs for procuring the promised product from another source. The US
Government can also suspend operations if Congress does not allocate sufficient
funds, and the US Government may allow our competitors to protest our
successful bids. The US Government also may ban webMethods from doing business
with any government entity, and could also impose fines, levy sanctions or
subject us to a criminal prosecution. The US Government may refuse to invoke an
option to extend a contract and it could attempt to claim rights in
technologies and systems we invent. Some government agencies we contract with
may prohibit us from seeking contracts with certain other government agencies.
If any of these events occur, they may negatively affect our business and
financial results. In order to maintain contracts with the US Government,
webMethods must also comply with many rules and regulations that may affect our
relationship with other customers. The US Government can terminate its contract
with us if we come under foreign government control or influence, may require
that we disclose our pricing data during the course of negotiations, and may
require us to prevent access to classified data. If the US Government requires
us to meet any of these demands, it could result in increased costs or an
inability to take advantage of certain opportunities that may present
themselves in the future. US Government agencies routinely investigate and
audit government contractors administrative processes. They may audit our
performance and our pricing, and review our compliance with rules and
regulations. If they find that we have improperly allocated costs, they may
require us to refund those costs or may refuse to pay us for outstanding
balances related to the improper allocation. An unfavorable audit could result
in a reduction of revenue, and may result in civil or criminal liability if the
audit uncovers improper or illegal activities. This could harm our business,
financial results and reputation.

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

Customers that license our software typically engage our professional
services staff or third party consultants to assist with support, training,
consulting and implementation. We believe that many of our software sales
depend, in part, on our ability to provide our customers with these services
and to attract and educate third-party consultants to provide similar services.
New professional services personnel and service providers require training and
education and take time to reach full productivity, and competition for
qualified personnel and service providers is intense. Our business may be
harmed if we are unable to provide professional services to our customers and
establish and maintain relationships with third-party implementation providers.

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

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

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

Our success depends upon the continued service of our executive officers
and other key employees, and none of these officers or key employees is bound
by an employment agreement for any specific term. If we lose the services of
one or more of our executive officers or key employees, or if one or more of
them decide to join a competitor or otherwise compete directly or indirectly
with us, our business, operating results and financial condition could be
harmed. In particular, Phillip Merrick, our Chairman of the Board and Chief
Executive Officer, David Mitchell, our President and Chief Operating Officer,
R. James Green, our Chief Technology Officer and Executive Vice President, and
Mary Dridi, our Chief Financial Officer and Executive Vice President, would be
particularly difficult to replace. Our future success will also depend in large
part on our ability to attract and retain experienced technical, sales,
marketing and management personnel.

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

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

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

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

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

We have been, and intend to continue, expanding our international sales
efforts. We have limited experience in marketing, selling and supporting our
software and services abroad. Expansion of our international operations will
require a significant amount of attention from our management and substantial
financial resources. If we are unable to continue expanding our international
operations successfully and in a timely manner, our business and operating
results could be harmed. In addition, doing business internationally involves
additional risks, particularly: the difficulties and costs of staffing and
managing foreign operations; unexpected changes in regulatory requirements,
taxes, trade laws and tariffs; differing intellectual property rights;
differing labor regulations; and changes in a specific countrys or regions
political or economic conditions.

We are a young company and have a limited operating history with which to
evaluate our respective business and prospects.

We commenced operations in June 1996 and commercially released our first
software product in June 1998. Active Software, with which we completed a
merger in August 2000, was incorporated in September 1995 and commercially
released its first software product in August 1996. We have been operating as a
combined company since August 2000. If we do not generate sufficient cash
resources from our business to fund operations, our growth could be limited
unless we are willing to incur operating losses that may be substantial and are
able to fund those operating losses from our available assets or, if necessary,
from the sale of additional capital through public or private equity or debt
financings. If we are unable to grow as planned, our chances of achieving and
maintaining profitability and the anticipated or forecasted results of
operations could be reduced, which, in turn, could have a material adverse
effect on the market price of webMethods stock. Our software is complex and
generally involves significant capital expenditures by our customers. We do not
have a long history of selling our software, and we often have to devote
substantial resources to educate prospective customers about the benefits of
our software. Our efforts to educate potential customers may not result in our
software being accepted by the potential customer or achieving market
acceptance. In addition, many of these prospective customers have made
significant investments in internally-developed or custom systems and would
incur significant costs in switching to third party software such as ours.
Furthermore, even if our software is effective, our potential customers may not
choose it for technical, cost, support or other reasons. If the market for our
software fails to grow or grows more slowly than we anticipate, our business
could suffer.

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

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

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

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

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

We may acquire or make investments in other complementary businesses and
technologies in the future. We may not be able to identify other future
suitable acquisition or investment candidates, and even if we identify suitable
candidates, may not be able to make these acquisitions or investments on
commercially acceptable terms, or at all. If we acquire or invest in other
companies, we may not be able to realize the benefits we expected to achieve at
the time of entering into the transaction. In any future acquisitions, we will
likely face many or all of the risks inherent in integrating two corporate
cultures, product lines, operations and businesses. Further, we may have to
incur debt or issue equity securities to pay for any future acquisitions or
investments, the issuance of which could be dilutive to our existing
stockholders.

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

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

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

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

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

Third party claims that we infringe upon their intellectual property rights
could be costly to defend or settle.

Litigation regarding intellectual property rights is common in the
software industry. We expect that integration technologies and software
products and services may be increasingly subject to third-party infringement
claims as the number of competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. We may from
time to time encounter disputes over rights and obligations concerning
intellectual property. Although we believe that our intellectual property
rights are sufficient to allow us to market our software without incurring
liability to third parties, third parties may bring claims of infringement
against us. Such claims may be with or without merit. Any litigation to defend
against claims of infringement or invalidity could result in substantial costs
and diversion of resources. Furthermore, a party making such a claim could
secure a judgment that requires us to pay substantial damages. A judgment could
also include an injunction or other court order that could prevent us from
selling our software. Our business, operating results and financial condition
could be harmed if any of these events occurred. Furthermore, former employers
of our current and future employees may assert that our employees have
improperly disclosed confidential or proprietary information to us. In
addition, we have agreed, and may agree in the future, to indemnify certain of
our customers against claims that our software infringes upon the intellectual
property rights of others. We could incur substantial costs in defending
ourself and our customers against infringement claims. In the event of a claim
of infringement, we, as well as our customers, may be required to obtain one or
more licenses from third parties.

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We, or our customers, may be unable to obtain
necessary licenses from third parties at a reasonable cost, or at all. Defense
of any lawsuit or failure to obtain any such required licenses could harm our
business, operating results and financial condition.

Because our software incorporates technology licensed from third parties, the
loss of our right to use this licensed technology could harm our business.

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

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

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

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

Our Board of Directors adopted a shareholder rights plan and declared a
dividend distribution of one right for each outstanding share of webMethods
stock, payable to stockholders of record at the close of business on October
18, 2001. Each right, when exercisable, entitles the registered holder to
purchase certain securities at a specified purchase price, subject to
adjustment. The rights plan may have the anti-takeover effect of causing
substantial dilution to a person or group that attempts to acquire webMethods
on terms not approved by our Board of Directors. The existence of the rights plan could
limit the price that certain investors might be willing to pay in the future
for shares of webMethods stock and could discourage, delay or prevent a merger
or acquisition of webMethods, Inc. that stockholders may consider favorable. In
addition, provisions of the current certificate of incorporation and bylaws of
webMethods, Inc., as well as Delaware corporate law, could make it more
difficult for a third party to acquire us with the support of our Board of
Directors, even if doing so would be beneficial to our stockholders

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires that all business combinations initiated after
June 30, 2002 be accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that intangible assets
with finite useful lives be amortized and that goodwill and intangible assets
with indefinite lives will not be amortized, but will rather be tested at least
annually for impairment. Under the provisions of SFAS No. 142, any impairment
loss identified upon adoption of this standard is recognized as a cumulative
effect of a change in accounting principle. Any impairment loss incurred
subsequent to initial adoption of SFAS No. 142 is recorded as a charge to
current period earnings. In the event we acquire goodwill subsequent to June 30, 2002 it will not
be amortized. We adopted SFAS No. 142 on April 1, 2002 and, at that time, stopped
amortizing goodwill that
resulted from business combinations completed prior to the adoption of SFAS No. 141.
See the notes to the financial
statements for this impact of these standards.

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In June 2002, the Financial Accounting Standards Board issued
SFAS No. 146 Accounting for Costs Associated with Exit or
Disposal Activities,. This standard is effective for exit or
disposal activities that are initiated after December 31, 2002. The adoption
of this standard is not expected to have a material effect on the Companys
financial position or results of operations.

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest rate risk.We maintain our funds in money market accounts,
corporate bonds, commercial paper, Treasury notes, and agency notes. Our
exposure to market risk due to fluctuations in interest rates relates primarily
to our interest earnings on our cash deposits. These securities are subject to
interest rate risk inasmuch as their fair value will fall if market interest
rates increase. If market interest rates were to increase immediately and
uniformly by 10% from the levels prevailing as of June 30, 2002, the fair value
of the portfolio would not decline by a material amount. We do not use
derivative financial instruments to mitigate risks. However, we do have an
investment policy that would allow us to invest in short-term and long-term
investments such as money market instruments and corporate debt securities. Our
policy attempts to reduce such risks by typically limiting the maturity date of
such securities to no more than twenty-four months with a maximum average
maturity to our whole portfolio of such investments at twelve months, placing
our investments with high credit quality issuers and limiting the amount of
credit exposure with any one issuer.

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

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

PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On November 30, 2001, a purported class action lawsuit was filed in the Southern District of New York
naming the Company, several of its executive officers at the time of our initial public offering and the
managing underwriters of our initial public offering as defendants. The complaint alleges that the Companys
initial public offering registration statement and final prospectus contained material misrepresentations and
omissions related in part to certain commissions allegedly solicited and received by the underwriters, and
tie-in arrangements allegedly demanded by the underwriters, in connection with their allocation of shares in
our initial public offering. The complaint seeks unspecified damages on behalf of a purported class of
purchasers of common stock between February 10, 2000 and December 6, 2000. This case is at a very early
stage, and the Company has not formally responded to the allegations. However, management believes that the
claims against the Company and its officers are without merit, and we intend to defend against the complaint
vigorously.

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

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On February 10, 2000, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-91309) was declared effective by
the Securities and Exchange Commission, pursuant to which 4,715,000 share of
our common stock were offered and sold for our account at a price of $35.00 per
share, generating aggregate gross proceeds of $165 million for the account of
the Company. The managing underwriters were Morgan Stanley Dean Witter, Merrill
Lynch & Co., Dain Rauscher Wessels and Freidman Billings Ramsey. After
deduction approximately $11.6 million in underwriting discounts and $1.5
million in other related expenses, the net proceeds of the offering were
approximately $151.9 million. As of June 30, 2002, $151.9 million of the net
proceeds were invested in cash and cash equivalents, short-term and long-term
investments. We intend to use such proceeds for capital expenditures and for
general corporate purposes, including working capital to fund anticipated
operating losses.

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

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(a)  Exhibits.

|        |  |                                                                                                                                        |  |  |  | 
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Exhibit |  |                                                                                                                                        |  |  |  | 
|Number  |  | Description                                                                                                                            |  |  |  | 
|        |  |                                                                                                                                        |  |  |  | 
|2.1(1)  |  | Agreement and Plan of Merger dated as of May 20, 2000, by and
among webMethods, Inc., Wolf Acquisition, Inc. and Active
Software, Inc.
|3.1(2)  |  | Fifth Amended and Restated Certificate of Incorporation of
webMethods, Inc., as amended                                               
|3.2(3)  |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                       
|4.1(3)  |  | Specimen certificate for shares of webMethods Common Stock                                                                            
|4.2(4)  |  | Rights Agreement dated as of October 18, 2001 between webMethods, Inc. and American Stock Transfer & Trust Company.                   
|10.1(3) |  | Second Amended and Restated Investor Rights Agreement                                                                                 
|10.2(5) |  | webMethods, Inc. Amended and Restated Stock Option Plan                                                                               
|10.3(3) |  | Employee Stock Purchase Plan                                                                                                          
|10.4(3) |  | Indemnification Agreement entered into between webMethods, Inc.
and each of its directors and executive officers                      
|99.1*   |  | Certification of Chief Executive Officer                                                                                              
|99.2*   |  | Certification of Chief Financial Officer                                                                                              



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| | (1) |  | Incorporated by reference to webMethods Registration Statement on
Form S-4, as amended (File No. 333-39572).              
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------
|
| | (2) |  | Incorporated by reference to webMethods Annual Report on Form 10-K
for the year ended March 31, 2001 (File No. 001-15681).
|
| | (3) |  | Incorporated by reference to webMethods Registration Statement on
Form S-1, as amended (File No. 333-91309).              
|
| | (4) |  | Incorporated by reference to webMethods Registration Statement on
Form 8-A (File No. 001-15681)                           
|
| | (5) |  | Incorporated by reference to webMethods Annual Report on Form 10-K
for the year ended March 31, 2002 (File No. 001-15681).
|
| | *   |  | Filed herewith.                                                                                                            

(b)  Reports on Form 8-K.webMethods, Inc. filed no reports on
Form 8-K since the beginning of its fiscal quarter on April 1, 2002:

SIGNATURES

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

|                      |  |                                                                                         
|--------------------- |  | ----------------------------------------------------------------------------------------
|                      |  | WEBMETHODS, INC.                                                                        
|                     
|Date: August 13, 2002 |  | By: /s/ PHILLIP MERRICKPhillip Merrick
Chairman of the Board and
Chief Executive Officer
|                     
|Date: August 13, 2002 |  | By: /s/ MARY DRIDIMary Dridi
Chief Financial Officer
(Principal Financial Officer)      

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