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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549



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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, 2001

OR

|     |  |                                                                                         
|---- |  | ----------------------------------------------------------------------------------------
|[  ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 001-15681



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WEBMETHODS, INC.
(Exact Name of Registrant as Specified in its Charter)

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

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



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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 July 31, 2001,
49,426,083 shares of the registrants Common Stock, par
value $.01 per share, were issued and outstanding.



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WEBMETHODS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED JUNE 30, 2001
TABLE OF CONTENTS

|        |  |                                                                 
|------- |  | ----------------------------------------------------------------
|Part I  |  | Financial Information                                           
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|       
|       
|       
|Item 1  |  | Financial Statements                                            
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|       
|       
|        |  | Condensed Consolidated Financial Statements                     
|       
|       
|       
|       
|        |  | Condensed Consolidated Balance Sheets as of                     
|       
|       
|       
|       
|        |  | June 30, 2001 (unaudited) and March 31, 2001                    
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Operations (unaudited) -   
|       
|       
|       
|       
|        |  | Three months ended June 30, 2001 and 2000                       
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Cash Flows (unaudited) -   
|       
|       
|       
|       
|        |  | Three months ended June 30, 2001 and 2000                       
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|       
|       
|       
|        |  | Notes to Condensed Consolidated Financial Statements (unaudited)
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|       
|       
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|Item 2  |  | Managements Discussion and Analysis of Financial               
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|       
|       
|       
|        |  | Condition and Results of Operations                             
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|       
|       
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|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk      
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|Part II |  | Other Information                                               
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|Item 2  |  | Changes in Securities and Use of Proceeds                       
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|Item 6  |  | Exhibits and Reports on Form 8-K                                
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|        |  | (a) Exhibits                                                    
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|       
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|        |  | (b) Reports on Form 8-K                                         

1



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PART I FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

WEBMETHODS, INC.

CONSOLIDATED BALANCE SHEETS

|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |          |         | 
|---------------------------------------- | ----------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ---------------------------------------- | ------- | --------- | ------ | -------- | ------- | 
|                                         |                                                                                                                         |                                            |        | JUNE 30,                                 |         | MARCH 31,
|                                         |                                                                                                                         |                                            |        | 2001                                     |         | 2001     
|                                         |                                                                                                                         |                                            |        |                                          |         |          
|                                         |                                                                                                                         |                                            |        | (unaudited)                             
|                                         |                                                                                                                         |                                            |        | (in thousands, except share information)
|ASSETS                                  
|                                        
|                                        
|                                        
|                                        
|Current assets:                         
|                                        
|                                        
|                                        
|                                        
|                                         | Cash and cash equivalents                                                                                               |                                            | $      | 74,296                                   |         |           | $      | 109,713  |        
|                                        
|                                        
|                                        
|                                        
|                                         | Marketable securities available for sale                                                                                |                                            |        | 104,219                                  |         |           |        | 96,676   |        
|                                        
|                                        
|                                        
|                                        
|                                         | Accounts receivable, net of allowances of $4,759 and
$4,342, respectively                                               |                                            |        | 50,952                                   |         |           |        | 58,757   |        
|                                        
|                                        
|                                        
|                                        
|                                         | Prepaid expenses and other current assets                                                                               |                                            |        | 9,310                                    |         |           |        | 9,846    |        
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                         |                                                                                                                         | Total current assets                       |        |                                          | 238,777 |           |        |          | 274,992 | 
|                                        
|                                        
|                                        
|                                        
|Marketable securities available for sale |                                                                                                                         |                                            | 29,565 |                                          |         |           |       |         
|                                        
|                                        
|                                        
|                                        
|Property and equipment, net              |                                                                                                                         |                                            | 19,354 |                                          |         |           | 17,364 |         
|                                        
|                                        
|                                        
|                                        
|Goodwill and acquired intangibles, net   |                                                                                                                         |                                            | 58,026 |                                          |         |           | 68,535 |         
|                                        
|                                        
|                                        
|                                        
|Other assets                             |                                                                                                                         |                                            | 14,380 |                                          |         |           | 14,397 |         
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                         |                                                                                                                         | Total assets                               |        | $                                        | 360,102 |           |        | $        | 375,288 | 
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY    
|                                        
|                                        
|                                        
|                                        
|Current liabilities:                    
|                                        
|                                        
|                                        
|                                        
|                                         | Accounts payable                                                                                                        |                                            | $      | 8,698                                    |         |           | $      | 8,368    |        
|                                        
|                                        
|                                        
|                                        
|                                         | Accrued expenses                                                                                                        |                                            |        | 12,049                                   |         |           |        | 13,008   |        
|                                        
|                                        
|                                        
|                                        
|                                         | Accrued salaries and commissions                                                                                        |                                            |        | 12,246                                   |         |           |        | 15,536   |        
|                                        
|                                        
|                                        
|                                        
|                                         | Deferred revenue                                                                                                        |                                            |        | 41,243                                   |         |           |        | 45,585   |        
|                                        
|                                        
|                                        
|                                        
|                                         | Current portion of capital lease obligations                                                                            |                                            |        | 2,571                                    |         |           |        | 1,773    |        
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                         |                                                                                                                         | Total current liabilities                  |        |                                          | 76,807  |           |        |          | 84,270  | 
|                                         | Capital lease obligations, net of current portion and other                                                             |                                            |        | 3,054                                    |         |           |        | 2,613    |        
|                                        
|                                        
|                                        
|                                        
|                                         | Long term deferred revenue                                                                                              |                                            |        | 24,171                                   |         |           |        | 22,796   |        
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                         |                                                                                                                         | Total liabilities                          |        |                                          | 104,032 |           |        |          | 109,679 | 
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|Stockholders equity:                    |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                        
|                                        
|                                        
|                                        
|                                         | Common stock, $0.01 par value; 500,000,000 shares
authorized;   49,290,016 and 48,732,800 shares issued and
outstanding |                                            |        | 493                                      |         |           |        | 487      |        
|                                        
|                                        
|                                        
|                                        
|                                         | Additional paid-in capital                                                                                              |                                            |        | 502,766                                  |         |           |        | 499,825  |        
|                                        
|                                        
|                                        
|                                        
|                                         | Deferred stock compensation and warrant charge                                                                          |                                            |        | (30,644                                  | )       |           |        | (38,154  | )      
|                                        
|                                        
|                                        
|                                        
|                                         | Accumulated deficit                                                                                                     |                                            |        | (217,093                                 | )       |           |        | (197,155 | )      
|                                        
|                                        
|                                        
|                                        
|                                         | Accumulated other comprehensive gain                                                                                    |                                            |        | 548                                      |         |           |        | 606      |        
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                         |                                                                                                                         | Total stockholders equity                 |        |                                          | 256,070 |           |        |          | 265,609 | 
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         
|                                         |                                                                                                                         | Total liabilities and stockholders equity |        | $                                        | 360,102 |           |        | $        | 375,288 | 
|                                         |                                                                                                                         |                                            |        |                                          |         |           |        |         

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

2



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WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)

|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |        |         |        |         |  
|------------------------------------------------------------- | ---------------------------------------- | ------------------------- | ------------------------------------------- | -------------------------------------------------- | ------- | ----------------------------------------------- | ---------- | ------ | ------- | ------ | ------- | -
|                                                              |                                          |                           |                                             |                                                    |         | THREE MONTHS ENDED JUNE 30,                    
|                                                              |                                          |                           |                                             |                                                    |         |                                                
|                                                              |                                          |                           |                                             |                                                    |         | 2001                                            |            | 2000  
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|                                                              |                                          |                           |                                             |                                                    |         | (in
thousands, except share and per share data)
|Revenue:                                                     
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | License                                  |                           | $                                           | 36,804                                             |         |                                                 | $          | 23,986 |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Professional services                    |                           |                                             | 9,691                                              |         |                                                 |            | 7,743  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Maintenance                              |                           |                                             | 8,902                                              |         |                                                 |            | 3,336  |        
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|                                                              |                                          |                           |                                             | Total revenue                                      |         |                                                 | 55,397     |        |         |        | 35,065  |  
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Cost of revenue:                                             
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | License                                  |                           |                                             | 701                                                |         |                                                 |            | 1,002  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Professional services and maintenance:  
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Stock based compensation                    |                                                    |         | 192                                             |            |        |         | 217    |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Other professional services and maintenance |                                                    |         | 12,399                                          |            |        |         | 10,105 |        
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|                                                              |                                          |                           |                                             | Total cost of revenue                              |         |                                                 | 13,292     |        |         |        | 11,324  |  
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Gross profit                                                  |                                          |                           | 42,105                                      |                                                    |         |                                                 | 23,741     |       
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Operating expenses:                                          
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Sales and marketing:                    
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Stock based compensation and warrant charge |                                                    |         | 1,232                                           |            |        |         | 1,027  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Other sales and marketing costs             |                                                    |         | 30,200                                          |            |        |         | 19,474 |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Research and development:               
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Stock based compensation                    |                                                    |         | 3,490                                           |            |        |         | 2,752  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Other research and development costs        |                                                    |         | 13,299                                          |            |        |         | 7,661  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | General and administrative:             
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Stock based compensation                    |                                                    |         | 87                                              |            |        |         | 862    |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           | Other general and administrative costs      |                                                    |         | 5,904                                           |            |        |         | 4,105  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Amortization of goodwill and intangibles |                           |                                             | 10,508                                             |         |                                                 |            | 9,680  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | In-process research and development      |                           |                                             |                                                   |         |                                                 |            | 2,311  |        
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|                                                              |                                          |                           |                                             | Total operating expenses                           |         |                                                 | 64,720     |        |         |        | 47,872  |  
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Operating loss                                                |                                          |                           | (22,615                                     | )                                                  |         |                                                 | (24,131    | )     
|                                                             
|                                                             
|                                                             
|                                                             
|Interest income, net                                          |                                          |                           | 2,677                                       |                                                    |         |                                                 | 3,212      |       
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|                                                              |                                          | Net loss                  |                                             | $                                                  | (19,938 | )                                               |            | $      | (20,919 | )     
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Basic and diluted net loss per share                          |                                          | $                         | (0.41                                       | )                                                  |         | $                                               | (0.46      | )     
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Shares used in computing basic and diluted net
loss per share |                                          |                           | 48,839,735                                  |                                                    |         |                                                 | 45,907,352 |       
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|Comprehensive loss:                                          
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          | Net loss                  |                                             | $                                                  | (19,938 | )                                               |            | $      | (20,919 | )     
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          | Other comprehensive loss:
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           |                                             | Unrealized loss on securities available for
sale   |         |                                                 | (104       | )      |         |        | (14     | )
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                                          |                           |                                             | Foreign currency cumulative translation
adjustment |         |                                                 | 46         |        |         |        | 58      |  
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       
|                                                              |                                          |                           |                                             | Total comprehensive loss                           |         | $                                               | (19,996    | )      |         | $      | (20,875 | )
|                                                              |                                          |                           |                                             |                                                    |         |                                                 |            |       

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

3



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WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |         |         |  
|-------------------------------------------------------------------------------- | ------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | ------- | --------------------------- | ------ | ---- | ------- | ------- | ------- | -
|                                                                                 |                                                                                 |                                                                                                                       |         | THREE MONTHS ENDED JUNE 30,
|                                                                                 |                                                                                 |                                                                                                                       |         |                            
|                                                                                 |                                                                                 |                                                                                                                       |         | 2001                        |        | 2000
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |     
|                                                                                 |                                                                                 |                                                                                                                       |         | (in thousands)             
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flows from operating activities:                                           
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Net loss                                                                        |                                                                                                                       | $       | (19,938                     | )      |      | $       | (20,919 | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Adjustments to reconcile net loss to net
    cash used in operating activities:
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Depreciation and amortization                                                                                         |         |                             | 1,833  |      |         |         | 556     |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Provision for allowance for doubtful accounts                                                                         |         |                             | 1,320  |      |         |         | 367     |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Provision for warranty                                                                                                |         |                             |       |      |         |         | 88      |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Amortization of deferred stock compensation
    related to employee stock options and
    non-employee stock warrants |         |                             | 5,001  |      |         |         | 4,858   |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Amortization of goodwill and intangibles                                                                              |         |                             | 10,508 |      |         |         | 9,680   |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Write off of in-process research and development                                                                      |         |                             |       |      |         |         | 2,311   |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Increase (decrease) in cash resulting from
   changes in assets and liabilities:
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Accounts receivable                                                                                                   |         |                             | 6,055  |      |         |         | (11,642 | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Prepaid expenses and other current assets                                                                             |         |                             | 934    |      |         |         | (4,290  | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Other assets                                                                                                          |         |                             | (463   | )    |         |         | (1,096  | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Accounts payable                                                                                                      |         |                             | 486    |      |         |         | (347    | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Accrued expenses                                                                                                      |         |                             | (978   | )    |         |         | 2,173   |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Accrued salaries and commissions                                                                                      |         |                             | (843   | )    |         |         | 22      |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Accrued ESPP                                                                                                          |         |                             | (2,331 | )    |         |         | (688    | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                                                 | Deferred revenue                                                                                                      |         |                             | (2,763 | )    |         |         | 12,809  |  
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Net cash used in operating activities                                            |                                                                                 |                                                                                                                       | (1,179  | )                           |        |      | (6,118  | )      
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Cash flows from investing activities:                                           
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Purchases of property and equipment                                             |                                                                                                                       |         | (1,908                      | )      |      |         | (954    | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Net purchases of marketable securities available
    for sale                   |                                                                                                                       |         | (37,210                     | )      |      |         | (22,476 | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Purchase of investments in private companies                                    |                                                                                                                       |         |                            |        |      |         | (7,000  | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Acquisition of business, net of cash acquired                                   |                                                                                                                       |         |                            |        |      |         | (4,741  | )      
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Net cash used in investing activities                                            |                                                                                 |                                                                                                                       | (39,118 | )                           |        |      | (35,171 | )      
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Cash flows from financing activities:                                           
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Payments on capital leases                                                      |                                                                                                                       |         | (717                        | )      |      |         | (70     | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Repayments under notes and lines of credit                                      |                                                                                                                       |         |                            |        |      |         | (723    | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Proceeds from exercise of stock options and
    stock issued under the ESPP     |                                                                                                                       |         | 5,454                       |        |      |         | 3,768   |        
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Net cash provided by financing activities                                        |                                                                                 |                                                                                                                       | 4,737   |                             |        |      | 2,975   |        
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Effect of exchange rate on cash                                                  |                                                                                 |                                                                                                                       | 143     |                             |        |      | (46     | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Net decrease in cash and cash equivalents                                        |                                                                                 |                                                                                                                       | (35,417 | )                           |        |      | (38,360 | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash and cash equivalents at beginning of period                                 |                                                                                 |                                                                                                                       | 109,713 |                             |        |      | 171,716 |        
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        
|Cash and cash equivalents at end of period                                       |                                                                                 | $                                                                                                                     | 74,296  |                             |        | $    | 133,356 |        
|                                                                                 |                                                                                 |                                                                                                                       |         |                             |        |      |         |        

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

4



---



WEBMETHODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial
statements of webMethods, Inc. and its subsidiaries (collectively, the
Company) reflect all adjustments which, in the opinion of management, are
necessary for a fair presentation of the results of the interim periods
presented in conformity with generally accepted accounting principles for the
interim financial information. Such adjustments are of a normal recurring
nature. Intercompany balances and transactions have been eliminated in
consolidation.

The results of the interim periods presented are not necessarily
indicative of the results for the year or any current or 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, 2001 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, 2001 it will not be amortized.
The Company will adopt SFAS No. 142 in fiscal 2003 and, at that time, will stop
amortizing goodwill that resulted from business combinations completed prior to
the adoption of SFAS No. 141. The Company is currently evaluating the provisions of SFAS No. 142
and has not yet determined the effect that adoption of this standard will have
on its consolidated financial statements.

3. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

|                                            |                                                        |       |     |                    |   |      |       |         |   | 
|------------------------------------------- | ------------------------------------------------------ | ----- | --- | ------------------ | - | ---- | ----- | ------- | - | 
|                                            |                                                        |       |     | THREE MONTHS ENDED
|                                            |                                                        |       |     | JUNE 30,          
|                                            |                                                        |       |     |                   
|                                            |                                                        |       |     | 2001               |   | 2000
|                                            |                                                        |       |     |                    |   |     
|                                            |                                                        |       |     | (in
thousands)    
|Cash paid during the period for interest    |                                                        | $     | 122 |                    |   | $    | 46    |        
|                                            |                                                        |       |     |                    |   |      |       |        
|Non-cash investing and financing activities |                                                        |       |     |                    |   |      |       |        
|                                            | Equipment purchased under capital lease                |       | $   | 1,934              |   |      | $     | 190     |  
|                                            |                                                        |       |     |                    |   |      |       |        
|                                            | Change in net unrealized loss of
marketable securities |       | $   | (104               | ) |      | $     | (14     | )
|                                            |                                                        |       |     |                    |   |      |       |        
|Translink Acquisition:                     
|                                           
|                                           
|                                           
|                                           
|                                            | Fair value of assets acquired, net of cash acquired    |       |     |                   |   |      | $     | 82,209  |  
|                                           
|                                           
|                                           
|                                           
|                                            |                                                        | Less:
|                                           
|                                           
|                                           
|                                           
|                                            | Liabilities assumed                                    |       |     |                   |   |      |       | (593    | )
|                                           
|                                           
|                                           
|                                           
|                                            | Common stock issued in connection with the
acquisition |       |     |                   |   |      |       | (79,678 | )
|                                            |                                                        |       |     |                    |   |      |       |        
|                                            |                                                        |       |    |                    |   |      | 1,938 |        
|                                           
|                                           
|                                           
|                                           
|                                            | Write off of in-process research and development       |       |     |                   |   |      |       | 2,311   |  
|                                            |                                                        |       |     |                    |   |      |       |        
|                                            | Cash paid for acquisition, net of cash acquired        |       | $   |                   |   |      | $     | 4,249   |  
|                                            |                                                        |       |     |                    |   |      |       |        
|Premier Acquisition:                       
|                                           
|                                           
|                                           
|                                           
|                                            | Fair value of assets acquired, net of cash acquired    |       |     |                   |   |      |       | 13,947  |  
|                                           
|                                           
|                                           
|                                           
|                                            |                                                        | Less:
|                                           
|                                           
|                                           
|                                           
|                                            | Liabilities assumed                                    |       |     |                   |   |      |       | (462    | )
|                                           
|                                           
|                                           
|                                           
|                                            | Common stock issued in connection with the
acquisition |       |     |                   |   |      |       | (12,993 | )
|                                            |                                                        |       |     |                    |   |      |       |        
|                                            | Cash paid for acquisition, net of cash acquired        |       | $   |                   |   |      | $     | 492     |  
|                                            |                                                        |       |     |                    |   |      |       |        

5



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WEBMETHODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

4. SEGMENT INFORMATION

The Company markets its products in the United States and in foreign
countries. Information regarding geographic areas for the three months ended
June 30, 2001 and 2000 are as follows:

|              |       |                |                    |        |  |   |        |        | 
|------------- | ----- | -------------- | ------------------ | ------ |  | - | ------ | ------ | 
|              |       |                | THREE MONTHS ENDED
|              |       |                | JUNE 30,          
|              |       |                |                   
|REVENUES      |       | 2001           |                    | 2000  
|              |       |                |                    |       
|              |       | (in thousands)
|North America |       | $              | 40,366             |        |  | $ | 33,817 |       
|             
|             
|             
|             
|Europe        |       |                | 10,810             |        |  |   | 1,248  |       
|             
|             
|             
|             
|Asia Pacific  |       |                | 4,221              |        |  |   |       |       
|              |       |                |                    |        |  |   |        |       
|              | Total |                | $                  | 55,397 |  |   | $      | 35,065 | 
|              |       |                |                    |        |  |   |        |       

|                  |       |                |          |         |           |   |        |         | 
|----------------- | ----- | -------------- | -------- | ------- | --------- | - | ------ | ------- | 
|                  |       |                | AS OF    |         | AS OF    
|                  |       |                | JUNE 30, |         | MARCH 31,
|LONG LIVED ASSETS |       | 2001           |          | 2001   
|                  |       |                |          |        
|                  |       | (in thousands)
|North America     |       | $              | 119,113  |         |           | $ | 97,853 |        
|                 
|                 
|                 
|                 
|Europe            |       |                | 1,319    |         |           |   | 1,236  |        
|                 
|                 
|                 
|                 
|Asia Pacific      |       |                | 893      |         |           |   | 1,207  |        
|                  |       |                |          |         |           |   |        |        
|                  | Total |                | $        | 121,325 |           |   | $      | 100,296 | 
|                  |       |                |          |         |           |   |        |        

5. OPTION EXCHANGE PROGRAM

In April 2001, the Company implemented an option exchange program whereby
employees were offered the opportunity to exchange stock options with
split-adjusted exercise prices of $40.00 and above for new options to purchase
an equal number of shares. The new options will be granted at least six months
and one day following the date the options were accepted for exchange but no
later than December 31, 2001. The exercise price of the new options will be
the closing market price of the Companys common stock on the Nasdaq Stock
Market on the grant date of the new options. A total of 7,489,000 options were surrendered for
exchange under this program.

6. SUBSEQUENT EVENTS

In July 2001, the Company announced a reduction in force and will take a
restructuring charge in the quarter ending September 30, 2001. This
restructuring charge will consist primarily of charges related to headcount
reductions and consolidation of facilities. The plan will result in headcount
reductions of approximately 15%, and the Company expects to consolidate certain of its main
facilities and close excess field offices.

6



---



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

The following discussion of the Companys financial condition and results
of operations should be read in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations contained in the
Companys Annual Report on Form 10-K for the year ended March 31, 2001 (File
No. 001-15681). The information contained herein is not a comprehensive
discussion and analysis of the financial condition and results of operations,
but rather updates the disclosures made in the Companys Annual Report on Form
10-K.

Certain information contained herein should be considered forward-looking
information, which is subject to a number of substantial risks and
uncertainties. Statements contained herein that are not statements of
historical fact may be deemed to be forward-looking information. Without
limiting the foregoing, words such as anticipates, believes, could,
estimate, expect, intend, may, might, should, will, and would
and other forms of these words or similar words are intended to identify
forward-looking information. Such forward-looking statements are made only as
of the date of this report. The Companys actual results could differ
materially from those contained in forward-looking statements. Important
factors known to the Company that could cause such material differences are
discussed under the caption Factors that May Affect Future Operating Results
in the Business section of the Companys abovementioned Form 10-K. The Company
undertakes no obligations to publicly update or revise any forward-looking
information, whether as a result of new information, future events or
otherwise.

OVERVIEW

Background

We are a leading provider of infrastructure software and services for
comprehensive end-to-end integration solutions that enable our customers to
achieve comprehensive automation of business processes by integrating their
systems in real time. Our customers use our software,
webMethods Enterprise, webMethods B2B, and webMethods Mainframe
Integration Server, to integrate
business processes among different systems within their enterprise and to work more closely with their
customers, suppliers and other business partners through the real-time exchange
of information and transactions. webMethods Extended Enterprise
Solution Suite permits our customers to rapidly and cost effectively
deploy new real-time business-to-business (B2B) e-commerce
applications by better integrating their existing internal enterprise
systems and by integrating those systems with those of their business
partners.

webMethods was founded in June 1996. In August 2000, webMethods acquired Active
Software, Inc. (Active) in a transaction which was accounted for as a pooling
of interests. Active was founded in September 1995. We have grown from 94
employees as of March 31, 1998 to 1,067 employees as of
June 30, 2001.

Revenue

We enter into arrangements, which may include the sale of licenses of our
integration 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 and no other
significant obligations remain. Historically we have not experienced
significant returns or offered exchanges of our products.

For multi-element arrangements, each element of the arrangement is
analyzed and we allocate a portion of the total fee under the arrangement to
the undelivered elements, such as professional services, training and
maintenance. 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), under the residual method. Vendor specific-objective
evidence of fair value is based on the price the customer is required to pay
when the element is sold separately (i.e. hourly time and material rates
charged for consulting services when sold separately from a software license
and the optional renewal rates charged by us for maintenance arrangements).

For electronic delivery, the product is considered to have been delivered
when the access code to download the software from our website and activation
key, as applicable, have been provided to the customer. If an element of the
license agreement has not been delivered, revenue for the element is deferred
based on its vendor-specific objective evidence of fair value. If
vendor-specific objective evidence of fair value does not exist, all revenue is
deferred until sufficient objective evidence exists or all elements have been
delivered. If the fee due from the customer is not fixed or determinable,
revenue is recognized as payments become due. If collectibility is not
considered probable, revenue is recognized when the fee is collected.

License Revenue:Amounts allocated to license revenue under the residual
method are recognized at the time of delivery of the software when
vendor-specific objective evidence of fair value exists for the undelivered
elements, if any, and all the other revenue recognition criteria discussed
above have been met.

Professional Services Revenue:Revenue from professional services is
comprised of consulting, implementation services and training. Consulting
services are generally sold on a time-and-materials basis and include services
such as installation and building non-complex interfaces to allow the software
to operate in customized environments. Services are generally separable from
the other elements under the arrangement since the performance of the services
is not essential to the functionality (i.e. the services do not involve
significant production, modification or customization of the software or
building complex interfaces) of any other element of the transaction. Revenue
for professional services and training is recognized when the services are
performed.

Maintenance Revenue:Maintenance revenue consists primarily of fees for
providing when-and-if-available unspecified software upgrades and technical
support over a specified term. Maintenance revenue is recognized on a
straight-line basis over the term of the contract.

Costs of Revenue

Our cost of license revenue primarily includes royalties related to third
parties software embedded in our products or sold to our customers. Our cost
of professional services and maintenance revenue includes compensation and
related expenses for our professional services and technical support
organizations, costs of third-party consultants we use to provide professional
services to customers and an allocation of overhead and recruitment costs.

7



---



Operating Expenses

Our operating expenses are 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 include expenses which are specific to the sales
and marketing activities, such as commissions, trade shows, public relations,
promotional costs and marketing collateral. Also included in our operating
expenses is the amortization of deferred stock compensation and deferred
warrant charge.

RECENT DEVELOPMENTS

In July 2001, we announced a reduction in force and will take a
restructuring charge in the quarter ending September 30, 2001. This
restructuring charge will consist primarily of charges related to headcount
reductions and consolidation of facilities. The plan will result in headcount
reductions of approximately 15%, and we expect to
consolidate some of our main
facilities and close excess field offices.

RESULTS OF OPERATIONS

Revenue

Total revenue increased by
approximately $20.3 million, or 58.0%, to $55.4
million for the three months ended June 30, 2001 from $35.1 million for the
three months ended June 30, 2000.

License. License revenue increased by approximately $12.8 million, or
53.4%, to $36.8 million for the three months ended June 30, 2001 from $24.0
million for the three months ended June 30, 2000. License revenue as a
percentage of total revenue was 66.4% and 68.4% for the quarters ended June 30,
2001 and 2000, respectively. The absolute dollar increase was primarily
attributable to an increase in sales to new and existing customers resulting
from increased sales force headcount, new products, features and enhancements,
a growing acceptance of our integration software, new and expanded
relationships with many systems integration and enterprise application vendors
and an increased presence internationally.

Professional Services. Professional services revenue increased by
approximately $1.9 million, or 25.2%, to $9.7 million for the three months
ended June 30, 2001 from $7.7 million for the three months ended June 30, 2000.
Professional services revenue as a percentage of total revenue was 17.5% and
22.1% for the quarters ended June 30, 2001 and 2000,
respectively. The absolute dollar increase
was attributable to the increased licensing activity described above, which has
resulted in increased customer implementation activity and follow-on
professional services. The decrease in professional service revenue as a
percentage of total revenue was due primarily to our increased use of
systems integration partners to provide professional services to our customers.

Maintenance. Maintenance revenue increased by approximately $5.6 million,
or 166.8%, to $8.9 million for the three months ended June 30, 2001 from $3.3
million for the three months ended June 30, 2000. Maintenance revenue as a
percentage of total revenue was 16.1% and 9.5% for the quarters ended June 30,
2001 and 2000, respectively. These increases are due primarily to our increased
license activity as described above since most license contracts include post
contract maintenance and support which is recognized as revenue on a ratable
basis over the term of the maintenance agreement.

Cost of Revenue

License. Cost of license revenue decreased by approximately $301,000, or
30.0%, to $701,000 for the three months ended June 30, 2001 from $1.0 million
for the three months ended June 30, 2000. Cost of license revenue as a
percentage of total revenue was 1.3% and 2.9% for the quarters ended June 30,
2001 and 2000, respectively. This decrease in the cost of license
revenue was
primarily due to decreased sales of our product which incorporates third party
technology for which we pay royalties, and to a lesser extent, the amortization
of prepaid third party software licensing fees. Gross profit margin on license
revenue increased to 98.1% for the three months ended June 30, 2001 compared to
95.8% for the three months ended June 30, 2000. The improvement in gross
margin was attributable to a smaller proportion of our products sold
that incorporated third party technology for which we pay royalties.

Professional Services and
Maintenance. Cost of professional services and
maintenance, excluding stock based compensation, increased by approximately $2.3 million, or 22.7%, to $12.4 million
for the three months ended June 30, 2001 from $10.1 million for the three
months ended June 30, 2000. Cost of professional services and

8



---



maintenance revenue, excluding
stock based compensation, as a percentage of total
revenue was 22.4% and 28.8% for the quarters ended June 30, 2001 and 2000,
respectively. The absolute dollar increase was primarily attributable to
increases in the number of professional service and technical support personnel
and, to a lesser extent, increases in subcontractor and travel expenses. Gross
profit margin on professional services and maintenance, excluding
stock based compensation, increased to 33.3% of
professional services and maintenance revenue for the three months ended June
30, 2001 compared to 8.8% for the three months ended June 30, 2000. The
increase in gross profit margin was due primarily to the increase in maintenance
revenue, which has a lower cost associated with it, as well as increase in the
rates charged on professional services.

Gross Profit

Gross profit increased by approximately $18.4 million, or 77.4%, to $42.1
million for the three months ended June 30, 2001 from $23.7 million for the
three months ended June 30, 2000. The increase was attributable to the growth
in our customer base, which contributed to increased revenue from software
licenses, professional services and maintenance, and, to a lesser extent, a
decrease in third party royalties as a percentage of license revenue and a
decrease in professional services revenue as a percentage of total revenue.
The gross profit margin was 76.0% for the quarter ended June 30, 2001, up from
67.7% for the quarter ended June 30, 2000.

Operating Expenses

Sales and Marketing. Sales and marketing expenses, excluding
stock based compensation, increased by
approximately $10.7 million, or 55.1%, to $30.2 million for the three months
ended June 30, 2001 from $19.5 million for the three months ended June 30,
2000. Sales and marketing expense, excluding
stock based compensation, as a percentage of total revenue was 54.5% and
55.5% for the quarters ended June 30, 2001 and 2000, respectively. The absolute
dollar increase in sales and marketing expenses was primarily attributable to an
increase in the number of sales and marketing employees, commissions,
international expansion and, to a lesser extent, increases in external
commissions and marketing programs which include trade shows, public relations,
promotional costs and marketing collateral.

Research and
Development. Research and development expenses, excluding
stock based compensation, increased by
approximately $5.6 million, or 73.6%, to $13.3 million for the three months
ended June 30, 2001 from $7.7 million for the three months ended June 30, 2000.
Research and development expense, excluding
stock based compensation, as a percentage of total revenue is 24.0% and
21.8% for the quarters ended June 30, 2001 and 2000, respectively. The absolute
dollar increase in research and development expenses was primarily attributable to
increases in the number of software development, pre-commercial release quality
assurance and documentation personnel, and, to a lesser extent, third-party
development costs.

General and
Administrative. General and administrative expenses, excluding
stock based compensation, increased
by approximately $1.8 million, or 43.8%, to $5.9 million for the three months
ended June 30, 2001 from $4.1 million for the three months ended June 30, 2000.
General and administrative expense, excluding
stock based compensation, as a percentage of total revenue is 10.7%
and 11.7% for the quarters ended June 30, 2001 and 2000, respectively. The
absolute dollar increase in general and administrative expenses was
primarily attributable
to external legal, accounting and other professional fees, provision for
allowance for doubtful accounts, increases in the number of accounting, finance
and human resources personnel and implementation of systems infrastructure.

Stock Based Compensation
and Warrant Charge. In connection with the grant
of stock options to employees and non-employee directors during the years 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. As a
result of the acquisitions of companies in February and April 2000 we recorded a
deferred stock compensation charge of $27.9 million related to restricted stock
issued to stockholders of the acquired companies. In connection with the
Active merger, 50% of Active's remaining options vested upon consummation of the merger which resulted
in an acceleration of amortization of deferred stock compensation.

In connection with an
OEM/Reseller agreement with i2 Technologies (i2), we issued a
warrant, as amended, to i2 to purchase 710,000 shares of our common stock at an
exercise price of $28.70 per share. The fair value of the original warrant based on the
Black-Scholes valuation model was $23.6 million on the date of issuance which
has been recorded as a deferred warrant charge. As part of the agreement, i2
will pay us OEM fees of $10,000,000 over the term of the 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 deferred 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. Of the
total deferred stock compensation and warrant charge recorded for options,
restricted stock and warrants, approximately $5.0 million was amortized during
the quarter ended June 30, 2001, compared to $4.9 million during the quarter
ended June 30, 2000.

Amortization of Goodwill
and Acquired Intangibles. Amortization of goodwill and
acquired intangibles was $10.5 million for the quarter ended June 30,
2001 and $9.7 million for the quarter ended June 30, 2000. The
estimated useful life of the goodwill and the acquired intangibles is
3 years for trained and acquired assembled workforce, one year for
license agreements, 2 years for non-compete agreements, 3 years for
goodwill and 4 years for favorable lease terms. The goodwill and
acquired intangibles relate to the acquisitions of companies in
February and April 2000.

In-process research and
development. In-process research and development
was expensed upon consummation of an acquisition in April
2000 as acquired technology had not
reached technological feasibility and, in the opinion of management, has no
alternative future use. For the
three months ended June 30, 2000, $2.3 million was expensed related to
in-process research and development.

9



---



Interest Income, Net

Interest income, net decreased
by approximately $535,000, or 16.7%, to
$2.7 million for the three months ended June 30, 2001 from $3.2 million for the
three months ended June 30, 2000. This decrease was primarily
attributable to lower interest rates on corporate paper, bonds and money market funds
available in the quarter ended June 30, 2001 compared to those in the
quarter ended June 30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations through an initial public offering of our
common stock which was completed on February 10, 2000, private sales of
mandatorily redeemable, convertible preferred stock, prior to March 31, 2000, and, to a lesser extent, through bank loans
and equipment leases. As of June 30, 2001, we had approximately $74.3 million in
cash and cash equivalents, approximately $104.2 million in short-term
investments, approximately $29.6 million in long-term investments and
approximately $162.0 million in working capital.

Net cash used in operating activities was approximately $1.2 million for
the three months ended June 30, 2001, and approximately $6.1 million for the three months ended June 30, 2000. Net cash used
from operating activities in each period reflects net losses offset in part by
amortization of goodwill and intangibles and a decrease in accounts
receivable as of June 30, 2001.

Net cash used in investing activities was approximately $39.1 million for
the three months ended June 30, 2001, and approximately $35.2 million for the
three months ended June 30, 2000. Cash used in investing activities primarily
reflects purchases of marketable securities available for sale in each period.
Capital expenditures were approximately $1.9 million for the three months ended
June 30, 2001 and $954,000 for the three months ended June 30, 2000. Capital
expenditures consisted primarily of purchases of operating resources to manage
operations, including computer hardware and software, office furniture and
equipment and leasehold improvements. Since inception we have generally funded
capital expenditures either through capital leases, the use of working capital,
or bank loans.

Net cash from financing activities was approximately $4.7 million for the
three months ended June 30, 2001, and approximately $3.0 million for the three
months ended June 30, 2000. These cash flows in the three months ended June 30,
2001 primarily reflect net cash proceeds from issuance of shares of
our common stock through the employee stock purchase plan and the proceeds from the exercise of stock
options. As of June 30, 2001, we had a line of
credit to borrow up to a maximum principal amount of $10,000,000 with a
maturity date of July 10, 2002. Borrowings under this line of
credit are limited to 80% of eligible accounts receivable. Interest is payable on the unpaid principal
balance at the banks prime rate. As of June 30, 2001 and 2000, we had not
borrowed against this line of credit. In connection with the line of credit,
we obtained a letter of credit totaling $750,000 outstanding as of June 30,
2000, which was subsequently reduced to $475,000 outstanding as of June 30,
2001. This letter of credit expires in May 2002 and relates 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
twelve months. Thereafter, we may find it necessary to obtain additional equity
or debt financing. In the event additional financing is required, we may not be
able to raise it on acceptable terms or at all.

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, 2001 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, 2001 it will not be amortized. The Company will adopt SFAS No. 142 in
fiscal in 2003 and,
at that time, will stop amortizing goodwill that resulted from business
combinations completed prior to the adoption of SFAS No. 141. The Company is currently evaluating
the provisions of SFAS No. 142 and has not yet determined the effect that
adoption of this standard will have on its consolidated financial statements.

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 and certificate of deposit accounts
at financial institutions. 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 in as much as their fair value may fall if market interest rates increase.
If market interest rates were to increase immediately and uniformly by 10% from the levels
prevailing as of March 31, 2001, 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 and Singapore. Although we transact
business in various foreign countries, settlement amounts are usually based on U.S. currency.
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, French franc, deutschmark, guilder, 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, analysis of the direct effects of interest rate and foreign currency
exchange rate fluctuations on the value of certain of our investments and accounts, 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.

10



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PART II OTHER INFORMATION

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, 2001, $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.

11



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

(a) Exhibits.

|        |  |                                                                                                                                       
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
|Number  |  | Description                                                                                                                           
|        |  |                                                                                                                                       
|2.1(1)  |  | Agreement and Plan of Merger dated as of May 20, 2000, by
and among webMethods, Inc., Wolf Acquisition, Inc. and
Active Software, Inc.
|       
|       
|       
|       
|3.1(2)  |  | Fifth Amended and Restated Certificate of Incorporation of
webMethods, Inc., as amended                                               
|       
|       
|       
|       
|3.2(3)  |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                       
|       
|       
|       
|       
|4.1(3)  |  | Specimen certificate for shares of webMethods Common Stock                                                                            
|       
|       
|       
|       
|10.1(3) |  | Second Amended and Restated Investor Rights Agreement                                                                                 
|       
|       
|       
|       
|10.2(4) |  | 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                                             



---

|(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 definitive Proxy Statement
filed with the Securities and Exchange Commission on July 21, 2000
(File No. 001-15681)

(b) Reports on Form 8-K.webMethods, Inc. filed the following report on
Form 8-K since the beginning of its fiscal quarter on April 1, 2001:

|               |  |          |   |               |  |                                                                               
|-------------- |  | -------- | - | ------------- |  | ------------------------------------------------------------------------------
|Date of Report |  | Item No. |   | Item Reported
|               |  |          |   |              
|June 1, 2001   |  |          | 5 |               |  | Announcement of amendment and restatement of
warrant issued to i2 Technologies





---



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, 2001
|                      |  | By:   /s/ PHILLIP MERRICK    
|                      |  | Phillip Merrick              
|                      |  | Chairman of the Board and    
|                      |  | Chief Executive Officer      
|                     
|Date: August 13, 2001
|                      |  | By:   /s/ MARY DRIDI         
|                      |  | Mary Dridi                   
|                      |  | Chief Financial Officer      
|                      |  | (Principal Financial Officer)