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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 SEPTEMBER 30, 2002

OR



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

COMMISSION FILE NUMBER 001-15681

______

WEBMETHODS, INC.

(Exact Name of Registrant as Specified in its Charter)

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

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

______

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

As of November 5, 2002, 51,102,469 shares of the registrants Common
Stock, par value $.01 per share, were issued and outstanding.

1



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

|        |  |                                                                                                                                            
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|Part I  |  | Financial Information                                                                                                                      
|Item 1  |  | Financial Statements                                                                                                                       
|        |  | Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2002 (unaudited) and March 31, 2002  
|        |  | Condensed Consolidated Statements of Operations and Comprehensive
Loss (unaudited) - Three and six months ended September 30, 2002 and 2001
|        |  | Condensed Consolidated Statements of Cash Flows (unaudited) -
Six months ended September 30, 2002 and 2001                                 
|        |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                           
|Item 2  |  | Managements Discussion and Analysis of Financial
Condition and Results of Operations                                                      
|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                 
|Item 4  |  | Controls and Procedures                                                                                                                    
|       
|Part II |  | Other Information                                                                                                                          
|Item 1. |  | Legal Proceedings                                                                                                                          
|Item 2  |  | Changes in Securities and Use of Proceeds                                                                                                  
|Item 6  |  | Exhibits and Reports on Form 8-K                                                                                                           
|        |  | (a) Exhibits                                                                                                                               
|        |  | (b) Reports on Form 8-K                                                                                                                    

2



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PART I
FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

WEBMETHODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |     |         | 
|-------------------------------------------------- | ---------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------------ | -------- | ------------- | ------- | --------- | -------- | --- | ------- | 
|                                                   |                                                                              |                                          |                                            |          | SEPTEMBER 30, |         | MARCH 31,
|                                                   |                                                                              |                                          |                                            |          | 2002          |         | 2002     
|                                                   |                                                                              |                                          |                                            |          | (UNAUDITED)   |         |          
|ASSETS                                             |                                                                              |                                          |                                            |          |               |         |           |         
|Current assets:                                    |                                                                              |                                          |                                            |          |               |         |           |         
|                                                   | Cash and cash equivalents                                                    |                                          | $                                          | 66,933   |               |         | $         | 98,497   |    
|                                                   | Marketable securities available for sale                                     |                                          |                                            | 103,589  |               |         |           | 113,345  |    
|                                                   | Accounts receivable, net of allowance of $3,291 and $3,685                   |                                          |                                            | 41,070   |               |         |           | 46,417   |    
|                                                   | Prepaid expenses and other current assets                                    |                                          |                                            | 9,256    |               |         |           | 7,516    |    
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              |                                          | Total current assets                       |          |               | 220,848 |           |          |     | 265,775 | 
|Marketable securities available for sale           |                                                                              |                                          | 28,219                                     |          |               |         |          |         
|Property and equipment, net                        |                                                                              |                                          | 15,370                                     |          |               |         | 17,181    |         
|Goodwill and acquired intangibles, net             |                                                                              |                                          | 29,838                                     |          |               |         | 29,838    |         
|Other assets                                       |                                                                              |                                          | 9,707                                      |          |               |         | 11,269    |         
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              |                                          | Total assets                               |          | $             | 303,982 |           |          | $   | 324,063 | 
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|LIABILITIES AND STOCKHOLDERS EQUITY               |                                                                              |                                          |                                            |          |               |         |           |         
|Current liabilities:                               |                                                                              |                                          |                                            |          |               |         |           |         
|                                                   | Accounts payable                                                             |                                          | $                                          | 12,633   |               |         | $         | 15,105   |    
|                                                   | Accrued expenses                                                             |                                          |                                            | 13,512   |               |         |           | 16,170   |    
|                                                   | Accrued salaries and commissions                                             |                                          |                                            | 11,367   |               |         |           | 15,594   |    
|                                                   | Deferred revenue                                                             |                                          |                                            | 37,187   |               |         |           | 37,298   |    
|                                                   | Current portion of capital lease obligations                                 |                                          |                                            | 4,595    |               |         |           | 2,699    |    
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              |                                          | Total current liabilities                  |          |               | 79,294  |           |          |     | 86,866  | 
|                                                   | Capital lease obligations, net of current portion and other                  |                                          |                                            | 1,263    |               |         |           | 1,765    |    
|                                                   | Long term deferred revenue                                                   |                                          |                                            | 10,974   |               |         |           | 19,888   |    
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              |                                          | Total liabilities                          |          |               | 91,531  |           |          |     | 108,519 | 
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|Commitments
and contingenciesStockholders equity: |                                                                              |                                          |                                            |          |               |         |           |         
|                                                   | Common stock, $0.01 par value; 500,000,000 shares authorized; 50,883,905 and |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              | 50,477,383 shares issued and outstanding |                                            |          | 509           |         |           |          | 505 |        
|                                                   | Additional paid-in capital                                                   |                                          |                                            | 512,889  |               |         |           | 510,281  |    
|                                                   | Deferred stock compensation and warrant charge                               |                                          |                                            | (12,673  | )             |         |           | (14,875  | )  
|                                                   | Accumulated deficit                                                          |                                          |                                            | (287,867 | )             |         |           | (279,864 | )  
|                                                   | Accumulated other comprehensive loss                                         |                                          |                                            | (407     | )             |         |           | (503     | )  
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              |                                          | Total stockholders equity                 |          |               | 212,451 |           |          |     | 215,544 | 
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    
|                                                   |                                                                              |                                          | Total liabilities and stockholders equity |          | $             | 303,982 |           |          | $   | 324,063 | 
|                                                   |                                                                              |                                          |                                            |          |               |         |           |          |    

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

3



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WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS

(In thousands, except share and per share amounts)

(UNAUDITED)

|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |         |         |        |  
|-------------------------------------------------------------------- | -------------------------------------- | ------------------------ | ------------------------- | --------------------------------------------------------------------------------- | ------ | ------------------ | ---------- | ---------------- | ------- | ------- | ---------- | ------ | ------ | ------ | ---------- | ------ | ------- | ------- | ------ | -
|                                                                     |                                        |                          |                           |                                                                                   |        | THREE MONTHS ENDED |            | SIX MONTHS ENDED
|                                                                     |                                        |                          |                           |                                                                                   |        | SEPTEMBER 30,      |            | SEPTEMBER 30,   
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                 
|                                                                     |                                        |                          |                           |                                                                                   |        | 2002               |            | 2001             |         | 2002    |            | 2001  
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |       
|Revenue:                                                             |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |       
|                                                                     | License                                |                          | $                         | 26,475                                                                            |        |                    | $          | 21,742           |         |         | $          | 55,144 |        |        | $          | 58,546 |        
|                                                                     | Professional services                  |                          |                           | 8,584                                                                             |        |                    |            | 9,401            |         |         |            | 16,786 |        |        |            | 19,092 |        
|                                                                     | Maintenance                            |                          |                           | 11,103                                                                            |        |                    |            | 9,594            |         |         |            | 21,913 |        |        |            | 18,496 |        
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        | Total revenue            |                           |                                                                                   | 46,162 |                    |            |                  | 40,737  |         |            |        | 93,843 |        |            |        | 96,134  |        
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Cost of revenue:                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |       
|                                                                     | License                                |                          |                           | 525                                                                               |        |                    |            | 651              |         |         |            | 660    |        |        |            | 1,352  |        
|                                                                     | Professional services and maintenance: |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        |                          |                           | Stock based compensation                                                          |        |                    | 76         |                  |         |         | 129        |        |        |        | 152        |        |         |         | 321    |  
|                                                                     |                                        |                          |                           | Other professional services and maintenance costs                                 |        |                    | 10,668     |                  |         |         | 9,968      |        |        |        | 20,935     |        |         |         | 22,367 |  
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        | Total cost of revenue    |                           |                                                                                   | 11,269 |                    |            |                  | 10,748  |         |            |        | 21,747 |        |            |        | 24,040  |        
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Gross profit                                                         |                                        |                          | 34,893                    |                                                                                   |        |                    | 29,989     |                  |         |         | 72,096     |        |        |        | 72,094     |       
|Operating expenses:                                                  |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |       
|                                                                     | Sales and marketing:                   |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        |                          |                           | Stock based compensation and warrant charge                                       |        |                    | 983        |                  |         |         | 434        |        |        |        | 1,953      |        |         |         | 1,666  |  
|                                                                     |                                        |                          |                           | Other sales and marketing costs                                                   |        |                    | 22,592     |                  |         |         | 24,109     |        |        |        | 46,902     |        |         |         | 54,309 |  
|                                                                     | Research and development:              |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        |                          |                           | Stock based compensation                                                          |        |                    | 40         |                  |         |         | 6,715      |        |        |        | 59         |        |         |         | 10,205 |  
|                                                                     |                                        |                          |                           | Other research and development costs                                              |        |                    | 11,821     |                  |         |         | 12,110     |        |        |        | 24,100     |        |         |         | 25,409 |  
|                                                                     | General and administrative:            |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        |                          |                           | Stock based compensation                                                          |        |                    | 23         |                  |         |         | 52         |        |        |        | 44         |        |         |         | 139    |  
|                                                                     |                                        |                          |                           | Other general and administrative costs                                            |        |                    | 4,228      |                  |         |         | 4,711      |        |        |        | 8,293      |        |         |         | 10,614 |  
|Restructuring costs                                                  |                                        |                          |                          |                                                                                   |        |                    | 7,243      |                  |         |         |           |        |        |        | 7,243      |       
|Amortization of goodwill and acquired intangibles                    |                                        |                          |                          |                                                                                   |        |                    | 10,516     |                  |         |         |           |        |        |        | 21,025     |       
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        | Total operating expenses |                           |                                                                                   | 39,687 |                    |            |                  | 65,890  |         |            |        | 81,351 |        |            |        | 130,610 |        
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Operating loss                                                       |                                        |                          | (4,794                    | )                                                                                 |        |                    | (35,901    | )                |         |         | (9,255     | )      |        |        | (58,516    | )     
|Interest income, net                                                 |                                        |                          | 913                       |                                                                                   |        |                    | 2,730      |                  |         |         | 2,252      |        |        |        | 5,407      |       
|Impairment of equity investment in private company                   |                                        |                          | (1,000                    | )                                                                                 |        |                    |           |                  |         |         | (1,000     | )      |        |        |           |       
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|                                                                     |                                        | Net loss                 |                           | $                                                                                 | (4,881 | )                  |            | $                | (33,171 | )       |            | $      | (8,003 | )      |            | $      | (53,109 | )      
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Basic and diluted net loss per common share                          |                                        | $                        | (0.10                     | )                                                                                 |        | $                  | (0.67      | )                |         | $       | (0.16      | )      |        | $      | (1.08      | )     
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Shares used in computing basic and diluted
net loss per common share |                                        |                          | 50,845,878                |                                                                                   |        |                    | 49,348,808 |                  |         |         | 50,706,018 |        |        |        | 49,095,663 |       
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Comprehensive loss:                                                  |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |       
|                                                                     |                                        |                          | Net loss                  |                                                                                   | $      | (4,881             | )          |                  | $       | (33,171 | )          |        | $      | (8,003 | )          |        | $       | (53,109 | )     
|                                                                     |                                        |                          | Other comprehensive loss: |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |         |         |       
|                                                                     |                                        |                          |                           | Unrealized
(loss) gain on marketable                                              |        |                    | (260       | )                |         |         | 391        |        |        |        | (230       | )      |         |         | 288    |  
|                                                                     |                                        |                          |                           | securities
available for saleForeign currency
cumulative   translation adjustment |        |                    | (209       | )                |         |         | (215       | )      |        |        | 326        |        |         |         | (169   | )
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        
|Total comprehensive loss                                             |                                        | $                        | (5,350                    | )                                                                                 |        | $                  | (32,995    | )                |         | $       | (7,907     | )      |        | $      | (52,990    | )     
|                                                                     |                                        |                          |                           |                                                                                   |        |                    |            |                  |         |         |            |        |        |        |            |        |        

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

4



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WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)

|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|----------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------- | - | ------------------------------ | ------- | ---- | - | ------- | ------- | -
|                                                                              |                                                                                                               |   | SIX MONTHS ENDED SEPTEMBER 30,
|                                                                              |                                                                                                               |   |                               
|                                                                              |                                                                                                               |   | 2002                           |         | 2001
|                                                                              |                                                                                                               |   |                                |         |     
|Cash flows from operating activities:                                         |                                                                                                               |   |                                |         |      |   |         |        
|                                                                              | Net loss                                                                                                      |   | $                              | (8,003  | )    |   | $       | (53,109 | )
|                                                                              | Adjustments to reconcile net loss to net
cash used in operating activities:                                   |   |                                |         |      |   |         |         |  
|                                                                              | Depreciation and amortization                                                                                 |   |                                | 4,835   |      |   |         | 3,917   |  
|                                                                              | (Recoveries) provision for allowance for
doubtful accounts                                                    |   |                                | (12     | )    |   |         | 2,009   |  
|                                                                              | Loss on disposal of equipment                                                                                 |   |                                |        |      |   |         | 574     |  
|                                                                              | Amortization of deferred stock
compensation related to employee stock
options and non-employee stock warrants |   |                                | 2,208   |      |   |         | 12,331  |  
|                                                                              | Impairment of equity investment in
private company                                                            |   |                                | 1,000   |      |   |         |        |  
|                                                                              | Amortization of goodwill and intangibles                                                                      |   |                                |        |      |   |         | 21,025  |  
|Increase (decrease) in cash resulting from
changes in assets and liabilities: |                                                                                                               |   |                                |         |      |   |         |        
|                                                                              | Accounts receivable                                                                                           |   |                                | 6,549   |      |   |         | 22,676  |  
|                                                                              | Prepaid expenses and other current assets                                                                     |   |                                | (1,604  | )    |   |         | 3,102   |  
|                                                                              | Other non-current assets                                                                                      |   |                                | 807     |      |   |         | (494    | )
|                                                                              | Accounts payable                                                                                              |   |                                | (2,871  | )    |   |         | (540    | )
|                                                                              | Accrued expenses                                                                                              |   |                                | (2,676  | )    |   |         | 3,356   |  
|                                                                              | Accrued salaries and commissions                                                                              |   |                                | (4,627  | )    |   |         | (2,936  | )
|                                                                              | Accrued ESPP                                                                                                  |   |                                | (141    | )    |   |         | (1,621  | )
|                                                                              | Deferred revenue                                                                                              |   |                                | (10,032 | )    |   |         | (7,241  | )
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|Net cash (used in) provided by operating activities                           |                                                                                                               |   | (14,567                        | )       |      |   | 3,049   |        
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|Cash flows from investing activities:                                         |                                                                                                               |   |                                |         |      |   |         |        
|                                                                              | Purchases of property and equipment                                                                           |   |                                | (1,958  | )    |   |         | (3,565  | )
|                                                                              | Net purchases of marketable securities
available for sale                                                     |   |                                | (18,697 | )    |   |         | (17,728 | )
|                                                                              | Sale of investment in private company                                                                         |   |                                |        |      |   |         | 2,000   |  
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|                                                                              | Net cash used in investing activities                                                                         |   |                                | (20,655 | )    |   |         | (19,293 | )
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|Cash flows from financing activities:                                         |                                                                                                               |   |                                |         |      |   |         |        
|                                                                              | Borrowings under leasing agreements                                                                           |   |                                | 2,500   |      |   |         |        |  
|                                                                              | Payments on capital leases                                                                                    |   |                                | (2,070  | )    |   |         | (1,502  | )
|                                                                              | Proceeds from exercise of stock options
and stock issued under the ESPP                                       |   |                                | 2,606   |      |   |         | 6,205   |  
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|Net cash provided by financing activities                                     |                                                                                                               |   | 3,036                          |         |      |   | 4,703   |        
|Effect of exchange rate on cash and cash equivalents                          |                                                                                                               |   | 622                            |         |      |   | (310    | )      
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|Net decrease in cash and cash equivalents                                     |                                                                                                               |   | (31,564                        | )       |      |   | (11,851 | )      
|Cash and cash equivalents at beginning of period                              |                                                                                                               |   | 98,497                         |         |      |   | 109,713 |        
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  
|Cash and cash equivalents at end of period                                    |                                                                                                               | $ | 66,933                         |         |      | $ | 97,862  |        
|                                                                              |                                                                                                               |   |                                |         |      |   |         |         |  

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

5



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

1. BASIS OF PRESENTATION

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

2. RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires that all business combinations initiated after
June 30, 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 will 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 adopted SFAS
No. 142 on April 1, 2002 and, at that time, stopped amortizing goodwill that
resulted from business combinations completed prior to the adoption of SFAS No.
141.

The following table presents the impact of SFAS No. 142 on net loss and
net loss per share had SFAS No. 142 been in effect for the quarter and six months ended
September 30, 2001 and 2002 (in thousands, except share and per share amounts):

|                                          |  |                                  |            |                                |  |      |            |      |  |   |            |   |  |   |            |  
|----------------------------------------- |  | -------------------------------- | ---------- | ------------------------------ |  | ---- | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                          |  | THREE MONTHS ENDED SEPTEMBER 30, |            | SIX MONTHS ENDED SEPTEMBER 30,
|                                          |  | 2002                             |            | 2001                           |  | 2002 |            | 2001
|                                          |  |                                  |            |                                |  |      |            |     
|Net loss                                  |  | $                                | (4,881     | )                              |  | $    | (33,171    | )    |  | $ | (8,003     | ) |  | $ | (53,109    | )
|Adjustments:                              |  |                                  |            |                                |  |      |            |      |  |   |            |   |  |   |            |  
|Amortization of goodwill                  |  |                                  |           |                                |  |      | 10,360     |      |  |   |           |   |  |   | 20,842     |  
|                                          |  |                                  |            |                                |  |      |            |      |  |   |            |   |  |   |            |  
|Adjusted net loss                         |  | $                                | (4,881     | )                              |  | $    | (22,811    | )    |  | $ | (8,003     | ) |  | $ | (32,267    | )
|Weighted average shares-basic and diluted |  |                                  | 50,845,878 |                                |  |      | 49,348,806 |      |  |   | 50,706,018 |   |  |   | 49,095,663 |  
|                                          |  |                                  |            |                                |  |      |            |      |  |   |            |   |  |   |            |  
|Adjusted basic and diluted EPS            |  | $                                | (0.10      | )                              |  | $    | (0.46      | )    |  | $ | (0.16      | ) |  | $ | (0.66      | )
|Reported basic and diluted EPS            |  | $                                | (0.10      | )                              |  | $    | (0.67      | )    |  | $ | (0.16      | ) |  | $ | (1.08      | )

There was no impairment recorded for the quarter and six months ended September 30,
2002.

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

6



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##### 



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

3. IMPAIRMENT OF EQUITY INVESTMENT IN PRIVATE COMPANIES

For the quarter ended
September 30, 2002, the Company recorded an other-than-temporary
decline in value of $1.0 million in one of the equity
investments the Company made in a private company during 2000. After that impairment charge, the Company
had a remaining balance of $1.8 million in equity investments in private companies. There was no impairment of these investments recorded in the quarter
ended September 30, 2001.

4. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Information regarding cash flow is as follows (in thousands):

|                                                       |  |   |                  |   |      |   |       |  | 
|------------------------------------------------------ |  | - | ---------------- | - | ---- | - | ----- |  | 
|                                                       |  |   | SIX MONTHS ENDED
|                                                       |  |   | SEPTEMBER 30,   
|                                                       |  |   |                 
|                                                       |  |   | 2002             |   | 2001
|                                                       |  |   |                  |   |     
|                                                       |  |   |                 
|Cash paid during the period for interest               |  | $ | 353              |   |      | $ | 271   | 
|                                                       |  |   |                  |   |      |   |       | 
|Non-cash investing and financing activities:           |  |   |                  |   |      |   |       | 
|Equipment purchased under capital lease                |  | $ | 900              |   |      | $ | 2,544 | 
|                                                       |  |   |                  |   |      |   |       | 
|Change in net unrealized loss on
marketable securities |  | $ | (230             | ) |      | $ | 288   | 
|                                                       |  |   |                  |   |      |   |       | 

5. SEGMENT INFORMATION

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

|             |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 
|------------ |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|             |  | THREE MONTHS ENDED |        | SIX MONTHS ENDED
|             |  | SEPTEMBER 30,      |        | SEPTEMBER 30,   
|             |  |                    |        |                 
|REVENUES     |  | 2002               |        | 2001             |  | 2002 |        | 2001
|             |  |                    |        |                  |  |      |        |     
|Americas     |  | $                  | 30,441 |                  |  | $    | 29,946 |      |  | $ | 63,265 |  |  | $ | 70,312 | 
|Europe       |  |                    | 7,308  |                  |  |      | 7,007  |      |  |   | 16,538 |  |  |   | 17,817 | 
|Asia Pacific |  |                    | 8,413  |                  |  |      | 3,784  |      |  |   | 14,040 |  |  |   | 8,005  | 
|             |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 
|Total        |  | $                  | 46,162 |                  |  | $    | 40,737 |      |  | $ | 93,843 |  |  | $ | 96,134 | 
|             |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 

|                  |       |      |               |        |           |   |        |        | 
|----------------- | ----- | ---- | ------------- | ------ | --------- | - | ------ | ------ | 
|                  |       |      | AS OF         |        | AS OF    
|                  |       |      | SEPTEMBER 30, |        | MARCH 31,
|LONG LIVED ASSETS |       | 2002 |               | 2002  
|                  |       |      |               |       
|Americas          |       | $    | 79,585        |        |           | $ | 55,360 |       
|Europe            |       |      | 1,950         |        |           |   | 1,555  |       
|Asia Pacific      |       |      | 1,599         |        |           |   | 1,373  |       
|                  |       |      |               |        |           |   |        |       
|                  | Total |      | $             | 83,134 |           |   | $      | 58,288 | 
|                  |       |      |               |        |           |   |        |       

6. RESTRUCTURING CHARGE

During the quarter ended September 30, 2001, the Company recorded a
restructuring charge of $7.2 million, consisting of $2.5 million for headcount
reductions, $4.0 million for consolidations of facilities, and $700,000 of
other related restructuring charges. These restructuring charges were incurred to
align the Companys cost structure with changing market conditions. The
restructuring plan resulted in a headcount reduction of approximately 150
employees or 14% of the workforce. As of September 30, 2002 and March 31,
2002, respectively, $2.2 million and $3.0 million of restructuring charges
remained unpaid. This unpaid portion primarily relates to rent on the excess
facilities and will be paid over the remaining rental periods.

7



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##### 



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

7. TRANSACTION WITH POTENTIAL RELATED PARTY

The Company recorded approximately
$341,000 in royalty expenses for the quarter ended September 30, 2002 with a
third party who shares a common Board member with the Company. In April, 2000, the
Company made an equity investment of approximately $1 million and a $1 million
convertible debt investment in the third party, as a result of which the Company
held, at September 30, 2002, an equity ownership position in the third party of less than 4% on a
fully-diluted basis (excluding conversion of convertible notes).

8. SUBSEQUENT EVENT

In October 2002, the Company reduced its headcount by approximately 35
employees to better align the Companys investments and cost structure
with changing market conditions. In connection with this reduction, the
Company expects to record a restructuring charge in the range of $2.0 million to $2.5 million during the quarter ending December 31, 2003.

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

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

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

OVERVIEW

Background

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

8



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##### 



Overview of Second Quarter of Fiscal 2003

Our total revenue for the
second quarter ended September 30, 2002 was $46.2 million, an
increase of 13% compared to the quarter ended September 30, 2001. This increase in revenue was due primarily to the $4.6 million, or 122%, increase in revenue in the Asia Pacific region for the
quarter. We decreased our net loss to $4.9 million in the quarter ended
September 30, 2002 from $33.2 million from the quarter ended September 30, 2001
primarily due to a reduction in goodwill amortization of $10.5 million
resulting from the adoption of SFAS No. 142 (see Recently Issued Accounting
Pronouncements), a reduction in restructuring charges of $7.2 million, a
reduction of $6.2 million of amortization relating to deferred compensation
costs and a reduction in other operating expenses, as well as a $5.4 million increase
in total revenue.

License revenue increased by approximately $4.7 million, or 22%, to $26.5
million for the quarter ended September 30, 2002 from $21.7 million for the
quarter ended September 30, 2001. The prior years license revenue was
significantly impacted by the economic slow down and the deferral of purchasing
decisions following the tragic events of September 11, 2001. Professional
services revenue decreased by approximately $817,000, or 9%, to $8.6 million
for the quarter ended September 30, 2002 from $9.4 million for the quarter
ended September 30, 2001. This decrease in professional services revenue
resulted from the increase
in system integrator led customer implementations, a decrease in our billable
consultants and, to a lesser extent, an increase in the self-sufficiency of our
customers to do their own implementations. Maintenance revenue increased by
approximately $1.5 million, or 16%, to $11.1 million for the quarter ended
September 30, 2002 from $9.6 million for the quarter ended September 30, 2001.
This increase is due primarily to the increase in customers licensing our
software, and the cumulative effect of agreements for post-contract maintenance
and support, which are recognized as revenue ratably over the term of the
agreement.

We have continued to focus on cost management while continuing to expand
and service our customer base. While our total revenues increased by 13%
during the quarter ended September 30, 2002, as compared to the quarter ended
September 30, 2001, our cost of revenue and operating expenses were lower
in the same period. The increase in revenue and the decrease in costs has resulted in an improvement in operating loss and net loss for the quarter ended September 30, 2002.

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

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

Our focus on customer success and satisfaction has resulted in an
increasing number of referenceable customers, and a substantial portion of our
license revenue in the quarter ended September 30, 2002 came from our existing
customers. We strive to provide the most comprehensive integration platform
available, and will continue to invest as we strive to achieve an advantageous positioning
relative to our competition resulting in recognized industry and technology
leadership and increasing market share.

9



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##### 



During the six months ended September 30, 2002, we began shipping
webMethods Manager and webMethods 6, the next-generation of its comprehensive integration platform. webMethods 6 is a standards-based, massively
scalable integration platform designed to be the foundation for next generation integration suites, and is built on a fully service-oriented architecture
so that customers can leverage integration and Web services more widely and flexibly across their enterprise and assemble solutions that meet their specific
needs. During the quarter ended March 31, 2002, we introduced and began shipping its Workflow product, which provides powerful workflow capabilities enabling non-programmers to model,
prototype and deploy sophisticated human workflows within a business process without any coding.

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

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

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

Allowance for Doubtful Accounts

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

10



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##### 



Valuation of Private Company Equity Investments

We record an investment impairment charge when we believe an investment in
corporate debt securities or in equity securities of private companies has
declined in value and that such a decline is other than temporary. The
determination of the value of the investments is based on information provided
to us from the private companies such as audited financial statements,
valuations based on recent sales of equity, projections, representations by
management, and third party valuations if available. Future adverse changes in
market conditions or poor operating results of the underlying companies could
result in losses or a perceived inability to recover the carrying value of the
investments that may not be reflected in an investments current carrying
value, thereby possibly requiring an impairment charge in the future. As of September 30, 2002, we had a remaining balance of $1.8 million in private company equity
investments.

Goodwill and Indefinite Lived Intangible Assets

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

Foreign Currency Effects

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

Accounting for Income Taxes

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

11



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##### 



RESULTS OF OPERATIONS

The following table summarizes the results of our operations for the three
and six months ended September 30, 2002 compared with the three and six months
ended September 30, 2001 (in thousands):

|                         |  |               |        |               |  |                    |         |               |  |               |     |            |  |   |        |                  |  |   |         |    |  |  |     |   
|------------------------ |  | ------------- | ------ | ------------- |  | ------------------ | ------- | ------------- |  | ------------- | --- | ---------- |  | - | ------ | ---------------- |  | - | ------- | -- |  |  | --- | --
|                         |  |               |        |               |  | Three Months Ended |         |               |  |               |     |            |  |   |        | Six Months Ended |  |   |         |   
|                         |  |               |        |              
|                         |  | September 30, |        | September 30, |  | Percentage         |         | September 30, |  | September 30, |     | Percentage
|                         |  | 2002          |        | 2001          |  | Change             |         | 2002          |  | 2001          |     | Change    
|                         |  |               |        |               |  |                    |         |               |  |               |     |           
|Total revenue            |  | $             | 46,162 |               |  | $                  | 40,737  |               |  |               | 13  | %          |  | $ | 93,843 |                  |  | $ | 96,134  |    |  |  | (2  | )%
|Gross Profit             |  |               | 34,893 |               |  |                    | 29,989  |               |  |               | 16  | %          |  |   | 72,096 |                  |  |   | 72,094  |    |  |  | 0   | % 
|% of total revenue       |  |               | 76     | %             |  |                    | 74      | %             |  |               |     |            |  |   | 77     | %                |  |   | 75      | %  |  |  |     |   
|Total operating expenses |  |               | 39,687 |               |  |                    | 65,890  |               |  |               | (40 | )%         |  |   | 81,351 |                  |  |   | 130,610 |    |  |  | (38 | )%
|% of total revenue       |  |               | 86     | %             |  |                    | 162     | %             |  |               |     |            |  |   | 87     | %                |  |   | 136     | %  |  |  |     |   
|Operating loss           |  |               | (4,794 | )             |  |                    | (35,901 | )             |  |               | (87 | )%         |  |   | (9,255 | )                |  |   | (58,516 | )  |  |  | (84 | )%
|% of total revenue       |  |               | (10    | )%            |  |                    | (88     | )%            |  |               |     |            |  |   | (10    | )%               |  |   | (61     | )% |  |  |     |   
|Net loss                 |  | $             | (4,881 | )             |  | $                  | (33,171 | )             |  |               | (85 | )%         |  | $ | (8,003 | )                |  | $ | (53,109 | )  |  |  | (85 | )%
|% of total revenue       |  |               | (11    | )%            |  |                    | (81     | )%            |  |               |     |            |  |   | (9     | )%               |  |   | (55     | )% |  |  |     |   

Total revenue decreased by approximately $2.3 million, or 2%, to $93.8
million for the six months ended September 30, 2002 from $96.1 million for the
six months ended September 30, 2001. We believe this decrease is due primarily
to the continued global economic weakness and decline in technology spending.
During the quarter ended September 30, 2002, total revenue increased
approximately $5.4 million, or 13%, to $46.1 million from $40.7 million for the
quarter ended September 30, 2001. The increase was principally due to
increased license revenue in the Asia Pacific and Americas regions and
increases in maintenance revenue in all regions offset by decreases in
professional services revenue. License revenue in the quarter ended September
30, 2001 were impacted by the events of September 11, 2001 as well as the
weakness in the global economy.

Our net loss of $8.0 million for the six months ended September 30, 2002
decreased by approximately $45.1 million, or 85%, from the six months ended
September 30, 2001. During the quarter ended September 30, 2002, our net loss
decreased by approximately $28.3 million, or 85%, to $4.9 million from $33.2 million for the
quarter ended September 30, 2001. The decrease in net loss for the quarter
and six months ended September 30, 2002 was primarily due to a reduction in
goodwill amortization, restructuring charges, amortization of deferred compensation costs and operating
expenses.

Revenue

The following table summarizes the Companys revenue for the quarter and
six months ended September 30, 2002 compared with the quarter and six months
ended September 30, 2001 (in thousands):

|                      |  |  |  |  |  |                    |        |               |  |            |        |                  |  |  |    |               |  |               |  |            |  |   |        |  |  |   |        |  |  |  |     |    |  |  |  | 
|--------------------- |  |  |  |  |  | ------------------ | ------ | ------------- |  | ---------- | ------ | ---------------- |  |  | -- | ------------- |  | ------------- |  | ---------- |  | - | ------ |  |  | - | ------ |  |  |  | --- | -- |  |  |  | 
|                      |  |  |  |  |  | Three Months Ended |        |               |  |            |        | Six Months Ended
|                      |  |  |  |  |  |                    |        |               |  |            |        |                 
|                      |  |  |  |  |  | September 30,      |        | September 30, |  | Percentage |        |                  |  |  |    | September 30, |  | September 30, |  | Percentage
|                      |  |  |  |  |  | 2002               |        | 2001          |  | Change     |        |                  |  |  |    | 2002          |  | 2001          |  | Change    
|                      |  |  |  |  |  |                    |        |               |  |            |        |                  |  |  |    |               |  |               |  |           
|License               |  |  |  |  |  | $                  | 26,475 |               |  | $          | 21,742 |                  |  |  | 22 | %             |  |               |  |            |  | $ | 55,144 |  |  | $ | 58,546 |  |  |  | (6  | )%
|Professional
services |  |  |  |  |  |                    | 8,584  |               |  |            | 9,401  |                  |  |  | (9 | )%            |  |               |  |            |  |   | 16,786 |  |  |   | 19,092 |  |  |  | (12 | )%
|Maintenance           |  |  |  |  |  |                    | 11,103 |               |  |            | 9,594  |                  |  |  | 16 | %             |  |               |  |            |  |   | 21,913 |  |  |   | 18,496 |  |  |  | 18  | % 
|                      |  |  |  |  |  |                    |        |               |  |            |        |                  |  |  |    |               |  |               |  |           
|Total revenue         |  |  |  |  |  | $                  | 46,162 |               |  | $          | 40,737 |                  |  |  | 13 | %             |  |               |  |            |  | $ | 93,843 |  |  | $ | 96,134 |  |  |  | (2  | )%

12



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Total revenue decreased by approximately 2% for the six months ended
September 30, 2002 compared to the six months ended September 30, 2001. The
decrease in license and professional services revenue during the six month
period was substantially offset by an increase in maintenance revenue. During
the quarter ended September 30, 2002, total revenue increased 13% compared to
the quarter ended September 30, 2001 due to an increase in license and
maintenance revenue, which was partially offset by a decrease in professional
services revenue. License revenues for the quarter ended September 30, 2001
were negatively impacted by the events of September 11, 2001, while license
revenue for the quarter ended September 30, 2002 was positively affected by
sales of webMethods Workflow and webMethods Manager, which began shipping in
March 2002 and July 2002, respectively.

For the six months ended September 30, 2002, license revenue decreased by
approximately $3.4 million, or 6%, to $55.1 million from $58.5 million for the
six months ended September 30, 2001. This decrease was principally due to the
weakness in the global economy, longer sales cycles and the decline in
technology spending. License revenue increased by approximately $4.8 million,
or 22%, to $26.5 million in the quarter ended September 30, 2002 from $21.7
million in the quarter ended September 30, 2001. License revenue increased in
both The Americas and Asia Pacific and was flat in Europe during the quarter
ended September 30, 2002 as compared to the quarter ended September 30, 2001.
Americas license revenue during the quarter ended September 30, 2001 was
negatively impacted by the deferral in technology spending and the events of
September 11, 2001. Asia Pacific license revenue grew in the quarter ended
September 30, 2002 due to increased acceptance of our software and a large
transaction with a new customer in Japan.

For the six months ended September 30, 2002, professional services revenue
decreased by approximately $2.3 million, or 12%, to $16.8 million from $19.1
million for the six months ended September 30, 2002. Professional services
revenue decreased by approximately $817,000, or 9%, to $8.6 million from $9.4
million for the quarter ended September 30, 2001. This decrease in
professional services revenue was due to the increase in system integrator led customer implementations, and,
to a lesser extent, an increase in the self-sufficiency of existing customers
to expand the deployment of our products.

For the six months ended September 30, 2002, maintenance revenue increased
by approximately $3.4 million, or 18%, to $21.9 million from $18.5 million for
the six months ended September 30, 2001. For the quarter ended September 30, 2002, maintenance revenue increased by
approximately $1.5 million, or 16%, to $11.1 million from $9.6 million for the
quarter ended September 30, 2001. These increases were due primarily to the
increase in customers licensing our software, the renewal of existing
maintenance contracts and the cumulative effect of agreements for post-contract
maintenance and support, which are recognized as revenue ratably over the term
of the agreement.

The following table summarizes the Companys net revenue by geographic region
for the quarter and six months ended September 30, 2002 compared with the
quarter and six months ended September 30, 2001 (in thousands):

|              |  |  |  |  |  |                    |        |               |  |            |        |                  |  |  |     |               |  |               |  |            |  |   |        |  |  |   |        |  |  |  |     |    |  |  |  | 
|------------- |  |  |  |  |  | ------------------ | ------ | ------------- |  | ---------- | ------ | ---------------- |  |  | --- | ------------- |  | ------------- |  | ---------- |  | - | ------ |  |  | - | ------ |  |  |  | --- | -- |  |  |  | 
|              |  |  |  |  |  | Three Months Ended |        |               |  |            |        | Six Months Ended
|              |  |  |  |  |  |                    |        |               |  |            |        |                 
|              |  |  |  |  |  | September 30,      |        | September 30, |  | Percentage |        |                  |  |  |     | September 30, |  | September 30, |  | Percentage
|              |  |  |  |  |  | 2002               |        | 2001          |  | Change     |        |                  |  |  |     | 2002          |  | 2001          |  | Change    
|              |  |  |  |  |  |                    |        |               |  |            |        |                  |  |  |     |               |  |               |  |           
|Americas      |  |  |  |  |  | $                  | 30,441 |               |  | $          | 29,946 |                  |  |  | 2   | %             |  |               |  |            |  | $ | 63,265 |  |  | $ | 70,312 |  |  |  | (10 | )%
|Europe        |  |  |  |  |  |                    | 7,308  |               |  |            | 7,007  |                  |  |  | 4   | %             |  |               |  |            |  |   | 16,538 |  |  |   | 17,817 |  |  |  | (7  | )%
|Asia Pacific  |  |  |  |  |  |                    | 8,413  |               |  |            | 3,784  |                  |  |  | 122 | %             |  |               |  |            |  |   | 14,040 |  |  |   | 8,005  |  |  |  | 75  | % 
|              |  |  |  |  |  |                    |        |               |  |            |        |                  |  |  |     |               |  |               |  |           
|Total Revenue |  |  |  |  |  | $                  | 46,162 |               |  | $          | 40,737 |                  |  |  | 13  | %             |  |               |  |            |  | $ | 93,843 |  |  | $ | 96,134 |  |  |  | (2  | )%

13



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For the six months ended September 30, 2002, revenue from the Americas
decreased by approximately $7.0 million, or 10%, to $63.3 million from $70.3
million for the six months ended September 30, 2001. We believe this decrease
was due primarily to the continued economic slowdown and the decline in
technology spending. For the quarter ended September 30, 2002, revenue from
the Americas increased approximately $495,000, or 2%, to $30.4 million from
$29.9 million for the quarter ended September 30, 2001. Increases in Americas license
and maintenance revenue during the quarter ended September 30, 2002 were offset
by a decline in professional services revenue.

For the quarter and
six month periods ended September 30, 2002, revenue from Europe and
Asia Pacific (international revenue) increased by approximately $4.9 million, or
46%, and approximately $4.8 million, or 18%, to $15.7 million and $30.6 million, respectively, as
compared to the quarter and six month periods ended September 30, 2001.
International revenue accounted for 34% of our total revenue in the quarter
ended September 30, 2002, as compared to 26% in the quarter ended September 30,
2001. The increases in international revenue were principally due to our
increased focus and investments in the Asia Pacific region, an increased
acceptance of our software in this region and larger deals sizes, particularly
in Japan.

Gross Margin

The following table summarizes the Companys gross profit by type of
revenue, excluding stock based compensation, for the quarter and six months
ended September 30, 2002 compared with the quarter and six months ended
September 30, 2001:

|                                             |  |                    |    |                  |  |               |    |               |  |  |    |   |  |  |    |  
|-------------------------------------------- |  | ------------------ | -- | ---------------- |  | ------------- | -- | ------------- |  |  | -- | - |  |  | -- | -
|                                             |  | Three Months Ended |    | Six Months Ended
|                                             |  |                    |    |                 
|                                             |  | September 30,      |    | September 30,    |  | September 30, |    | September 30,
|                                             |  | 2002               |    | 2001             |  | 2002          |    | 2001         
|                                             |  |                    |    |                  |  |               |    |              
|License margin                               |  |                    | 98 | %                |  |               | 97 | %             |  |  | 99 | % |  |  | 98 | %
|Professional services and maintenance margin |  |                    | 46 | %                |  |               | 48 | %             |  |  | 46 | % |  |  | 40 | %
|Gross Margin                                 |  |                    | 76 | %                |  |               | 74 | %             |  |  | 77 | % |  |  | 75 | %

We improved our total gross margin, excluding stock based compensation, to
77% for the six months ended September 30, 2002 from 75% for the six months
ended September 30, 2001. For the quarter ending September 30, 2002, we
improved our total gross margin excluding stock based compensation to 76% from 74% for the quarter ending September 30,
2001.

Our cost of license revenue, excluding stock based compensation, consists
of royalties for products licensed from third parties. Our gross profit on
license revenue, excluding stock based compensation, was 99% and 98% for the
six months ended September 30, 2002 and 2001, respectively. Our gross profit on
license revenue, excluding stock based compensation, was 98% and 97% for the
quarter ended September 30, 2002 and 2001, respectively. These improvements in
license gross profit, excluding stock based compensation, are due primarily to
the end of the amortization period under certain third party OEM contracts.

Our cost of professional services and maintenance, excluding stock based
compensation, consists of costs related to internal professional services and
support personnel, and subcontractors hired to provide implementation and
support services. Our gross margin on maintenance and services, excluding stock
based compensation, was 46% and 40%, respectively, for the six months ended
September 2002 and 2001 and 46% and 48%, respectively, for the quarters ended
September 30, 2002 and 2001. The six month improvement in these margins is due
primarily to lower costs of professional services due to a decrease in our number of professional services personnel. The quarterly decline in these margins for
the period ended September 30, 2002 primarily reflects the increased use of
subcontractors for implementation and customer support projects.

14



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Operating Expenses

The following table presents certain information regarding the Companys
operating expenses during the quarter and six months ended September 30, 2002
compared with the quarter and six months ended September 30, 2001 (in
thousands):

|                                          |  |                    |        |                  |  |            |        |               |  |               |      |            |  |   |        |   |  |   |         |   |  |  |      |   
|----------------------------------------- |  | ------------------ | ------ | ---------------- |  | ---------- | ------ | ------------- |  | ------------- | ---- | ---------- |  | - | ------ | - |  | - | ------- | - |  |  | ---- | --
|                                          |  | Three Months Ended |        | Six Months Ended
|                                          |  |                    |        |                 
|                                          |  | September 30,      |        | September 30,    |  | Percentage |        | September 30, |  | September 30, |      | Percentage
|                                          |  | 2002               |        | 2002             |  | Change     |        | 2002          |  | 2001          |      | Change    
|                                          |  |                    |        |                  |  |            |        |               |  |               |      |           
|Operating Expenses:                       |  |                    |        |                  |  |            |        |               |  |               |      |            |  |   |        |   |  |   |         |   |  |  |      |   
|Sales and Marketing*                      |  | $                  | 22,592 |                  |  | $          | 24,109 |               |  |               | (6   | )%         |  | $ | 46,902 |   |  | $ | 54,309  |   |  |  | (14  | )%
|% of Total Revenue                        |  |                    | 49     | %                |  |            | 59     | %             |  |               |      |            |  |   | 50     | % |  |   | 56      | % |  |  |      |   
|Research and Development*                 |  |                    | 11,821 |                  |  |            | 12,110 |               |  |               | (2   | )%         |  |   | 24,100 |   |  |   | 25,409  |   |  |  | (5   | )%
|% Total Revenue                           |  |                    | 26     | %                |  |            | 30     | %             |  |               |      |            |  |   | 26     | % |  |   | 26      | % |  |  |      |   
|General and Administrative*               |  |                    | 4,228  |                  |  |            | 4,711  |               |  |               | (10  | )%         |  |   | 8,293  |   |  |   | 10,614  |   |  |  | (22  | )%
|% of Total Revenue                        |  |                    | 9      | %                |  |            | 12     | %             |  |               |      |            |  |   | 9      | % |  |   | 11      | % |  |  |      |   
|Stock Based Compensation                  |  |                    | 1,046  |                  |  |            | 7,201  |               |  |               | (85  | )%         |  |   | 2,056  |   |  |   | 12,010  |   |  |  | (83  | )%
|% of Total Revenue                        |  |                    | 2      | %                |  |            | 18     | %             |  |               |      |            |  |   | 2      | % |  |   | 12      | % |  |  |      |   
|Restructuring costs                       |  |                    |       |                  |  |            | 7,243  |               |  |               | (100 | )%         |  |   |       |   |  |   | 7,243   |   |  |  | (100 | )%
|% of Total Revenue                        |  |                    | 0      | %                |  |            | 18     | %             |  |               |      |            |  |   | 0      | % |  |   | 8       | % |  |  |      |   
|Amoritization of Goodwill and
Intangibles |  |                    |       |                  |  |            | 10,516 |               |  |               | (100 | )%         |  |   |       |   |  |   | 21,025  |   |  |  | (100 | )%
|% of Total Revenue                        |  |                    | 0      | %                |  |            | 26     | %             |  |               |      |            |  |   | 0      | % |  |   | 22      | % |  |  |      |   
|Operating Expenses:                       |  | $                  | 39,687 |                  |  | $          | 65,890 |               |  |               | 40   | %          |  | $ | 81,351 |   |  | $ | 130,610 |   |  |  | (38  | )%
|% of Total Revenue                        |  |                    | 86     | %                |  |            | 162    | %             |  |               |      |            |  |   | 87     | % |  |   | 136     | % |  |  |      |   



---

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

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

In July 2001, we took decisive actions to reduce our operating expenses to
realign our cost structure to address the changing market conditions caused by
the slowing of the global economy and technology spending. As part of this
action, we reduced our headcount by 14% or 150 employees through a reduction in
force, closed excess sales offices and consolidated our California facilities
into two locations. The headcount reductions were across all departments with
the exception of customer support. Since the restructuring, we have reduced our
quarterly operating expenses, excluding stock based compensation and warrant
charge, and amortization of goodwill and intangibles, by approximately 22% from
$49.4 million in the quarter ended June 30, 2001, to $38.6 million in the
quarter ended September 30, 2002.

15



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Sales and marketing expenses, excluding stock based compensation and
warrant charge, decreased by approximately $7.4 million, or 14% to $46.9
million for the six months ended September 30, 2002 from $54.3 for the six
months ended September 30, 2001 and represented 50% and 56% of total revenue,
respectively. This decrease was primarily due to sales and marketing headcount
reductions which were done in July of 2001. During the quarter ended
September 30, 2002, sales and marketing expense, excluding stock based
compensation and warrant charge, decreased $1.5 million, or 6% to $22.6 million
from $24.1 million for the quarter ended September 30, 2001 and represented 49%
and 59% of total revenue respectively. This decrease was primarily due to
additional sales and marketing headcount reductions, a reduction in sales assistance fees, a decrease in recruiting fees, and a decrease in
marketing trade show activity in the quarter ended September 30, 2002.

Research and development expenses, excluding stock based compensation,
decreased by approximately $1.3 million, or 5% to $24.1 million for the six
months ended September 30, 2002 from $25.4 million for the six months ended September
30, 2001 and each represented 26% of total revenue. This decrease
is primarily due to reduced headcount associated with the July 2001
restructuring. During the quarter ended September 30, 2002, research and
development expenses, excluding stock based compensation, decreased approximately $289,000,
or 2% to $11.8 million from $12.1 million for the quarter ended September 30,
2001 and represented 26% and 30% of total revenues, respectively. This
decrease was primarily due to decreases in compensation and benefits expense, travel expense, and contractor expenses.

General and administrative expenses, excluding stock based compensation,
decreased by approximately $2.3 million, or 22% to $8.3 million for the six
months ended September 30, 2002 from $10.6 million for the six months ended September
30, 2001 and represented 9% and 11% of total revenue, respectively. This
decrease was primarily due to reduced headcount associated with the July
2001 restructuring. During the quarter ended September 30, 2002, general and
administrative expenses, excluding stock based compensation, decreased approximately
$483,000, or 10% to $4.2 million from $4.7 million for the quarter ended
September 30, 2001 and represented 9% and 12% of total revenue respectively.
This decrease was primarily attributable to a decrease in provision for
allowance for doubtful accounts and to a lesser degree, decreases in external
legal and other professional fees.

Stock based compensation and warrant charge were $2.2 million and $12.3
million during the six months ended September 30, 2002 and 2001, respectively,
of which $152,000 and $321,000, respectively, was included in cost of sales.
During the quarters ended September 30, 2002 and 2001, stock based
compensation and warrant charge were $1.1 million and $7.3 million,
respectively, of which $76,000 and $129,000 was included in cost of sales.
Deferred stock based compensation and warrant charge were recorded for the
following transactions:

(i)  In connection with the grant of stock options to employees and non-employee
directors during the quarters ended June 30, 2000 and 1999, we recorded
aggregate unearned compensation of $15.5 million, representing the difference
between the deemed fair value of our common stock at the date of grant and the
exercise price of such options.

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

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

16



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

We recorded goodwill and intangible assets in connection with the
acquisition of Premier and Translink in fiscal 2001 and Alier in fiscal 2000.
The estimated useful life of the goodwill and the acquired intangibles during
the quarter ended September 30, 2001 was three years for trained and acquired
assembled workforce, one year for license agreements, two years for non-compete
agreements, three years for goodwill and four years for favorable lease terms.
We recorded $10.5 million of amortization of goodwill and acquired intangibles
in the quarter ended September 30, 2001. Amortization of the goodwill and
acquired intangibles ceased on April 1, 2002 upon our adoption of SFAS No. 142
(see Recently Issued Accounting Pronouncements for more information).

Interest income, net

Net interest income decreased by approximately $3.1 million, or 58%, to $2.3
million for the six months ended September 30, 2002 from $5.4 million for the
six months ended September 30, 2001. During the quarter ended September 30,
2002, net interest income decreased $1.8 million, or 67%, to $913,000 from $2.7
million for the quarter ended September 30, 2001. These decreases were primarily
attributable to lower interest rates on corporate paper, bonds and money market
funds in the respective period of fiscal 2003, compared to those in the same
period in the prior year.

Income taxes

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

LIQUIDITY AND CAPITAL RESOURCES

The following table presents selected financial statistics and information
for the six month periods ended September 30, 2002 and 2001:

|                                                                |  |   |                |  |               |   |         |  | 
|--------------------------------------------------------------- |  | - | -------------- |  | ------------- | - | ------- |  | 
|                                                                |  |   | September 30,  |  | September 30,
|                                                                |  |   | 2002           |  | 2001         
|                                                                |  |   |                |  |              
|                                                                |  |   | (in thousands)
|Cash, marketable
securities and long term
marketable securities |  | $ | 198,741        |  |               | $ | 212,555 | 
|Working capital                                                 |  | $ | 141,554        |  |               | $ | 138,445 | 

Historically we have financed our operations and met our capital
requirements though the sales of equity securities. Our liquidity and financial
position at September 30, 2002, showed a 6% decrease in our cash and
investments and a 2% increase in our working capital from our positions at
September 30, 2001. The increase in working capital is primarily due to an
increase in accounts receivable and prepaid expenses at September 30, 2002, as
compared to September 30, 2001.

Net cash used in operating activities was $14.6 million during the six
months ended September 30, 2002, and approximately $3.0 million was provided by
operating activities during the six months ended September 30, 2001. The
increase in net cash used in operating activities from 2001 to 2002 was due
primarily to larger decreases in our deferred revenue, accounts payable and
accrued salaries and commissions for the six months ended September 30, 2002
compared to decreases in the six months ended September 30, 2001.

Net cash used in investing activities during the six months ended
September 30, 2002 and 2001, was $20.7 million and $19.3 million, respectively.
This was primarily due to the purchase of marketable securities and, to a
lesser extent, to the purchase of property and equipment. Capital expenditures
were $2.0 million and $3.6 million during the six months ended September 30,
2002 and 2001, respectively. Capital expenditures consisted of purchases of operating resources to manage
operations, including computer hardware and software, office furniture and
equipment and leasehold improvements.

17



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##### 



We generally fund capital expenditures
either through capital leases or the use of working capital. Net cash used in
investing activities was offset by the sale of an investment in a private company
during the six months ended September 30, 2001.

Net cash provided by financing activities was $3.0 million and $4.7
million during the six months ended September 30, 2002 and 2001, respectively.
These cash flows primarily reflect net cash proceeds from exercises of stock
option and employee stock purchase plan purchases during the respective periods
and borrowings under lease agreements during the six months ended September 30,
2002.

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

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

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

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

We believe that quarter-to-quarter or year-to-year comparisons of our
financial results are not necessarily meaningful indicators of our future
revenue or operating results and should not be relied on as an indication of
our future performance. If our quarterly or annual revenue or operating results
fail to meet the expectations of investors or analysts, the market price of
webMethods stock could be negatively affected. Our quarterly operating results
have varied substantially in the past and may vary substantially in the future
depending upon a number of factors, including the changes in demand for our
products and services, economic conditions, competitive pressures, amount and
timing of operating costs and changes that we may make in our business,
operations and infrastructure. In addition, uncertainties and economic
after-effects of terrorist acts or other major, unanticipated events may impact
our quarterly operating results. In our fiscal 2002 and the first two quarter
of fiscal year 2003, we closed a substantial number of license transactions in
the last month of each quarter, which makes it more difficult to gauge the
level of license revenue we will have in any quarter until near to, or after,
its conclusion. We expect to continue devoting resources to our sales and
marketing operations and our research and development activities. Our operating
expenses, which include sales and marketing, research and development and
general and administrative expenses, are based on our expectations of future
revenue and are relatively fixed in the short term. If revenue falls below our
expectations in a quarter and we are not able to quickly reduce our spending in
response, our operating results for that quarter could be significantly below
the expectations of investors or analysts. It is possible that our revenue or
operating results in the future may be below the expectations of investors or
analysts and, as a result, the market price of webMethods stock may fall. In
addition, the stock market, particularly the stock prices of independent
infrastructure software companies, has been very volatile. This volatility is
often not related to the operating performance of the companies. From our
initial public offering in February 2000 until November 1, 2002, the closing
price of webMethods stock on NASDAQ has ranged from a high of $336.25 to a low
of $4.25.

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

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

18



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##### 



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

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

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

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

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

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

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

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

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

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

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

We cannot be certain that our software and the services do not infringe
issued patents, copyrights or other intellectual property rights of third
parties. Litigation regarding intellectual property rights is common in the
software industry, and we may be increasingly subject to legal proceedings and
claims from time to time, including claims of alleged infringement of
intellectual property rights of third parties by us or our licensees concerning
their use of our software products and integration technologies and services.
Although we believe that our intellectual property rights are sufficient to allow us to
market our software without

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incurring liability to third parties, third parties
may bring claims of infringement against us. Such claims may be with or without
merit. Claims of alleged infringement may have a material adverse effect on our
business and may discourage potential customers from doing business with us on
acceptable terms, if at all. Litigation to defend against claims of
infringement or contests of validity could be very time-consuming and could
result in substantial costs and diversion of resources, including our
managements attention to our business. Furthermore, a party making such a
claim could secure a judgment that requires us to pay substantial damages. A
judgment could also include an injunction or other court order that could
prevent us from selling our software. Our business, operating results and
financial condition could be harmed significantly if any of these events
occurred, and the price of webMethods common stock could be adversely affected.
Furthermore, former employers of our current and future employees may assert
that our employees have improperly disclosed confidential or proprietary
information to us. In addition, we have agreed, and may agree in the future, to
indemnify certain of our customers against claims that our software infringes
upon the intellectual property rights of others. We could incur substantial
costs in defending ourself and our customers against infringement claims. In
the event of a claim of infringement, we, as well as our customers, may be
required to obtain one or more licenses from third parties, which may not be
available on acceptable terms, if at all. Defense of any lawsuit or failure to
obtain any such required licenses could harm our business, operating results
and financial condition and the price of webMethods common stock.

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

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

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

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

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

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

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

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

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

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

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

We need to maintain and further develop our direct and indirect sales and
distribution efforts, both domestically and internationally, in order to
increase market awareness and sales of our software and the

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

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

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

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

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

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

Our software is integrated with our customers networks and software
applications and is often used for mission critical applications. Errors,
defects or other performance problems could result in financial or other damages to our customers. Customers could seek damages for losses from
us, which, if successful, could have a material adverse effect on our business,
operating results or financial condition. In addition, the failure of our
software to perform to customer expectations could give rise to warranty
claims. Although our license agreements typically contain provisions designed
to limit our exposure to product liability claims, existing or future laws or
unfavorable judicial decisions could negate these limitation of

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liability provisions. We have not experienced any product liability claims to date.
However, a product liability claim brought against us, even if not successful,
could be time consuming and costly to defend and could harm our reputation. In
addition, although we carry general liability insurance, our current insurance
coverage would likely be insufficient to protect us from all liability that may
be imposed under these types of claims.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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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 we acquire goodwill subsequent to
June 30, 2001 it will not be amortized. We adopted SFAS No. 142 on April
1, 2002 and, at that time, stopped amortizing goodwill that resulted from
business combinations completed prior to the adoption of SFAS No. 141.
See note 2 to the financial statements (recent accounting pronouncements) for the
impact of these standards.

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

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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

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

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ITEM 4. CONTROLS AND PROCEDURES

Within 90 days prior to the filing of this report, the Companys management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures are effective in ensuring
that all material information required to be filed in this quarterly report on
Form 10-Q has been made known to them in a timely fashion. There have been no
significant changes in internal controls, or in factors that could
significantly affect internal controls, subsequent to the date the Chief
Executive Officer and Chief Financial Officer completed their evaluation.

PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On November 30, 2001, a purported class action lawsuit was filed in the
Southern District of New York naming webMethods, Inc., several of its executive
officers at the time of our initial public offering and the managing
underwriters of our initial public offering as defendants. The complaint, as
amended, alleges that webMethods initial public offering registration
statement and final prospectus contained material misrepresentations and
omissions related in part to certain commissions allegedly solicited and
received by the underwriters, and tie-in arrangements allegedly demanded by the
underwriters, in connection with their allocation of shares in our initial
public offering. The complaint seeks unspecified damages on behalf of a
purported class of purchasers of common stock between February 10, 2000 and
December 6, 2000. This case is at an early stage and has been consolidated with
similar actions; the defendant issuers have moved to dismiss part or all of the
complaints. Management believes that the claims against webMethods and its
officers are without merit, and we intend to defend against the complaint
vigorously.

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

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

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

27



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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                                                                            
|4.2(4)  |  | Rights Agreement dated as of October 18, 2001 between
webMethods, Inc. and American Stock Transfer & Trust
Company.                   
|10.1(3) |  | Second Amended and Restated Investor Rights Agreement                                                                                 
|10.2(5) |  | webMethods, Inc. Amended and Restated Stock Option Plan                                                                               
|10.3(3) |  | Employee Stock Purchase Plan                                                                                                          
|10.4(3) |  | Indemnification Agreement entered into between
webMethods, Inc. and each of its directors and executive
officers                      
|99.1*   |  | Certification of Chief Executive Officer                                                                                              
|99.2*   |  | Certification of Chief Financial Officer                                                                                              



---

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


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

28



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##### 



SIGNATURES

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

|                        |  |                              
|----------------------- |  | -----------------------------
|                        |  | WEBMETHODS, INC              
|                        |  |                              
|Date: November 12, 2002 |  | By: /s/ PHILLIP MERRICK      
|                        |  |                              
|                        |  | Phillip Merrick              
|                        |  | Chairman of the Board and    
|                        |  | Chief Executive Officer      
|                        |  |                              
|Date: November 12, 2002 |  | By: /s/ MARY DRIDI           
|                        |  |                              
|                        |  | Mary Dridi                   
|                        |  | Chief Financial Officer      
|                        |  | (Principal Financial Officer)

29



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##### 



CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002

I, Phillip Merrick, the Chairman and Chief Executive Officer of webMethods,
Inc., have executed this certification in connection with the filing with the
Securities and Exchange Commission of the Companys Quarterly Report on Form
10-Q for the period ending September 30, 2002. I hereby certify that:

1.     I have reviewed this quarterly report on Form 10-Q of webMethods, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
issuer as of, and for, the periods presented in this quarterly report;

4.     The issuers other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the issuer, and we have:



| | (a) |  | designed such disclosure controls and procedures to ensure
that material information relating to the issuer, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | evaluated the effectiveness of the issuers disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the Evaluation Date); and                                                                                                  
|
| | (c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                    

5.     The issuers other certifying officer and I have disclosed, based on our
most recent evaluation, to the issuers auditors and the audit committee of the
issuers board of directors (or persons fulfilling the equivalent function):



| | (a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the issuers ability
to record, process, summarize and report financial data and have
identified for the issuers auditors any material weaknesses in
internal controls; and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | any fraud, whether or not material, that involves management
or other employees who have a significant role in the issuers
internal controls; and                                                                                                                                    

6.     The issuers other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

|                        |  |  |  |                                              
|----------------------- |  |  |  | ---------------------------------------------
|Date: November 12, 2002 |  |  |  | /s/ PHILLIP MERRICK                          
|                        |  |  | 
|                        |  |  |  | Name: Phillip Merrick                        
|                        |  |  |  | Title:   Chairman and Chief Executive Officer

30



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##### 



CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002

I, Mary Dridi, the Executive Vice President and Chief Financial Officer of
webMethods, Inc., have executed this certification in connection with the
filing with the Securities and Exchange Commission of the Companys Quarterly
Report on Form 10-Q for the period ending September 30, 2002. I hereby certify
that:

1.     I have reviewed this quarterly report on Form 10-Q of webMethods, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
issuer as of, and for, the periods presented in this quarterly report;

4.     The issuers other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the issuer, and we have:



| | (a) |  | designed such disclosure controls and procedures to ensure
that material information relating to the issuer, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | evaluated the effectiveness of the issuers disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the Evaluation Date); and                                                                                                  
|
| | (c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                    

5.     The issuers other certifying officer and I have disclosed, based on our
most recent evaluation, to the issuers auditors and the audit committee of the
issuers board of directors (or persons fulfilling the equivalent function):



| | (a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the issuers ability
to record, process, summarize and report financial data and have
identified for the issuers auditors any material weaknesses in
internal controls; and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | any fraud, whether or not material, that involves management
or other employees who have a significant role in the issuers
internal controls; and                                                                                                                                    

7.     The issuers other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

|                        |  |  |  |                                      
|----------------------- |  |  |  | -------------------------------------
|Date: November 12, 2002 |  |  |  | /s/ MARY DRIDI                       
|                        |  |  | 
|                        |  |  |  | Name:  Mary Dridi                    
|                        |  |  |  | Title:    Chief Financial Officer and
|                        |  |  |  | Executive Vice President             

31